Types of Unemployment

Modern, mainstream economics universally recognizes three types of unemployment:  frictional, structural, and cyclical.  Some people add in seasonal unemployment to give us four types of unemployment.  These types of unemployment are pretty universal.  Not only on the net(see here, here, here, and here), but in N. Gregory Mankiw's Intro text book, Principles of Economics, as well.  Let's take a brief look at each kind.

Frictional Unemployment are workers who are literally "between jobs".  It is only the time lag it takes for a worker to leave one job and go to another(or become self-employed).  There might be some delay while a worker works on her resume` and goes through the interview process and possible wage negotiations.  Frictional unemployment is normal and healthy in any economy.  In fact, not having any, I speculate, would be inefficient and have a lot more unhappy workers who are stuck in their jobs.

Structural unemployment is the type of unemployment that comes up when the jobs employers are offering do match the skill or desire of those who are looking for work.  In a way, this could be considered long-term frictional while employees get new skills or employers adjust their requirements.  But I think that it is right to separate this kind of unemployment from frictional.  It's causes are different and therefore solutions would be different.

Combating structural unemployment seems to be the one issue that unites liberals and conservatives in the United States.  Reducing structural unemployment seems relatively simple.  If workers don't have the skills they need, then they need training or education.  Job training appears to be the only "jobs" program conservatives are willing to fund.

Cyclical unemployment is of course unemployment related to downturns in the economy.  Classic Keynesian economists will say it's from a lack of demand in the economy.  Monetarists or neoliberals like Mankiw will call it a downturn out of sync with the "natural rate of unemployment".  Austrians will deny that such a thing exists(claiming it's a type of structural unemployment created by bad policy) .  Unlike structural unemployment, conservatives are usually less willing to do anything about this.  Although not always, since the Bush tax prebates in 2001 that sent money to people is a Keynesian solution to driving up demand.  It might not be considered an orthodox approach, but it accepts the Keynesian precepts of driving up demand via government.

Finally, we come to seasonal unemployment.  There are some jobs that are only demand for part of the year.  For instance, retail stores hire extra people before Christmas.  Another example are farm workers who are only needed during the planting season and harvest time.  These are jobs that naturally don't exist year round.  When the demand for those jobs end, workers are left unemployed.  I understand why some people don't consider this a type of unemployment.  Some might just call this frictional since, presumably the workers will find other seasonal jobs once laid off.  I can understand that reasoning of both sides.  Seasonal employees will likely have more than 1 job, but seasonal unemployment poses unique problems from the other types so it makes sense to track them separately.

So that's the three (or four) different types of unemployment.  Not a lot of controversy for the most part.  The only part up for debate between the different economic schools is the existence of cyclical unemployment, and how best to understand it.

General Theory Study Guide, Preface and Book 1, Chapter 1

After reading of the Preface and Introduction(Book 1, Chapter 1) of The General Theory I find four things worth mentioning.  The first is why he wrote the book and the urgency with which he writes it.  The second is who he wrote the book for and why.  The thrd is the books relationship to his earlier writing, "A Treatise on Money".  The last thing I'll discuss is Keynes preview of the book and the significance of his title.

In the preface, Keynes lists his reasons for writing the book.  His goal was to deconstruct current economic theory, refute it, and reconstruct a new theory. He wrote the book during the Great Depression.  A time when unemployment was persistently high and didn't seem to be going down.  Most mainstream economists of the time were offering either conflicting or ineffective advice. Keynes noted that the longer the recession went on, the less the public was listening because the traditional advice(let the markets clear!) wasn't working.  Therefore there was an urgency to get things figured to end the Great Depression.

Keynes also made clear that he was writing this book for his fellow economists.  Apparently, he felt that they needed to be convinced before he had any hope of convincing the general public of his new ideas.  Since Keynes work was directed towards his fellow economists, Keynes really lays down the gauntlet.  He declares his book is going to attack current economic theory by refuting some of it's most basic assumptions.  He also warns that his disagreement isn't because he doesn't understand the mainstream economics of the time, but because he believes that mainstream economics is wrong.  As evidence he offers that he once "held with conviction for many years the theories which I now attack, and I am not , I think, ignorant of their strong points".

In the preface, Keynes mentioned something I found interesting about his earlier work, "A Treatise on Money".  His treatise was not only critiqued by his most-famous-rival Hayek, but his contemporaries piled on.  Keynes makes a bold claim in his preface.  He states that any legitimate criticism of his Treatise wasn't the result of him getting too far away from mainstream economics, but because he hadn't gotten far away enough.  If you don't think that's bold, imagine this:  You have an argument with someone.  The other person clearly loses.  The next day that person comes back and states, "I figured out why I lost our debate,  it was because I underestimated how wrong you are".

