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Does it Make Sense to Increase Labour Supply to Stimulate Economic Growth?

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Introduction

The Australian Government recently released the 2015 Intergenerational Report in an effort to educate the Australian public on the challenges facing the government and society by 2055. According to Treasury’s modelling, net debt would increase from 15.2% of GDP to 60% by 2055. Per capita income growth would increase from 1.7% per year to 1.5%. What does the Australian Government propose to do about it? Their answer is to increase participation and productivity – i.e. increase the quantity and quality of inputs used in economic growth. The government seems to mean increasing labour supply and improving labour productivity. But does this policy prescription actually make sense?

Context of Labour Supply

Labour supply is bought and sold on a labour market like any good. Yes, it’s more personal and it is about humans not inert objects. Specifically, it is a market for time – i.e. I am prepared to work for $x for you given my skills and experience. So, that means there must be some form of demand. Demand in the labour market is driven by employers across the economy. In theory, where the intersection of labour supply and demand meets, the wage rate is set and all those who are willing to work at that price will be able to find work.

But what happens if you increase labour supply? Assuming that employers do not increase their demand for labour, then the wage rate will fall. In the real world, there is often a minimum wage rate that legally prevents people being paid less than that. It also means that those who are willing to work below the minimum wage may not always find work. The result is unemployment – too many people chasing too few jobs.

What if labour demand increased? If labour demand increased more than the increase in labour supply, this could actually reduce unemployment. It would appear that any discussion of labour supply policies needs to include demand. Raising the expectations of vulnerable people could be as damaging as giving them no hope.

So what tools do governments have to stimulate labour demand? At the macro level, governments can adjust fiscal policy. Some governments may be able to directly adjust monetary policy or at least have a strong influence on it. With fiscal policy, governments could increase spending or reduce taxation which would create demand for labour and supplies across the economy. Monetary policy could be loosened to stimulate demand for credit in the private sector. Both of these can work in the short-term but could leave governments with unsavoury policy problems in the longer term.

In most countries, fiscal policy is not an option. Many governments already face debt issues and are more interested in reducing spending and/or increasing taxation. In Australia’s case, the government has specifically targeted national debt as a long-term problem to be fixed. So, labour demand is unlikely to be used to stimulate labour demand in the short-term.

For monetary policy, I have previously argued that loose monetary policy may actually be more damaging for the economy (see ‘Housing Bubbles as Economic Policy’ and ‘Too Big to Grow’). In short, loose monetary policy benefits the financial sector and encourages investment in less risky assets such as housing. Easy credit may starve innovative sectors of credit and skilled labour as the finance sector crowds out the productive sector. I am arguing that loose monetary policy may actually harm the Australian Government’s desire to increase productivity to meet the intergenerational challenge.

What about micro-level policies to increase labour demand? There is mixed evidence on the efficacy of labour market policies to increase demand. What is clear is that there is growing evidence that could be used to tackle unemployment such as vocational training matched to employers’ needs. Unfortunately, governments persist in choosing ineffective policies such as ‘Work for the Dole’ more for the ‘optics’ than meaningful impact.

Labour Supply Policies

Even if labour demand did increase, it is not a given that increasing labour supply would be absorbed. The reality is that employers have specific needs for their businesses and cannot hire anyone available. Labour supply policies that fail to equip unemployed people with the right skills to thrive in a workplace are unlikely to create long-term employment opportunities. At worst, they may actually make it more difficult for unemployed people to find a job (e.g. ‘Work for the Dole’).

Obviously, if labour supply policies provide the skills to do a certain job and how to interact in a workplace, this increases participants’ ability to find and keep a job. Such individual case management is often more costly but could be more effective for the participant. However, job placement policies (such as Job Network Australia) may inadvertently encourage ‘cream-skimming’ rather than assist the long-term unemployed. This is especially relevant for ‘work focused social enterprises’ that aim to provide such intensive case management.

Is there a Better Way?

Work focused social enterprises could be part of a solution to matching labour supply to demand. However, these organisations may be more appropriate for local rather than broad-scale reductions in unemployment. And how job placement policies influence their activities may affect their impact.

Recently, Business Council of Australia (BCA), Australian Council of Trade Unions (ACTU) and Australian Council of Social Services (ACOSS) in Australia advocate a ‘demand-led’ approach to resolving unemployment. Conceptually, this could help target increasing labour supply to match what employers are demanding. Currently, this proposal is a bit light on for detail. Hopefully, some interesting findings will come out of their Expert Roundtable.

While more research needs to be done on labour demand policies, the findings are clear that labour supply policies need to be designed carefully to achieve meaningful reductions in unemployment and to supply the right type of skills that a country needs for its future prosperity. That would seem to make sense.