Full employment with a difference: In the first of four articles, Robert Skidelsky sees a way to get Britain working again

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The Independent Online
IN POLITICS everyone is apparently waiting for the Big New Idea, but there is no sign of it from the present leaderships of any political party, or if it is there, they cannot find fit music for their visions. Yet one idea struggling for life is coherent, big, in the context of the Eighties certainly new, and captures the movement of thought from Thatcherism to post-Thatcherism.

It is nothing less than the reinstatement of full employment as a goal of economic policy; but a full employment pursued not by expansion of consumer demand, as advocated by Keynes, but by supply-side policy; that is, by government action to make markets more efficient.

Over the past dozen years or so, to talk of full employment has been a guarantee of political ostracism. This was a legacy of the monetarist revolution. The pursuit of full employment was identified with lax monetary policy, disregard for balancing budgets, and unworkable incomes policies. The double result was stagflation - simultaneous high inflation and high unemployment - and industrial chaos.

The philosophic basis of the Keynesian revolution, whereby deficit spending was used to stimulate consumer demand, was overturned by Nigel Lawson in his Mais Lecture of 1984. 'The conquest of inflation,' he said, 'should be the objective of macro-economic policy. And the creation of conditions conducive to growth and employment should be the objective of micro-economic policy.' In other words, monetary and fiscal policy should be aimed exclusively at controlling inflation, leaving it to supply-side policy to reduce unemployment. There was no commitment to full employment. Rather, the idea was to free markets as much as possible and accept whatever level of employment and unemployment they ground out.

This demand for a return to minimal government was an understandable reaction to the collapsing corporatism of the Seventies. But the fact remains that the market reforms of the Eighties never produced anything like full employment. In the 14 years of Conservative government, unemployment has fluctuated between 6 and 12 per cent, a record at least as bad as the Twenties, which gave birth to Keynesian economics.

Prosperity of a sort will surely return in the Nineties. In fact, the British recovery has started earlier than on the Continent. But if the Government sticks to its low- inflation target without doing anything else, there is little prospect that employment performance in the Nineties will be any better than in the Eighties. The new Chancellor seems to recognise this. 'Low inflation cannot be the sole end of economic policy,' Kenneth Clarke said in his Mansion House speech on 15 June.

The reason we have to be more ambitious is severely practical. The Government will never put its finances in order - much less push taxes down - unless the economy works closer to its potential capacity. The higher the unemployment, the more the Government has to pay out and the less revenue it receives.

For example, one in six of the population at present is on income support. It is true that in the Eighties the budget was balanced with three million out of work. But this depended far more than we are willing to admit on three sets of windfalls: North Sea oil, the proceeds of privatisation and tax proceeds generated by the unsustainable Lawson boom.

The first two are largely exhausted, and no one wants a repetition of the third. As Michael Portillo presses for cuts in the health, social security and education budgets, he would be wise to heed Keynes's words: 'Look after unemployment and the budget will look after itself.'

However, we cannot cure unemployment by old-fashioned Keynesian methods. This is not just because discretionary fiscal policy is subject to political abuse, or will frighten capitalists. It is because expansion of the budget deficit will not solve the supply-side problems created by the 'conquest of inflation' in the Eighties.

Bringing down inflation did not just make capacity idle, it destroyed capacity: it forced plants to close, caused human skills to rust away. Economists have an unlovely word for the effect of this rusting of an economy: hysteresis. It means that the supply consequences of a depression are not automatically reversed by recovery, and implies that, to return to full employment, we have to rebuild supply. For this, we require a partnership between entrepreneurs and government.

We must distinguish between full employment and what economists call the natural rate of unemployment. The natural rate, the employment total with stable inflation, is related to the efficiency of the markets for labour and capital.

Unemployment will tend in the long run towards its 'natural' rate: in Britain, about 7 or 8 per cent at present. Full employment is more difficult to define but may be said to exist when most people no longer believe we have an unemployment problem. The natural rate of unemployment can be higher than what most people would regard as full employment: it is the gap between the two that policy must aim to close.

In the particular conditions of our time, the route to full employment runs through the supply side of the economy. Supply-side policy comes in two forms: let us call them Mark I and Mark II. The first means reducing or sweeping away obstacles to market transactions. Weakening trade unions, reducing taxation, lowering unemployment benefits, privatisation, and deregulation all fall into this category. The latest example is the abolition of wage councils; they did good in the Eighties and still have their place, but they did not restore full employment.

Mark II policies are more active. They start from the recognition that some markets are inherently imperfect, and that there is a case for 'second best' solutions. The labour and capital markets, the factor markets, can be made to work better with positive intervention, and sometimes because of positive intervention. Not the crude planning policies of the Sixties and Seventies, which included an attempt to plan incomes, but a battery of imaginative micro-reforms, introduced on the back of the present recovery.

If the upsurge of orders that will come with recovery is not to lead to an upsurge in inflation and a falling pound, it must be met by an increase in supply. Labour and capital markets must be geared up to meet this challenge. In securing that response, government has an active part to play.

The author is chairman of the Social Market Foundation. A fuller version, 'Beyond Unemployment', can be obtained from the SMF, price pounds 6 (071-222 7060).