The last thing that I learned was from the introduction.  In the introduction, Keynes explains why the book is called "The General Theory".  Having never read the introduction before, I assumed that it was called "The General Theory" because he was laying a high level theory explaining the  economy.  Instead, Keynes had a subtler, more important meaning in mind for the title.

The title of the book, according to Keyne's introduction is that most of economics is based on a certain condition:  That the economy is in perfect equilibrium(everyone and thing is employed at what it is most efficient at).  Keynes says his book is an economic theory for when the economy isn't in equilibrium.  And, based on his intro, I believe that he believes the economy is almost never in that state.  From Keynes:

The characteristics of the special case assumed by the classical theory happen not to be those of the economic society which we actually live.

I specifically call this out because I've read economists that have claimed that Keynes was only writing for the Great Depression and his theory, conclusions, and recommendations didn't apply otherwise(see here, and here).  But his introduction leads me to believe that he was writing for almost every occasion.  He doesn't say 'currently' aren't living in.  He says flat-out, we don't "actually live" in the world assumed by classical economists.  I think this is the most significant thing I read as it refutes many people who suggest that Keynes didn't mean for his analysis to apply to non-depressions.

I didn't mention this in the intro, but be sure to read the footnote in Book 1, Chapter 1.  Keynes defines what he means by "The Classical School".  Apparently, he means any economist who can trace their work and theories back to David Ricardo.

For just a Preface and an Introduction, this was some pretty intense reading.  I have a feeling the rest of the book is going to be like this so I'd better settle in for a long ride.

How to define poor and poverty?

How do you define poverty and whether someone is "impoverished"? Someone asked me this question and i had a surprisingly hard time doing it. My problem is that i reject the numbers-based definition of poverty.

The U.S. government defines poverty based on someone's income and (to a lesser extent) how much stuff they have.  Being that governments need concrete rules for their bureaucracy, this makes sense.  If you make less than 'X' then you are poor.  No thinking or judgement required.  The problem i have with this approach is that it lumps people together without thinking.

A college student might not be making a lot of money, but I wouldn't necessarily call them impoverished.  Quite the contrary, I would call them privileged for the opportunity even if their income is low during their study.  We might also capture someone who has temporarily lost their job.  They might lose much of their income for a year, but with a little hard work and a little luck, they'll find a job and start rebuilding their nest egg.  They may temporarily need government assistance to get them through, but again, I wouldn't call that impoverished(Granted, I might call it stressful, awful, and wouldn't wish the situation on anyone).  Finally, even wealthy businessmen can declare bankruptcy and lose most of their fortune.  For a brief period they may technically qualify for government assistance, but with the help of a vast network of business contacts and established relationships, they can quickly rebuild their fortune.  So, again, I wouldn't call that person "impoverished".  It's because of these exceptions that I think "poverty" needs a better definition.  Something that can better explain the picture most of us have when we hear the word poverty.

Another class of definitions for poverty describes how well someone's basic needs are being met.  For instance, poverty is a lack of  shelter, food, etc...  This is better, but runs into some problems. First, how does one decide what items one should lack to be thought of as impoverished?  We can start with food, but what if someone has food, but no shelter.  A man living under a bridge might have all the food he needs from a nearby church, but that won't keep him warm at night.  So we add in shelter.  Well, what about health care?  Food and shelter is nice, but you're still suffering if you have tuberculosis and can't get the medicine you need.  Then, what about transportation?  What good are all those things if you can't get to wherever they are?  Now you can see the problem with this.  To get a full definition would require an exhaustive list and there would still probably be a form of poverty left out.

Here's another problem with this second definition.  Where the first definition might describe people as impoverished who really aren't, this has the opposite problem.  I think it doesn't necessarily capture everyone who is impoverished.  I think trying to define poverty by listing the things that poor people lacks is that your list is actually describing the manifestations of poverty, not necessarily the condition.  That brings me to the U.N. definition of poverty from 1998.

Fundamentally, poverty is a denial of choices and opportunities, a violation of human dignity. It means lack of basic capacity to participate effectively in society...

I think this was one of the best definitions of poverty I've ever found.  Lacking some income is not the problem for the impoverished, it is a denial of opportunities and choices that everyone else has.

Using this definition of poverty, one can easily explain why things like poverty and social justice matters.  Denying someone the opportunity or ability to participate in society and advance themselves is violence.  Just because nobody is holding a gun or knife to someone doesn't mean that a person cannot be harmed.

