The Trade-Off Problem Conflicting Goals

High-level employment and a stable price level are both desirable. Hopefully, we can achieve both. But, alas, these goals may sometimes conflict-we can have one only at the cost of giving up the other.

Look back at Fig. 5-2, at the dotted line that cuts across the corner at A. This shows that when aggregate demand rises, some inflation begins before we reach full employment. When there is widespread unemployment (e.g., with g.n.p. at OQi) obviously increased aggregate demand will lead mainly to more output and employment, not to higher prices. But as unemployment is reduced, more demand is increasingly likely to lead to higher prices. Wages are bid up as labor becomes scarce. Unions demand higher pay and costs rise. Rising aggregate demand leads to full employment in some industries before unemployment and excess capacity are eliminated in others.

Then further increases in aggregate demand bid up prices in the “bottleneck” industries before unemployment of men and machines is eliminated elsewhere.

What then? How shall we trade off the employment of 500,000 more men against a 1 per cent increase in the consumer price index? This is no imaginary problem. It has been a major dilemma of macro-economic policy over the past decade. For between 1953 and 1965 the economy persistently had more unemployment than in previous boom periods. Unemployment rose to 6 or 7 per cent of the labor force during recession periods and seldom was reduced below 5 per cent during upswings. But over the same period prices crept upward, not rapidly, but fast enough to warn that more aggregate demand might produce substantial inflation. Expansionary monetary-fiscal policy to eliminate unemployment thus was continually restrained by the danger that too much aggregate demand could restart the substantial inflation that followed World War II.

If we face the problem of conflicting goals, one path is to search for solutions that will eliminate this dilemma. But if we cannot find such a solution, so that in fact we face a trade-off between the two goals, an intelligent decision about policy requires a careful weighing of the relative advantages of achieving each of the goals. And it is important to see that as a practical matter, the choice is not all-or-none, not, is full employment or price stability more important? Instead, typically it is: Shall we seek a little more employment at the cost of a little more inflation? The real problems are marginal problems—a little more aggregate demand to cut employment a little more as against the disadvantages of a little more inflation.

THE COSTS OF UNEMPLOYMENT

The case for high-level employment of men and machines is clear. Involuntary unemployment means waste of productive capacity. It means less clothing, fewer refrigerators, highways, and factories than we could otherwise have. It means human misery, resentment, shame, decay of skills, degrading deprivation for the unemployed and their families. It means a lower average standard of living for the nation, and slower economic growth for our children and grandchildren.

How much has this waste cost? Figure 10-1 gives a rough measure of this cost since 1953. The straight line is a rough measure of high-employment capacity output for the economy; it is drawn by joining together the peaks of output during prosperous peacetime periods of high employment. It gives a rough measure of the economy’s growing capacity if unemployment stays at about 4 per cent. The fluctuating line below shows actual g.n.p. during the same period (in constant purchasing power dollars). Thus the colored area between the two lines is a rough measure of how far actual g.n.p. fell short of reasonably obtainable g.n.p. over the years shown.

These estimates suggest that the economy may have wasted as much as $50 billion per year through unemployment in the post-World War II recession years, such as 1958 and 1961. Over the 1955—65 decade we wasted some $300—$500 billion in potential real output (at current prices)—or in terms of wasted -manpower, the equivalent of some 20—30 million man-years of work.

Back in the Great Depression of the 1930’s, the waste was a far greater proportion of our potential production. In 1933, for example, actual g.n.p. was less than two-thirds of potential, and many estimates indicate that as much as $200 billion of potential output was wasted through unemployment during the decade of the 1930’s, compared to a total actual g.n.p. of less than $800 billion during the decade. Unemployment in 1932 and 1933 was between 20 and 30 per cent of the total labor force, and many of the employed held only part-time jobs.