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The end of Keynesianism as employment policy.

While unemployment in the Organization for Economic Cooperation and Development (OECD) countries has been well documented, few critics recognize the member nations' growing inability to absorb new and redundant workers during the economic expansion of the 1980's. But John Cornwall, in The Theory of Economic Breakdown: An Institutional-Analytic Approach,(1) and Fritz W. Scharpf, in Crisis and Choice in European Social Democracy,(2) share the conviction that unemployment remains a profoundly critical problem in Western economies.

Unemployment in the OECD averaged 7.1 percent during the cyclical expansion from 1984 to 1990--more than twice as high as in the expansion of the 1970's in Europe. In Germany alone, unemployment averaged 5.4 percent for the period, compared with 0.8 percent over the 1970-74 span. U.S. unemployment rates approached recession highs of the 1950's. The proportion of long-term unemployed swelled to one-half to two-thirds higher in 1989 than in 1979 (both years being, or being close to, cyclical peaks). The OECD estimates the number of unemployed workers will average 30 million in 1992.

Both Cornwall and Scharpf view high unemployment as rooted in institutional and political factors. Both see the problem in strictly macroeconomic terms. They leave aside all analyses of changes in the age or gender composition of the labor force, and they similarly slight structural unemployment and the active labor market policies designed to cope with it. Instead, they focus upon the dilemma of Keynesian macroeconomic policy which arose after the mid-1960's, and intensified throughout the 1970's, only to disappear when strict monetarist policies supervened in the 1980's: governments could no longer manage fiscal policy in a way which would achieve both full employment and price stability. The dilemma intensified in nearly all of the Western countries that viewed full employment as a political goal above all others. For full employment could evidently no longer be ensured without inflation-yet, inflation put upward pressure on interest rates, thus tending to lessen profitability, and injure balance of payments.

The Keynesian dilemma

Both authors make skillful use of international comparisons in order to highlight the reasons for the varying degrees of success with which governments in OECD countries attempted to reconcile full employment with low inflation. They do so, however, within a framework of broader considerations: their findings of variable success lead them to reject, albeit in qualified ways, theories that try to explain low productivity and low economic growth, high unemployment, and inflation through institutional behavior. These theories view the economic ills in terms of "a general overburdening of the productive forces of capitalism"; "institutional sclerosis" arising from the proliferation of organized interest groups; the inevitable stagnation of industrial innovation from growing institutional "rigidities"; or the intolerance of "ruling capitalist classes" to prolonged periods of full employment and inflation.(3)

Cornwall and Scharpf both reject these theories as being relevant to macroeconomic policy. Schaxpf's detailed statistical findings lead him to assert that to disregard the role of government, "would be justified only if the economies of all Western industrial countries had run the same course and their policies had produced the same results. But this is not the case."(4) And Cornwall writes that, while "the origins of the current difficulties are to a large extent institutional," and while institutional adjustments are necessary, "arguments which deny the role of restrictive aggregate-demand policies in today's breakdown and a place for stimulative aggregate-demand policies in a program for recovery are factually incorrect and dangerous." He adds that, contrary to the beliefs of monetarist economists, "capitalist economies are not self-correcting."(5)

Focusing on four countries run by social democratic governments during the 1970's and early 1980's, Scharpf devotes a large part of his book to describing and analyzing the politics of Keynesianism--the relationships between political and economic forces that affect macroeconomic policy. Scharpf also shows how a student of economic policy conflicts in the past two decades should understand the social democratic parties' programmatic goal of full employment. Cornwall, by contrast, does not take the ideological factors into account that, at least until the end of the 1970's, gave impetus to the priority of full employment, and an edge to the struggle for that goal. He attributes high unemployment to policies designed to increase slack in the economy in order "to curtail inflation or to correct balance-of-payments difficulties."(6)

The "economic breakdown" in Cornwall's tifle manifests itself in the "policy-induced unemployment and continued high inflation," and ultimately stems from an inability "to implement a successful social bargain."(7) Unemployment in the United States, for example, was indeed high during the cyclical upswing of the 1980's compared with other post-World War II expansions. But Scharpf, in contrast to Cornwall, rejects the idea that this unemployment was "induced" by a restrictive aggregate-demand policy. The enormous Federal budget deficits clearly helped sustain demand, even though high interest rates kept the dollar high and induced rising imports through the mid-1980's.

Cornwall's notion of "social bargain" refers to the tacit understanding between labor and management that by and large prevailed between the 1940's and the 1970's. Management would not challenge trade union activity and would regularly increase real compensation on the condition of continuously rising productivity and relatively high rates of growth. Cornwall shows how Austria, Sweden, and Norway were transiently successful in implementing these social bargains during the 1970's. No such bargain has been documented in Japan, but its unemployment remained low despite high inflation. During the 1980's, social bargains, such as they were, wilted under the pressure of factors beyond the control of elected national authorities. In the United States, for example, fight monetary policy imposed by the Federal Reserve beginning in 1978-79 dampened the expansionary effects of deficit spending.

Cornwall fails to examine the reasons why his "social bargain" broke down, nor does he explore the possible economic bases for a new one. He also ignores the question of who the partners to social bargains would become once organized labor in all but a few smaller industrial countries constituted less than 40 percent of the nonfarm work force.

