EMPLOYMENT, GROWTH AND

SOCIAL STABILITY
IN A DEVELOPING ECONOMY

Karl Theodore
HEU , Centre for Health Economics, UWI
February 2009
 EMPLOYMENT, GROWTH AND SOCIAL STABILITY
IN A DEVELOPING ECONOMY

Introduction

The apparent intractability of the employment problem in the Caribbean suggests that our
basic conception of the problem may be flawed1. The standard analysis which, in spite of
the work of Keynes, remains essentially neoclassical, speaks of a labour market
framework where we identify an equilibrium level of employment corresponding to an
equilibrium real wage rate. The thinking is that since the real wage is at once the
inducement to give up leisure as well as the marginal cost of labour to the firm, there will
always be a wage rate where those who are really willing to work will find employment.
In this context prolonged unemployment is a bit of a conundrum. However, the observed
unemployment will remain a conundrum only if we try to hold on to two implicit
assumptions which are, to say the least, really questionable.

The first of the questionable assumptions is that there is always enough factor
substitutability in the production system to be able to produce a given level of output with
more labour and, by implication, less capital. The more likely situation is one of a high
degree of complementarity.2 What this means is that except in a case where the context is
one of overall expansion in economic activity, which would clearly call for increased use
of capital, there is no necessary connection between falling wages and increased
employment. In fact, there have been periods in at least one country in the region where
falling wages were accompanied by falling employment.3

The second even more seriously questionable assumption is the notion that there is no
wage level below which it will not make economic sense for households to offer labour.
The reality of the reservation wage is conveniently ignored. In fact it is this reality which
provides the starting point for the present analysis.

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Dimensions of Wages and Employment

As the more recently introduced concept of the social wage has suggested, the wage rate
is more than the price of leisure and more than a marginal cost.4 For from the point of
view of the individual, in addition to the subsistence dimension and the transactions cost
dimension of the wage there is also an entitlement dimension which is related to the
distribution of income in the society. In some societies people and their leaders believe
that employment is a right since everyone has a right to the means of life. This merit good
interpretation of employment is what gives employment a distributional, and therefore
entitlement, dimension. Our contention is that the neoclassical concept of the wage rate,
in true Pareto fashion, excludes this last dimension. What this has meant is that the
merit-good influence on the labour market has either been omitted or always left as an
after thought.

Once we accept this latter dimension of employment we are then open to the possibility
that employment may not be the homogeneous quantity it is assumed to be in the
neoclassical analysis. In a trivial quantitative sense the homogeneity can be maintained
by measuring the different types of employment using the same numeraire. However, in a
qualitative sense what is being suggested is that different categories of employment
reflect different behavioural phenomena. In a sense it can be argued that while on one
level, employment is physically determined, on another level it is metaphysically
determined. Put another way, we can say that on one level some of the employment we
observe is linked to planned output and on another level there is employment that is
linked to the distribution sensitivity of the society.

In practice, the employment that is linked to planned output is determined by the profit
motive of businessmen while the other category of employment is related to beliefs about
the welfare and the stability of the society. What this has meant is that while the
employment linked to planned output would mainly be private- sector generated, the
employment linked to distribution concerns would mainly be a public sector
phenomenon. If the prevailing set of community values uphold the view that everyone in

3
the society is entitled to a decent standard of living, this would be reflected in the
political decisions made in respect of those members of the society who tend to face
consumption challenges.

However, the concept of providing jobs for those who have no work need not be purely
altruistic. Enlightened self-interest will lead the better-off sections of the society to
recognize that blatant inequity coupled with a devil-take-the-hindmost attitude will
provide ready fuel for tensions in the society. Such tensions have the potential to
undermine the economic well-being of the more fortunate members of the society. The
point that needs to be made is that whether it is done out of a brother’s keeper motivation
or out of pure self-interest, the better-off in the society will be willing to pay a
(distribution) premium to keep employment levels up. On this basis, one hypothesis
which seems reasonable is that the society would be willing to use up some of its current
economic surplus to provide additional (public) employment.

This approach to the employment phenomenon allows us to relabel the two distinct
components of total employment in relation to output. One category remains linked to
planned output, as before, but the other is now linked to surplus output. In other words,
one is based on plans the other based on outcomes.