Reading The General Theory

As much as I've talked about economics on this blog, I've never actually read Keynes's entire Magnum Opus, "The General Theory of Employment, Interest, and Money".  Sure, I've read parts of it here and there, but never all the way through as written.  Normally, I'd feel ridiculous about talking about a subject without reading one of the most famous books on the subject.  But apparently, most "real" economists haven't done so either and some even actively advocate against reading it.

So, I started reading "The General Theory" and very quickly learned new things and other things that I wanted to find more information about.  That's when I discovered there are no free, online study guides for The General Theory that are pro-
Keyensreality (the one I found was written by a very hostile austrian enthusiast).  So, I've decided to start one.  What qualifies me to do this?  Absolutely nothing but a curious intellect and a blog.  But, the way I figure it, until a more qualified person offers the same thing , I've got a monopoly on this niche.

So, what I'm going to do is read a selection.  Then I'll blog about what I read.  In the title, I'll put what section I'm talking about.  I'll point out things that I think are correct, things that I think are wrong, things I found insightful or interesting, and things that I found difficult to understand.  I'll then try to justify why and put in the correct information or summary.  I expect that I may occasionally change my mind or find new information and will have to update a post.  If it's a small change I'll edit the post.  If it's a big change I might just rewrite it and note that the older section is deprecated.

I'll also be creating a new page, The General Theory Study Guide, that puts the readings in order so that future readers can easily find the different sections.  I have no idea how long this will take, but it won't be finished unless I start it.  Hopefully, somebody will eventually find this helpful.  For those who are curious, this is the edition I'll be reading on the eBook reader device of my choosing.

Economic History Debunked: Economics Before Adam Smith

There was a rich history of economists long before there was an Adam Smith.  They didn't necessarily call themselves "economists" or use even the older term "political economy", but what they were studying was the "dismal" science known as economics.  Despite this, "Smith is widely cited as the father of modern economics and capitalism and is still among the most influential thinkers in the field of economics today" according to many.

Like so many other western sciences, economics has roots in the Greek philosophers of ancient times.  Plato stumbled onto a variation of the advantages of the division of labor.  One of Plato's greatest students, Aristotle, also touched on the subject of economics.  Just read book I of "Politics" Chapters 8(VIII) through 11(XI).  It is available online.  In it he discusses the "art of acquisition".  He touches on subjects that modern economists would refer to as "the nature of money", the concept of a monopoly, and markets.

Skipping ahead a few centuries... we come to Spanish Scholasticism at the University of Salamanca.  Scholasticism is a term usually used to describe a type of learning by medieval monks and scholars.   The University of Salamanca in Spain was founded by a group of scholastic scholars.  Austrian economist Joseph Schumpter did a lot of research to uncover much of the work done on economic thought at the University.

Similarly the Spanish Scholastic Diego de Covarrubias y Leiva (1512–1577) a distinguished expert on Roman law and a theologian at the University of Salamanca, wrote that the "value of an article" depends "on the estimation of men, even if that estimation be foolish." Wheat is more expensive in the Indies than in Spain "because men esteem it more highly, though the nature of the wheat is the same in both places." The just price should be considered not at all with reference to its original or labor cost but only with reference to the common market value where the good is sold, a value, Covarrubias pointed out, that will fall when buyers are few and goods are abundant and that will rise under opposite conditions

Schumpter gives a lot of credit to the late medievalearly Renaissance scholars at the school for making advances in economics that were later credited to Austrian economists that came 300+ years later.  Pretty good head start if you ask me.

To read more about these religious scholars struggle with "Just Price" you can read an excerpts from the book, "Modern Catholic Social Documents and Political Economy".  This link to Google Books should allow you read the whole excerpt "Scholastic Just Price" that starts on the bottom of page 63.  To sum up the excerpt, there was a great debate of whether the "Just Price" of a product was the market price, or the "cost to produce" price.    It is an interesting discussion because what they were discovering without realizing it, I think, was what came to be known as "economic rent".

The next group to talk about is probably the mercantilists.  For those who do talk about mercantilism, I think the conventional wisdom gets it right.  Mercantilism isn't so much a complete economic theory as much as it's a collection of disparate ideas of how to make the ruler of a nation state rich and rival rulers poor.  I won't rehash what others have said better:

Mercantilism was a reaction against the economic problems of earlier times when states were too weak to guide their economies and when every town or principality levied its own tariffs on goods passing through its borders.
The modern age brought the rise of powerful nation states (Holland, France, Spain and England) and was marked by almost constant warfare. Money (bullion) was needed to support ever-expanding armies and navies. Mercantilist concepts developed from this need.
Underlying this theory was the belief that wealth was finite. If one nation hoped to grow richer, it had to do so at the expense of some other nation.

