Unemployment: Too much Regulation or Lack of Demand?

On the day after the presentation of the governing Coalition’s budget in the United Kingdom (24 March), an “expert” form the Adam Smith Foundation was quoted in The Guardian asserting that if every small business were to hire only one new employee the UK would have no one without a job. He went on to assert that what prevented this happy outcome were government regulations.

This assertion is so simplistically absurd that I was tempted to dismiss it with the contempt it deserves: no explanation of which are the offending regulations; no explanation of why small business should be specified rather than all business; and no hint of potential constraints set by product demand. As I have thought further, I realize that assertion is widely believed, and not just by those on the political right.

The intellectually respectable statement of this view is that labor market “rigidities” represent a constraint on employment growth, and many of these rigidities result from the laws governing employment. In the United States where much legal protection of employees has been removed over the last four decades, there is less stress on public regulation than in Europe. This lack of protection is captured in a bit of black humor: “in the United States your employer cannot fire you for being a woman, gay, or in an ethnic minority; your employer can just fire you”.

In the United States the emphasis is more frequently on rigidities caused by trade unions, weak though these are. This anti-union motivation can be seen in the recent legislation in Ohio and Wisconsin denying public employees the right to organize. The reason this right has not been denied at the state level for private employees is its guarantee by federal legislation (The Wagner Act 1935). This association of market rigidities is frequently encountered in Western Europe, as well.

Given the frequency with which it is repeated, the regulation-causes-unemployment hypothesis must be considered seriously. We can dismiss the reference to small business, because even if the anti-regulation hypothesis is accepted, there is no rationale for discriminating by size of employer. In a market economy firms are expected to compete on equal footing. Having fewer or different rules for small business is a discriminatory subsidy. If a firm cannot compete without the subsidy, it should close. This is the point of so-called market forces.

If the regulation hypothesis is true, it must be the case that in the absence of the regulation, demand by consumers or producers would exist for the product that the increased employment would generate. In other words, removing one or more regulations must simultaneously stimulate business to hire more people and simulate households and/or other firms to spend more (increase demand).

First, I consider why reducing regulation in-and-of-itself might simulate business to hire more workers. One presumes that the argument is that removing the regulation[s] would reduce employment costs. For example, the UK chancellor claimed on Tuesday that the regulations he would scrap would reduce business costs by about £350 million. With about 23 million people in private employment, this implies a fall in annual cost per employee of twelve pounds a year (one pound a month), which is not very impressive. None the less, let’s accept that fewer regulations would inspire private firms to hire more people. This allows me to move on to the second part of the hypothesis: demand.

The increased demand for the increased output generated by the increased employment will not come from the wages paid to those new employees. The fallacy is obvious: the market value of the new products must be far greater than the wage payments they embody. Nor can the increased demand come from a fall in the prices of products (less regulation >> lower wage costs >> competition >> lower prices). A fall in product prices would cancel the gain to business of the lower employment costs.

As any mainstream economist knows, on the right, left or center, there is only one mechanism by which reducing regulation would simultaneously stimulate employment and create the demand to sustain that employment. This mechanism has the arcane name of Walrasian General Equilibrium Adjustment. In non-technical terms, a reduction in so-called labor market rigidities will lead to greater employment only if the natural state of the economy is full employment. In other words, the anti-regulation hypothesis sets itself a simple task, indeed: on the basis of no evidence it assumes market economies would be at full employment in the absence of public regulations, then recommends eliminating public regulations to achieve full employment.

During the past 150 years, legislation governing work and employment has been introduced in most countries: to protection of the health of employees; to prevent of discrimination in hiring and promotion; to guarantee against intimidation; and to ensure the right to organize and petition for redress of grievances. Almost without exception, private employers (and too frequently public employers) have opposed these measures. In the twentieth century the argument that capital by virtue of ownership alone has the unilateral right to determine wages and conditions of employment could no longer be maintained because of its obviously self-serving vulgarness. In its place we are offered faux-economic arguments to the same end: deny employees their rights and more will be employed.

The progressive answer to that brutal syllogism is clear: grant employees their rights and use the macroeconomic tools of the public sector to generate the demand that will sustain the full employment that a market economy cannot create on its own.

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