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Why Employment Is Not the Key to Economic Growth

In December 2021, the US unemployment rate fell to 3.9 percent from 4.2 percent in the month before. The number of unemployed individuals fell by 500,000 to 6.3 million. Many commentators have expressed satisfaction with the decline in unemployment. According to commentators, the fall in unemployment is indicative of a strong economy.

For most economists the key to economic growth is a strengthening in the labor market. This way of thinking is based on the view that because of the reduction in the number of unemployed, more individuals can afford to increase their expenditure. As a result, economic growth is likely to follow suit. This is based on the view that an increase in demand is going to trigger an increase in supply.

Expanding Savings Are the Key to Economic Growth 

The key driver of economic growth is an expanding pool of savings and not the state of the labor market as such. Fixing unemployment without addressing the issue of savings is not going to increase economic growth. According to Ludwig von Mises,

The sine qua non of any lengthening of the process of production adopted is saving, i.e., an excess of current production over current consumption. Saving is the first step on the way toward improvement of material well-being and toward every further progress on this way.

It is the pool of savings that funds the enhancement and expansion of the infrastructure. An enhanced and expanded infrastructure permits an increase in the production of the final goods and services required to maintain and promote individuals’ lives and well-being.

Now, if employment were the driving factor of economic growth, then it would make a lot of sense to eliminate unemployment as soon as possible by generating all sorts of employment programs.

For instance, policy makers could follow the advice of John Maynard Keynes and employ individuals in digging ditches or various other government-sponsored activities. Note that the aim here is just to employ as many individuals as possible.

Since government is not a wealth-generating entity, in order to fund the employment programs it would have to divert wealth from the wealth generators to the various individuals that are going to be employed in government employment programs. As a rule, this wealth diversion will occur either by means of various taxes and levies or by means of monetary pumping.

A policy of wealth diversion leads to the depletion of the pool of savings. Employing individuals in various non-wealth-generating activities that require wealth transfers from wealth-generating activities undermines wealth generators. This in turn weakens the process of wealth generation and in turn undermines prospects for real economic growth.

Unhampered Labor Markets and Unemployment

Unemployment as such can be fixed relatively easily by freeing the labor market from tampering by the government. In an unhampered labor market, any individual that wants to work will be able to find a job at the going wage for his particular skills.

Obviously, if an individual demands a non-market-related salary and is not prepared to move to other locations, there is no guarantee that he will find a job. For instance, if the market wage for John the baker is $80,000 per year, yet he insists on a salary of $500,000, obviously he is likely to be unemployed.

Over time, a free labor market makes sure that every individual earns in accordance with the value of the product he generated. Any deviation from the value of his contribution sets in motion corrective competitive forces.

Ultimately, what matters for the well-being of individuals is not that they are employed as such, but their purchasing power in terms of the goods and services that they earn.

Individuals’ earning power, all other things being equal, is conditioned upon the infrastructure that they operate. The better the infrastructure, the more output an individual can generate. A higher output means that a worker can command higher wages. 

Monetary pumping by the central bank that is supposedly aimed at helping workers improve their living standards achieves the exact opposite. Loose monetary policy undermines the pool of savings.

This in turn weakens the wealth generators’ ability to enhance and improve the infrastructure. As a result, workers’ productivity comes under pressure and their ability to command higher wages weakens.

Additionally, loose monetary policy after a time lag lifts the prices of goods and services, thereby eroding the purchasing power of workers’ earnings.

Do Wage Increases Increase the Prices of Goods?

Some economists are of the view that the currently observed acceleration in the momentum of the Consumer Price Index (CPI) is in response to the increase in the momentum of individuals’ wages. The yearly growth rate of the CPI jumped to 7 percent in December 2021 from 1.4 percent in December 2020.

These commentators hold that in order to lower the CPI’s momentum it is necessary to lower wages’ growth rate to around 4 percent.1 Note that the yearly growth rate of wages stood at 8.9 percent in November 2021, against 3.4 percent in November 2020. 

A visible correlation between the yearly growth rate in the CPI and the yearly growth rate in wages lagged by four months seems to support the view that wages are an important driver of CPI momentum (see chart). But statistical correlations can only describe, not explain. To explain, we have to establish the definition of what prices and wages are all about.

Observe that the price of a good and the price of labor is the amount of money paid per unit of a good and per hour of work. All other things being equal, an increase in money supply means that individuals can now spend more money on goods and labor services. This means an increase in the prices of goods and an increase in wages.

Hence, to set the foundation for low price inflation what is required is not to lower workers’ wages, but for the Fed to reverse its loose monetary policy. Note that the yearly growth rate of the Austrian money supply measure for the US climbed to 79 percent in February 2021 from 4.8 percent in January 2020.

Is Fixing Unemployment Cost-Free?

Once an economy falls into a recession and the unemployment rate starts to rise, most commentators are of the view that it is the duty of the government and the central bank to step in to counter it. Some commentators are of the view that the lowering of unemployment is going to be cost-free given that the unemployed individuals are idle.

According to Paul Krugman,

If you put 100,000 Americans to work right now digging ditches, it is not as if you are taking those 100,000 workers away from other good things they might be doing. You are putting them to work when they would have been doing nothing.2

But how is the lowering of unemployment going to be funded? Who is going to pay for this? It seems that Krugman and other commentators are of the view that funding can be easily generated by the central bank by means of printing presses.

Again, contrary to Krugman and other commentators, funding is not about money as such, but about savings, which is the amount of consumer goods produced less the consumption of these goods by their owners.

Observe that in order to maintain their lives and well-being people require final consumer goods and services, not money as such. Money only helps to facilitate trade among producers—it does not generate any real stuff.

Contrary to Krugman and other commentators, the artificial generation of employment such as digging ditches is not going to be cost-free. Various individuals employed in non-wealth-generating projects must be sustained (i.e., funded). Since government does not produce any wealth, obviously, it cannot save and therefore it cannot fund any activity.

Hence, for the government to engage in these activities, it must divert funding (i.e., savings) from wealth generators. This, however, weakens the process of wealth generation.

Conclusion

A reduction in unemployment is not the key factor for economic growth. The heart of economic growth is the expanding pool of savings. It is savings that are instrumental in the expansion and the enhancement of the production structure. With an expanded and enhanced production structure, stronger economic growth can be secured.

Contrary to some commentators, the government policies of lowering unemployment are not cost-free. The various government projects that are aimed at artificially boosting employment divert savings from wealth generators toward various government programs. In the process, this undermines wealth generators’ ability to grow the economy.

Also, contrary to popular thinking. it is not wages that drive price inflation, but the Fed’s loose monetary policy. Hence, what is required to arrest the acceleration in price inflation is for the Fed to arrest its loose monetary policy.

1. On CNBC on January 25, 2022, a Goldman economist said it’s tough to sustain wage gains of 5 percent to 6 percent without “meaningfully high” inflation. 2. Paul Krugman, interview by CNBC, CNBC, August 31, 2010.