In the neoclassical model all observed employment reflects a demand for labour and is
therefore all related to planned output. This is the homogeneity assumption that is being
called into question. In a sense this may have been the point that Keynes tried to make.
For his analysis refers to an employment component that is directly related to the labour
market and another component which comes about after policy intervention or exogenous
changes. It is important to note, however, that in the Keynesian analysis both
employment elements were assumed to be responsive to aggregate demand. This made
sense since the initial conditions Keynes had in mind were conditions of excess
production capacity. He therefore saw the sense in inverting Say’s Law, allowing for
demand to awaken supply.

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In the developing country context the situation is generally not one of excess capacity and
more often than not employment creation has no supply-creation motives. In these
situations where the maximum employment associated with profit-induced planned
output has been attained at a level below the level of employment that is consistent with
social stability, the society will feel justified in making the necessary policy injections to
boost the level of employment, even if it means that supply will not increase. In a sense,
the society will be operating with a trade off between increased employment and
increased future supply. The fact that expansionary employment policy is generally
always supported means that the society reckons the social cost of current unemployment
to be greater than the value of the future output which the current surplus being used up
would have made possible.

Employment and Economic Growth

From the previous discussion it is possible to develop two independent growth-related

employment relationships which maybe used to describe employment equilibrium for the
society.

From the basic relationship between planned output and employment we would expect
that employment in the current period would be a function of output in the current period
and output in future periods. For present purposes we highlight the relationship between
current employment and the change in future output. The thinking is that firms will know
that they need to have their labour in place to meet production increases in a future
period. So even in a case where there may be no aggregate production function to work
with, probably because output is mainly made up of services, we would be able to
identify a monotonic relationship between current employment and future output
changes. This relationship summarizes for us how the growth process impacts on
employment and is the relationship which reflects the behaviour of the private sector in
the society. This is the first of the two relationships needed for the equilibrium picture
and will be denoted by the line GG’.

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However, employment is also related to future output because of the behaviour of the rest
of the society, reflected in the behaviour of the public sector. For it is the public sector
that has the capacity to lay claim to any quantum of the society’s current surplus and it is
the public sector that has the direct responsibility to protect the stability of the society.
Clearly the more of the current surplus that is absorbed for purposes of employment
creation, the less will be the savings of the society, and the smaller will be the society’s
future output growth. Of course if the surplus is large enough to keep savings up as well
as to create employment the slope of the implied trade off will be moderated accordingly.
In this situation we arrive at a negative relationship between employment and the growth
of output. This is the relationship which captures the impact of the social stability
requirement on the society and will be denoted by the line SS’.

In the diagram below we put together the two relationships described. Growth values are
shown on the y-axis using the symbol, Ÿ, employment on the x-axis using the symbol, E.

Growth of S
Output, Ÿ G

Ÿ*

S’

G’
0 E* Employment, E

Equilibrium Employment with Growth and Social Stability

We have arrived at a position where there would be an equilibrium holding between what
the private sector would like to do and what the public sector believes is necessary. In the

6
diagram this is shown as the combination of current employment at E*, and output
growth at Ÿ*. What are the properties of this equilibrium?

Properties of the Equilibrium

The first question which arises is whether the equilibrium is one of full employment.
From the analysis above all we know is that this equilibrium is one where social stability
is being maintained at an acceptable level while profitable production is being pursued.
What this means is that this is an equilibrium which is consistent with any level of
unemployment that the society is comfortable with. This could mean that the number of
persons unemployed is small enough to ensure that the burden being carried (through
welfare programmes) by the rest of the society is not an uncomfortable or an
economically threatening one. Of course, it could also mean that the persons
unemployed belong to a group not considered a threat to the society, probably because for
some reason, they do not mind being unemployed. The point here is that in this context
the equilibrium does not have purely economic properties. For as long as social stability
remains the cradle within which economic well-being is nurtured, the employment
equilibrium will be one where profit-making does not cause social instability and where
stabilizing the society does not eliminate the possibilities for future output increases. One
of the dangers is that if the amount of output that needs to be sacrificed keeps getting
larger, at some stage the policy will become untenable. It will therefore be important to
know how to avoid coming to this pass. We take this up in another section.

