Expla ining and Critically Analysing Minskys ELR Solution to Full Employment

Written by Siyaduma Biniza* Minskys analysis of advanced capitalist economies led him to critique the traditional Keynesian analysis of investment and the Keynesian approaches to attaining full employment through prime pumping. The critique led him to develop a theory that incorporated the financial dynamics of investment in which argued that the importance of financial capital in advanced capital economies leads to fragility, unemployment and inequality. This is the core of Minksys argument in the financial instability hypothesis. Furthermore, the Keynesian approached to attaining full employment did not avert the financial instability but instead contributed to it. Therefore, Minsky proposed an alternative policy to solving the challenge of full employment known as the employer of last resort (ELR) scheme. Thus Minksys financial instability hypothesis leads him to argue that the only way to avoid the instability that is inherent in advanced capitalist economies is through an ELR scheme which can reduce poverty and inequality, remedy cyclical unemployment and stabilise price. Hence this essay explains why Minksys analysis of advanced capitalist economies led him to the ELR scheme; and critically assesses the ELR scheme. Minksys key macroeconomic theory proposition concerns the financialisation of advanced capitalist economies extending on Keynes theory of investment (Wray, 2011). He argues that advanced capitalist economies require complex financial systems to foster output and investment due to the capital intensity of new investment (Dodd, 2007; Minsky, 1993). The basic notion is that, although Keynes aptly analysed that investments depend on expectations about future profitability, Keynes failed to expand on his analysis to reach its limits because he did not include the complete financial aspects of investment (Minsky, 1993). Consequently Minksys analysis extends

Keynes analysis to include not only capitalist, or firms, expectations about future profitability but also the financial sectors expectations about future profitability. Therefore, because investment in advanced economies does not often occur without borrowing, expectations about future profitability are interwoven with lending conditions on the basis of lenders expectations about future profitability too (Dodd, 2007; Minsky, 1993). This is because firms borrow so that they can invest based on expectations about future profits; whereas banks lend to the firms based on expectations about future profitability of their lending. However, these expectations are made under uncertainty which means that there are risk for both banks and firms (Dodd, 2007). Thus, due to uncertainty and the fact that there are risks for lenders and borrowers, expectations about future profitability affect both the demand and supply for finance which affects actual investment in the economy (Dodd, 2007; Minsky, 1993). The consequence of this, which is consistent with Keynes, is that unemployment is characteristic of capitalist economies. Minksy argues that when firms have optimistic expectations about future profits they will increase investment, which increases income and expectations about future profits, that leads to self-reinforcing spiral of more investment and speculation causing high vulnerability in the economic system (Dodd, 2007; Minsky, 1993). This is because firms become more speculative as expectations about future profits rise with the increasing investment leading to investments made from borrowed capital whose returns are not immediately realised (Minsky, 1993). This results in a sharp rise in leveraged borrowing and lending. Hence, crisis ensues when the speculative behaviour becomes unsustainable and confidence about future profitability is lost leading to reduced lending and borrowing; which affects investment leading to unemployment and an economic bust (Dodd, 2007; Minsky, 1993; Wray, 2011). This is a characteristic of business cycles and cyclical

unemployment; which are permanent features of capitalism. Thus, in similar fashion to the Keynesian conclusion, Minksys financial instability hypothesis concludes that advanced capitalist economies are unstable and cannot support or sustain full employment without intervention. However, Minksy critically disagreed with the traditional Keynesian forms of government interventions intended to attain full employment through

macroeconomic stimuli to induce private investment, i.e. prime pumping (Wray, 2009). Most of these Keynesian interventions attributed unemployment to low levels of aggregate demand and thus implemented policies to stimulate aggregate demand through government spending or policies to stimulate private investments; which were all meant to contribute to higher output and thus higher employment (Wray, 2009). This is the traditional Keynesian approach to attaining full employment through government intervention that is meant to increase aggregate demand; either directly or by stimulating private investment. However, the challenge is that these policies lead to inflation without necessarily reaching full employment and they also contribute to the financial instability (Tse, 2001). The inflations occurs because firms, operating in a competitive environment, end up driving up wages to attract the best labour as unemployment drops to critically low levels before reaching full employment (Wray, 2009). Therefore, under conditions of scarcity, as unemployment drops the demand for certain types of skilled labour exceeds the supply and thus firms have to compete for the labour by raising their wage offers to attract the best labour. Furthermore, since aggregate demand could be stimulated beyond the economys productiveness, firms would drive up the prices of goods as a response to excess demand (Kalecki, 1971); which is another source of