Mercantilism drove economic and foreign policy during Renaissance Europe.  The reason I mention it is because it's existence was what our next group was rejecting:  The Physiocrats.  This group came on the scene in the mid 1700s - just a couple decades before Adam Smith published his Treatise.  They started and were based entirely within France.  There physical location is important.  The french economy was under severe distress at the time.  It makes sense that a group would be formed to understand why and come up with ideas of how to fix it.  While this group didn't come up with supply & demand concepts, they are sometimes still cited for things that they did come up with.  Some things that Smith also discovered and some things that he missed.  There is too much to put in this post, but they were a significant school of economic thought before Adam Smith(It is unclear to me how much Smith was affected by the french physiocrats). After the Physiocrats, finally came Adam Smith's treatise on the Wealth of Nations.

Here is one more worthy historical note.  My above analysis is extremely Anglo/European centric.  I've completely left out of my above are any non-western thinker.  There were several non-western thinkers that touched on economics that are worth exploring from the middle east, India, China, and probably others that I haven't found yet.  It's a shame our natural bias seems to leave out non-European thinkers from the official history.

As you can see he was most certainly not the first economics writer.  I'm not sure why he, historically, gets the credit for being the first.  Maybe because his book was the most complete and accurate tome written at the time.  A worthwhile accomplish no doubt, but not sure why he seems to get credit for "founding" economics.

Investopedia Unabshadly Comes Out in Favor of Keynesian Economics

Investopedia is a really good website to go to for the conventional economic view.  Being that, it is less than favorable to John Maynard Keynes and Keynesian economics in many of it's articles.  In many cases they state things he  supposedly got wrong or go as far as putting words in his mouth like, "the government can spend your money better than you"(note: he never suggested anything like that).  It's for that reason I had a good laugh when I read their article on Mercantilism which states(emphasis mine):

This approach assumes the wealth of a nation depends primarily on the possession of precious metals such as gold and silver. This type of system cannot be maintained forever, because the global economy would become stagnant if every country wanted to export and no one wanted to import. After a period of time, many people began to revolt against the idea of mercantilism and stressed the need for free trade. The continued pressure resulted in the implementation of laissez faire economics in the nineteenth century.

The emphasis part is exactly right.  It is impossible for every country to increase exports because those export must go to a country as an import.  If every country tries to do export and bans imports, then overall trade is reduced as nations stop importing.  The hilarious part is that this is one of the fundamental precepts of Keynesian economics.  This is almost exactly the Paradox of thrift.   It is impossible for every person to save money because that money they save must come from someone who is spending.  Your consumption is my Income.

The best part of this is how matter-of-fact it makes the point.  It offers no qualifications on the statement because mercantilism is so universally condemned.  It never occurred to me until recently that it's universally condemned for the opposite reason that market fundamentalists condemn Keynesian economics.

It's nice to see investopedia accept such an important keynesian concept.  Now, maybe a Keynesian wrote that article and would explain the apparent contradiction between the overall site and this particular article(probably not, but maybe).  Even so, I bet I could show that article to any market fundamentalist and they would not see anything wrong with that statement simply because it is used to promote "laissez faire".

The "Official" history of Economic Thought in 1000 words or less

The official history of economic thought has a surprisingly short history. As the official history this is what many people already know(or at least partly know) and is what's generally taught and passed on. Like many "official" histories, it contains many myths that are quickly uncovered after a little questioning more on those myths on another day. For now, let's just stick to the "official" history. For we cannot debunk myths without understanding the myths first.  If you knew all of the following you could sound reasonably informed in most  any conversation about the history of economics.

Our story starts about 240 years ago. A man named Adam Smith set out to discover why some countries were exceedingly wealthy and others very poor. The result of his research resulted in the first book on economics: "The Wealth of Nations". In it he laid out the laws of supply and demand and price vs. Value. He concluded that through trade, an "invisible hand" guided individuals to make decisions that caused a spontaneous order to develop. One in which great things were accomplished by everyone making smaller decisions. He opposed government involvement in the economy because centralized planning wasn't as efficient as everyone making decisions based on prices set by supply and demand. Therefore, the best economies were the ones without government involvement and where individuals were allowed to make their own decisions.

If there was a problem with Adam Smith it was his "Theory of Value". Smith made a distinction between price and value and ran into a problem he couldn't explain. The problem is known as the diamond-water problem. Why is water, necessary to life and needed everyday, was practically free, but diamonds which have no inherent worth go for a higher price.  He concluded that supply and demand set the price of an object, and that it didn't always set it to its real value. (remember this is the "official" history)

The next set of figures in our history are David Ricardo, John Baptist Say, and Thomas Malthus.  They all existed around the same time in the early 1800s, but each left their own unique contribution to economic theory.

