BEE Partner, South Africa Economy Watch

In this section we focus on inflation control and show that the Job Guarantee, able to simultaneously generate full employment and price stability, is superior to the current NAIRU approach, which uses unemployment to maintain inflation control. Broadly, there are three options available to an economy that desires price stability. First, as in the NAIRU approach, it can use unemployment as a tool to suppress price pressures. Second, it can introduce a Job Guarantee and use movements in the Buffer Employment Ratio (BER) to control inflation. Third, it can introduce the Job Guarantee policy and augment it with an incomes policy. We do not consider this third option.

The Role of Unemployment in Inflation Control

The OECD experience of the 1990s shows that high and prolonged unemployment eventually results in low inflation (Mitchell, 1996). There are several observationally equivalent theoretical explanations for the inflation—unemployment trade-off. The orthodox explanations center on the role of the NAIRU and the requirement that to lower unemployment the government must run agent expectations ahead of the actual data. Each time the agents are tricked into mistaking a nominal price change for a relative price change, the inflation rate rises. Ultimately the only sustainable non-inflationary unemployment rate occurs when expectations are realized, a condition immutable to aggregate policy manipulation.

Alternatively, Post-Keynesians and others locate the trade-off on a model of conflicting claims among capitalists and workers to real income. Sawyer (1985: 17) argues that unemployment acts as a ‘control mechanism, albeit a socially and economically inefficient one.’ By disciplining the aspirations of labor to be compatible with the profitability requirements of capital, unemployment can temporarily balance the conflicting demands of labor and capital (Kalecki, 1971). Similarly low product market demand, the analogue of high unemployment, suppresses the ability of firms to pass on prices to protect real margins. The lull in the wage—price spiral, in the sense that inflation is stable, could be termed a macroequilibrium state. The implied unemployment rate under this concept of inflation is termed the macroequilibrium unemployment rate (MRU) by Mitchell (1987a) and has no connotations of the voluntary maximizing individual behavior that underpins the NAIRU concept. Mitchell (1987a) develops this concept into an explanation of hysteresis.⁹

The fact that at some stable inflation rate there is an associated unemployment rate, and that increases in the latter ensure the former, does not provide a theoretical reason for income distribution conflicts between powerful groups in the economy. We might also call this unemployment rate the NAIRU, but in doing so we add nothing to the understanding of the inflation process. Clearly different theoretical underpinnings support this observation, each theoretical structure bringing with it an entirely different comprehension of the role of the NAIRU and its implications for activist government agendas designed to provide full employment.

Inflation Control — the NAIBER

To demonstrate how the Job Guarantee generates full employment with price stability, let us consider two situations: (a) introducing the Job Guarantee into a NAIRU economy with high unemployment; (b) maintaining the Job Guarantee in the fully employed economy subject to inflationary biases in the private sector. Initially we outline the relationship between falling unemployment and inflationary pressures in a NAIRU economy.

We consider a stylized economy with a dual labor market where the sectors are differentiated by their wage-setting mechanisms. Prices are set according to markups on unit costs in both sectors. Wage-setting in Sector A is contractual and responds in an inverse and lagged fashion to relative wage growth (A/B) and to the wait unemployment level (displaced workers who think they will be re-employed soon in Sector A). Wages are relatively flexible upwards in Sector B and respond immediately. A government stimulus to this economy increases output and employment in both sectors immediately. The compression of the A/B relative wage stimulates wage growth in Sector A after a time. Wait unemployment falls due to the rising employment in A but also rises due to the increased probability of getting a job in A. The net effect is unclear. The total unemployment rate falls after participation effects are absorbed.

The wage growth in both sectors may force firms to increase prices, although this will be attenuated somewhat by rising productivity as utilization increases. A combination of wage—wage and wage—price mechanisms in a soft product market can then drive inflation. This is a Phillips Curve world. To stop inflation, the government has to repress demand. Higher unemployment brings the real income expectations of workers and firms into line with the available real income, and inflation stabilizes. This describes the fundamental mechanisms in a NAIRU economy.

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