inflation. Thus the traditional Keynesian approaches were not useful to combating both unemployment and inflation (Wray, 2009). Moreover, considering the speculative nature of advanced capitalist economies, the policies intended to stimulate private investment would not solve the challenge of business cycles. Because the same conditions conducive to Minskys financial instability hypothesis hold. Furthermore, the prime pumping would lead to increased aggregate demand which reinforces the financial instability. In addition, since conditions to stimulate private investment could affect firms expectations about future profitability, the same spiral where increased investment leads to speculative behaviour and more optimism about future profits until the situation is unsustainable would be encouraged; and a financial crisis could ensue. This means that generalised policies aimed at increasing aggregate demand would not be helpful for attaining full employment without resulting in inflation and more frequent or sever cyclical changes. Thus, since unemployment was of these endogenous mechanisms of capitalism, Minsky felt that a targeted policy is what was needed to resolve both of these challenges; hence he proposed the ELR scheme (Argitis & Michopoulou, 2011). Minskys ELR scheme meant to deal with the persistent challenge of cyclical unemployment under capitalist as well the inflationary problems of low unemployment. The ELR scheme would be a government programme to offer employment to all those able and willing to work (Mitchell & Wray, 2005). But the government would have to offer jobs with immediate returns in public goods (Wray, 2009). ELR employment would offer basic benefits and a wage at rates similar to the minimum wage except that this wage would work as a market wage floor instead of a legislated minimum wage (Mitchell & Wray, 2005; Wray, 2009). In addition the ELR would be sensitive to cyclical changes in the economy so that it could smooth out the

effects of business cycles (Dodd, 2007; Wray, 2009). Therefore the government could expand the programme during a recession or contract it during a boom (Wray, 2009). Thus the ELR scheme would be a reserve of employed people in a way such that the private sector would be able to employ low-paid ELR workers during a boom and the scheme would offer low-paid employment to laid-off workers during a bust (Mitchell & Wray, 2005). The ELR wage would be similar to the minimum market wage so that all those who are not already employed due to a lack of opportunities could be employed. Moreover, the wage would work as a wage floor so as not to drive private sector wages up or compete with the private sector; so that only those private sector employees receiving wages below the minimum would have the incentive to get employment in the ELR scheme (Wray, 2009). Therefore, the ELR scheme would not compete directly with the private sector and wages would be economically sensitive and useful to improving the minimum working conditions. Consequently, the ELR would offer a uniform low wage which does not compete with the private sector thus the scheme would not lead to inflation as the economy came closer to full employment (Wray, 2009). Moreover, since the ELR scheme would offer jobs that have immediate returns, the aggregate demand rise due to higher employment would not cause demand inflation because of the economys increased productiveness (Wray, 2009). Thus the ELR scheme would be able to tackle both the challenges of cyclical unemployment and inflation. However, the ELR proposal has been criticised for increasing employment to levels that cause inflation, unruly labour; and being administratively unfeasible (Wray, 2009). Firstly, some opponents argue that low unemployment necessitates inflation (Wray, 2009). The argument is that the ELR scheme would lead to inflation because it would reduce the unemployment rate below the level of the non-accelerating inflation rate of

unemployment (NAIRU) (Sawyer, 2003). This criticism asserts that there is a critical rate of unemployment which does not lead to accelerating inflation (i.e. the NAIRU) which is determined by supply-side constraints (Sawyer, 2003). Therefore, the ELR scheme would necessarily cause inflation by driving unemployment below the NAIRU (Sawyer, 2003). However, this criticism misplaced, as discussed above, the increased aggregate demand in the economy would be met through employment that creates goods with immediate returns thus increasing output to meet the demand and avoiding inflation (Kalecki, 1971). Therefore, the supply-side constraints are no longer a challenge. This would mean that prices would not have to rise in order to reduce the excess aggregate demand in order to equilibrate it with aggregate supply. Furthermore, the ELR scheme would limit competitive bidding up of wages amongst firms because of the uniform wage offered by the scheme means that attracting workers from the ELR scheme would only require a small increase in wages above the minimum or ELR wage; which reduces the excessive bidding up of wages when there is no uniform wage (Wray, 2009). Lastly, this criticism does not take full cognisance of the countercyclical nature of the ELR programme which is useful in smoothing out cyclical changes (Fullwiler, 2007; Wray, 2009). Secondly some opponents argue that the ELR affect the work ethic of labour resulting in more shirking in the absence of the fear of being jobless under full employment (Kalecki, 1971; Wray, 2009). Furthermore, because workers are not hard-pressed to find employment their bargaining power is higher and they might demand higher wages or improved working conditions (Kalecki, 1971). Thus, the ELR conditions of full

employment diminish the relative power deficit of workers making labour unruly.