First up is John Baptist Say.  He is famous for "Says" law.  The theory that "products are paid for with product", and therefore there can be no general glut of goods that can cause a recession because price will even out in the end.  To put another way, anything that is produced will be consumed.  This was later simplified to "supply creates it's own demand".

Then there is David Ricardo who is still mentioned in modern textbooks for his theory of "comparative advantage".  Comparative Advantage showed "unequivocally" that "free trade" benefits both countries involved in the end.  He did some other stuff that people feel occasion to mention, but this is the only important thing to remember in the official history.

Finally, we come to Thoma Malthus.  The only reason to remember him in our "official" history is because of how stupid he was.  He predicted that mankind was headed for tragedy.  Eventually the world population would outstrip ability to produce food.  Thanks to technological advances we aren't there which proves how awesome free market capitalism is, and how stupid Malthus was.

Then, in 1867  Karl Marx published Das Capital which gave capitalism it's name.  That's it.  Nothing else to see here.  Move along now.

Then, circa 1870, something great happened in the world of economics.  It was called the Marginal Revolution!  Remember that whole "Labor Theory of Value" that Smith had wrong?  The Marginal Revolution fixed it.  The theory goes like this:  Everyone's needs and wants are subjective.  Additionally, each additional unit of "a thing" is less important than the previous.  For instance, a cup of water when thirsty is important.  However, the second, third, fourth, etc... cups are each less and less important as one's thirst is quenched.  That is why water is priceless because everyone has enough.  Additionally, diamonds are rare, and people subjectively want diamonds.  Adam Smith's water-diamond problem was solved and there was much rejoicing in the world of economics.

Then, something strange happens in our "official" history of economic though.  Nothing new and interesting happens for 60 years...

Then, the Great Depression happened in the 1930s:  A long run recession that "Say" said couldn't be possible.  Out of that, a rising star from Cambridge University had a thought.  "What if supply doesn't automatically create demand?  Maybe demand creates its own supply?"  That man, John Maynard Keynes then went on to write the second most important book in economics, "The General Theory of Employment, Interest, and Money".  In it he explained how "Demand creates its own Supply".  In it he said that governments should spend lots of money all willy nilly during depressions to fight unemployment, and then pay down the huge deficits in upticks so as to fight inflation. (Again, this is the "official" history as told today)  Capitalism would enter a "golden age" of growth for over 20 years.

In the 1970s, disaster struck.  Inflation and unemployment happened at the same time.  Something that the keynesians(as followers of Keynes were called) couldn't explain.  It just so happened, that there was a man, named Milton Friedman, who had predicted just such an event.  People flocked to this prophet and asked, "Mr. Friedman, what do we do, we're all so confused".  Mr. Friedman smiled and said, "you see, government is the problem.  Balance the budget and give control of the business cycle over to 'politically insulated' central bankers - they'll know what's in the nations long term interest".

It was 1981, and a form of Monetarism called "supply-side" economics was put into place.  Together they stated that Free Trade was good, remove rules and regulations because they only hamper industry, privatize public lands and utilities to increase efficiency, high taxes on the rich reduced investment and hampered growth, and only central bankers should try to control the business cycle.  The low inflation and high growth of the 80s "proved" that supply-side works.  Now we are at current day mainstream economics.

Over the next 25 years the country experienced low inflation and low(but steady) growth.  Economists called it "The Great Moderation" and patted themselves on the back for taming the business cycle.  They all rejoiced.  That is, until all hell broke loose in 2008, but that's closer to recent events than history so I won't go into it.

And so ends are fast paced journey through time in less than a thousand words(not counting the intro).  As I stated before, if you've made it this far, you're probably as well versed in economic history as most people are.  Unfortunately there are some myths in this "official" history.  Some myths are areas where the story the myth tells is flat-out wrong, and in others it leaves out important, sometimes crucial facts.

You'll note that I didn't link to anything in my "official" history.  This was deliberate.  I did it for 3 reasons.  The first reason is that the "official" history is so pervasive I don't feel required to have to justify it.  The second reason, is that links are usually required to "prove" something, and here I did nothing but repeat the common fable.  And the third reason, is that I will provide links to people repeating the common myth, and the debunking of the myth in separate posts.  I will, eventually, one-by-one, try to recreate the actual history of economic thought and compare it to the common myth.  If you're interested, I suggest you subscribe to my blog and watch for posts that start with the title Economic History debunked.