At this point it maybe useful to reflect somewhat on the broader implications of the
analysis above. To do this we ask the question: what is the theoretical basis of the
politico-economic equilibrium described? What is the nature of the environment within
which it will emerge?

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Outline of a Politico-Economic System

Before economics emerged as a social science, with a growing emphasis on its scientific
dimension, the discipline which engaged the attention of those interested in how people
in society went about building a standard of living for themselves and their loved ones
was called political economy. Presumably this was because it appeared very obvious that
major outcomes like income determination and the distribution of income did not emerge
without some element of contention among the key stakeholders in the society. Karl
Marx thought he was merely describing how the society operated when he posited that it
was struggle that was the basis of all outcomes that were important to people.5

As we moved to the latter half of the nineteenth century, however, another approach to
these questions gained ascendancy. This approach was dominated by the view that the
economic system is best described as a system of markets which operate in a way to
deliver all the answers which were being asked.6 We get wrong answers or sometimes we
get no answers when there is a problem with one or more of the markets. The solution
was then obvious: arrange to get the markets working as they should and create them
when they do not exist.

It is interesting that all these developments were taking place within the context of
countries that eventually became labelled as ‘developed’ or ‘first world’. In general, it
would seem that the development of the discipline of economics has served these
countries well. With the recognition that most of the people in the world do not live in
these developed countries, a special branch of economics – development economics –
emerged to try to find answers to the big question: how can these countries provide for
themselves the same kind of living standards which the developed countries were known
to be enjoying? Although the answers came with varying degrees of sophistication the
common thread seemed to be finding a way for these countries to accumulate a stock of
capital which would generate the incomes required.7 In more recent times emphasis has
grown on the human component of this desired capital stock.8

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While there is no doubt that the work of development economists has made a beneficial
difference to some of the countries targeted – a subset of Asian countries, in particular –
there is a sense that the majority of countries are yet to derive similar benefits. In some
cases, it has become difficult to identify the ways in which the economic analysis offered
today can meaningfully address the issues that seem to confront the ‘developing’
countries, as they have come to be called. Our interest of this study is the subset of
Caribbean countries and while the suggestion that the aim must be to convert low-savings
countries into high-saving countries is almost a logical truth, there remains a nagging
sense that we have not yet accurately represented the way these economies work. Many
pieces of the puzzle have been put out for our consideration but the knitting together
remains to be done.

The simple model that will be presented in this study is an attempt to set the knitting
together in train. The model does this by harking back to the early days of our discipline
when the political system was seen to be interwoven with the economic system. In fact
the model makes the bold claim that the only general equilibrium configurations that
make sense in contexts like those in the Caribbean are configurations that reflect
consistency between objectives and constraints that invoke a combination of economic
and political behaviours.

The Essence of the Politico-Economic System

The model begins with the assumption that all members of the society conscious enough
to be aware of these things are interested in the acquisition of incomes. This desire for
income is not for its own sake. For one set of citizens incomes are required so that they
could have a decent or acceptable standard of living. For another set the acquisition of
incomes serves their desire to accumulate capital. To this latter group, income for
consumption is secondary. Interestingly, this latter group will not be able to engage in the
capital accumulation process without making use of the labour that is owned by the group
whose ultimate objective is a decent standard of living. Labour therefore becomes the
first main economic link between these groups and since the labour has to be

9
compensated, the quantum of compensation becomes the first potential bone of
contention.

In a system where compensation for labour becomes the means by which individuals will
have access to the consumption levels they desire, the full employment of labour will be
an economic as well as a political necessity. It will obviously be an economic necessity
because of the link between income and consumption, and it will become a political
necessity because of the link between consumption and social stability.

This proposition leads us to the first assumption of the model, namely that, given the
motivation of the capital accumulation group in the society, the system will not have a
natural tendency towards full employment. Some writers like Kalecki argue that full
employment is not in the interest of this group.9 In our case we do not need to take this
position for the simple reason the since accumulation of capital - not full employment - is
that aim of this group, the maximandum in their objective function will not be
employment. What this means us that the rules they will follow in optimizing their
objectives will have no bias towards maximizing employment. Employment will be an
instrument for maximizing something else. Of course, this does mean that full
employment cannot happen in this system. However, if it does it will be accidental,
probably due to a favourable population scenario.