However, this would necessarily be true since the ELR programme does not compete directly with private sector labour since it is only primarily aimed at the unemployed labour force. Furthermore, because the ELR wage is a floor, the effectiveness of private sector workers bargaining power would be limited to those jobs that pay less than the ELR wage (Mitchell & Wray, 2005). In this case private sectors jobs that offer lower wages and less benefits would be pressured to improve working conditions and wages of the employees. This would be useful in to reducing poverty and inequality in the economy which is useful to improving living conditions and stimulating further economic growth (Wray, 2009). Moreover, this critism assumes that workers would be indifferent between employment and unemployment with or without unemployment benefits; which is a dubious claim (Mitchell & Wray, 2005). Lastly, opponents to the ELR scheme argue that the programme would be too big making an administrative nightmare and highly costly to maintain. However, in response to this claim proponents of the ELR argue that many job-creation interventions have been made throughout the world, with various targettedness and success rates, and that these programmes have all contributed towards curbing unemployment and stabilising economies during crisis (Wray, 2009). Furthermore, in response to the cost-related criticisms, proponents argue that these programmes are not only funded through the governments tax income. Governments can also run deficits which are reduced during a boom when the ELR scheme is contracted and tax income acrues in order to fund the expansion period during a bust (Wray, 2009). Moreover, proponents also argue that government can engage in open-market operations, by selling bonds, in order to pay for the ELR scheme or the central bank can print money in order to finance the ELR programme (Wray, 2009).

However, the counter argument to this defence is that the government does not engage in open-market operations and that this is primarily something that the central bank does. Furthermore, the central bank does not print money to finance government spending (Sawyer, 2005). The central bank does not engage in open-market operations to pay for government expenditure; instead the central bank does this to monetise debt (Sawyer, 2005). Central banks engage in open-market operations by selling or buying government bonds which affects the public portfolio composition and the money supply in the economy (Sawyer, 2005). Moreover, the success or failure of openmarket operations relies on the portfolio preference of private sector and the public at large (Sawyer, 2003; Kalecki, 1971). Therefore, the financing of the ELR scheme through open-market operations is precarious. Thus, the financing of the ELR scheme through these mechanisms is highly contentious. Regardless though there are stronger criticisms against the ELR proposal which relate to its inadequate development. For example, do ordinary labour laws apply to the ELR scheme? Will the ELR wage be consistent with minimum wage regulations in the various sectors that the programme would offer employment in? Moreover, would ELR employees be allowed to join a trade union or form ELR-specific trade unions (Sawyer, 2003)? It seems as though, from these questions, the appeal of the ELRs uniform wage and non-inflationary unemployment diminishes if the response is in the affirmative. Furthermore, if the response is in the negative, the proponents of the ELR do not deal with reasons as to why this might be the case nor is there consideration of the implications of these questions. Moreover, is it a concern that, if government employs workers at a lower ELR wage, other non-ELR public sector jobs might have their wages competitively driven down by the ELR wage (Sawyer, 2005)? Thus, the ELR proposal is inadequately developed in these areas although the proposal seems theoretically valid.

Thus, Minskys financial instability hypothesis highlights why the importance of financial capital in advanced capital economies leads to fragility, unemployment and inequality. Moreover, Minsky/s work also enlightens us as to why the traditional Keynesian approached to attaining full employment would not avert financial instability but instead contribute to it. However, Minskys ELR scheme needs further development to make it practically adequate for implementation. Thus even though ELR scheme can reduce poverty and inequality, remedy cyclical unemployment and stabilise prices; some finer implementation details need to be consider.

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* Siyaduma Biniza is currently a B.Com. (Hon) in Development Theory and Policy student at the University of the Witwatersrand, holding a B.Soc.Sci in Politics, Philosophy and Economics from the University of Cape Town.