This posture on the part of the capital accumulation group is an interesting one since, as
we have suggested earlier, the political system requires full employment, or at the very
least quasi full employment, which would have the same desired impact on social
stability. In these circumstances it would be natural for the political system to fill the
void created by the operations of the economic system. The mechanism for filling the
void already exists in the form of the government’s fiscal instruments. The government
as a political entity is the repository of the “coercive power” that can be used to get the
resources required to fill the employment gap. The only issue that emerges is how it will
use that power.

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This brings us to the motives of the government for using its coercive power. There
would seem to be three such motives:
i) its political survival will depend on how it succeeds in maintaining social
stability;
ii) where there is an exogenous source of income being enjoyed by the
government, its sustainability may depend on the level of social stability;
and
iii) the class identity of the government will lead to an income distribution
pressure which goes beyond merely providing access to consumption.

In other words, there is no question that with the failure of the economic system to
generate full employment, the government will act. The general principle is that when
the economic system fails to impact positively on social stability, political pressures
begin to build up for the activation of a distribution mechanism and political leaders will
emerge to champion the cause. The result is that variables that begin with ostensible
economic determination are now affected by political action and there will be no such
thing as a purely economic equilibrium in this context.

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References

Barro, Robert J. 1991. Economic Growth in a Cross Section of Countries. The Quarterly
Journal of Economics, MIT Press, vol. 106 no.2: 407-443.

Domar, Evsey. 1946. Capital Expansion, Rate of Growth and Employment.

Econometrica.

Friedman, Milton. 1962. Capitalism and Freedom. University of Chicago Press.

Harrod, Roy. 1939. An Essay in Dynamic Theory. Economic Journal IL, pp. 14-33.

Hayek, F. A. 1992. The Fortunes of Liberalism: Essays on Austrian Economics and the
Ideal of Freedom. Edited by Peter G. Klein. Routledge.

Health Economics Unit. 2006. Review of Socioeconomic Conditions in CAREC Member

Countries (CMCs) Final Report.

Kalecki, Michal. 1990. Collected Works of Michal Kalecki, Volume 1: Capitalism:

Business Cycles and Full Employment. Edited by Jerzy Osiatynski. Oxford:
Clarendon Press.

Marx, Karl and Friedrich Engels. 2005. The Communist Manifesto. Filiquarian
Publishing, LLC.

Pantin, Dennis.1996. The Challenge of Youth Unemployment in the Caribbean: the Role
of Youth Employment Training Programmes. International Labour Organisation.

Rowthorn, R.E. 1999. Unemployment, Wage Bargaining and Capital-Labour

Substitution. Cambridge Journal of Economics, Oxford University Press 23 no.4:
413-425.

Saunders, Peter. 1987. Aspects of the Social Wage: a Review of Social Expenditures and
Redistribution. The Australian Economic Planning Advisory Council (EPAC).

Sefton, Tom. 1997. The Changing Distribution of the Social Wage. STICERD
Occasional Paper 21. London School of Economics.

Smith, Adam. 1976. An Inquiry into the Nature and Causes of the Wealth of Nations:
Volumes 1 and 2. Oxford: Clarendon Press.

Solow, Robert. 1956. A Contribution to the Theory of Economic Growth. Quarterly

Journal of Economics 70: 65-94.

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Endnotes

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1
Refer to Pantin (1996).
2
There are several pieces of econometric work which have confirmed the low degree of substitutability in a developing
country context. See Rowthorn (1999) for example.
3
Refer to Roger Hosein’s work on the Macroeconomic Overview of the Caribbean Region with Emphasis on Income, Fiscal
Balance, Employment and International Trade for the Health Economics Unit (2006).
4
Refer to Saunders (1987) and Sefton (1997) for example.
5
Refer to Marx and Engels (2005).
6
Refer to the work of free market economists such as Adam Smith (1976) Friedrich Hayek (1992) and Milton Friedman
(1962).
7
Refer to the Solow Growth Model (1956) and the Harrod-Domar Model (1939, 1946) for example.
8
Refer to Barro (1991).
9
Refer to Kalecki (1990).