The contribution of Cornwall's work lies less in his institutional analyses than in his rebuttal of ruling economic theories. He rejects the notion that competitive labor markets would "clear' if it were not for "monopolistic" trade unions. In particular, he examines the econometrics of the vertical Phillips curve (which relates unemployment to rising prices when it declines below its "natural" rate). Cornwall disputes neoclassical economists' assumptions of voluntary unemployment--representing a choice of leisure over work--and other contributions to a "natural" rate of unemployment. He writes, "Unfortunately, the acceptance of the vertical Phillips curve has led economists to seek explanations other than insufficient aggregate demand for the persistence of high unemployment."(8) He concludes, "The natural rate hypothesis must be rejected for a number of reasons, but its built-in automatic full-employment tendencies, largely because of a competitive-haggling wage-setting process, is more than sufficient cause indeed....(9) Persuasive as Cornwall's rebuttal of ruling labor market theory is, his own insistence that the cause of unemployment in OECD countries has been deficient aggregate demand, and that appropriate Keynesian policies could overcome the deficiency, is not convincing.

Cornwall and Scharpf diverge when explaining both the causes of, and implied policy corrections for, relatively high unemployment. They both hold that Keynesian policies scored significant success over roughly the first quarter century after World War II. But where Cornwall accepts the Keynesian explanation of insufficient aggregate demand for the unemployment of the past 10-15 years, Scharpf blames such unemployment on the failure of social democratic governments to readjust their goals when faced with inflationary shocks.

Cornwall holds that"radical" institutional adaptations would have permitted (and would permit) the continued success of Keynesian policies. He does not specify those adaptations; his remarks about the "social bargain" merely imply them. Scharpf rejects any such belief, arguing that in the aftermath of the 1970's and of inflationary wage pressures, the Keynesian approach could no longer be sustained--even less so as global capital flows further impaired the effectiveness of Keynesian policies executed within national or even regional borders. The clashes between governments' full employment objectives and the increasing monetarism of the major central banks--the Bundesbank since 1973, the Federal Reserve at the latest since fall 1978-could not go on indefinitely. By the early 1980's, monetarism had carried the day.(10)

Scharpf limits his analysis to Austria, Sweden, the United Kingdom, and the pre-unification Federal Republic of Germany. All four nations were led by social democratic governments committed to full employment. But this commitment was conditioned upon the profitability of nonfinancial investment and a healthy balance of payments, which in turn depended on stable prices. Full employment, however, enabled labor to press for rising real compensation, jeopardizing price and interest rate stability.

Post-War social democracy

The European social democratic movements aspired to the democratic control of capitalism. The enormous human and political losses of the Great Depression, then fascism and war, were etched in the European collective memory. The social democrats hoped to banish capitalist business cycles and theft crises as the fate of modem man, and particularly of working people, by incorporating Keynesian control of the economy into a democratic political system.

The 1950's and 1960's. While the idea of capitalism as an exploitative---even immoral-economic system remained part of the social democratic ideology in the 1960's, advocates believed that democratic controls would in time mitigate capitalism's associated evils. In effect, instituting socialism as a political system was erased from the agenda of social democracy, especially as it became identified with Soviet totalitarianism and economic scarcity.

Even so, Scharpf writes, no genuine "convergence of interests" developed between social democratic parties and business and its allies. The exception was Austria, where the Left had upheld the common interests of labor and capital, and had stressed economic growth and investment over redistributive goals since the end of World War II. (11)

In Germany, too, the social democratic movement had abandoned its antagonism toward entrepreneurs by the late 1950's. Germany's 1959 Godesberg program supported the autonomy of employer and employee organizations as integral to a liberal order. But, Scharpf argues, the attempt at "concerted action" initiated by the German ministry of economics after the social democrats entered the government in 1966 (meant as a forum for employers, trade unions, and the state to thrash out macroeconomic policies) came to naught;(12) no viable corporatist institutions, no open recognition of common interests evolved.

The 1970's. Much of Scharpf's book narrates the differences in the responses of the four countries on which he focuses to the oil shocks of the 1970's and the associated price jumps along with the wage pressures, the slowdown in employment growth, and the mounting unemployment of the era. He relates the degree of success with which they met these problems to the extent to which their governments and businesses cooperated in setting macroeconomic objectives. The validity of his thesis is borne out by a comparison between the rates of inflation and unemployment in the four nations. Scharpf presents the following table in chapter 3 of his book. It shows annual average unemployment rates and rates of change in gross domestic product deflators over the 1974--79 span.
 Employment Inflation
Austria .......... 6.0 1.8
Germany (old FRG). 4.8 3.2
United Kingdom .. 16.1 5.0
Sweden ......... 10.6 1.9

Scharpf attributes Austria's comparative success in reconciling low unemployment with low inflation to a close collaboration between business and labor, and to an avoidance of a macro-economic policy driven purely by government. By contrast, trade unions in the United Kingdom (subject to competitive wage struggles owing largely to their internal divisions) took uninhibited advantage of the government's full employment policies. Scharpf says this compelled a "stop-go" pattern: the government could only stop the inflationary impetus of trade union demands and the deterioration in the balance of payments by creating economic slack and temporarily retreating from a full employment fiscal policy.

As noted, the German social democrats proved unable to create the corporatist institutions that might have lent continuity to their attempt at "concerted action" involving business, labor and the state. "Keynesian corporatism" thus failed during the 1970's, as Scharpf argues. Neither co-determination (limited to a very few older line industries, such as coal and steel) nor work councils (organized in individual plants only) nor the labor federation (which lacked authority over its constituent unions) were able to agree in devising a macroeconomic policy. Most important, Scharpf notes that, unlike the other three social democracies, the German Bundesbank, like the Federal Reserve, functioned independently of government policy and in fact resisted any employment program that threatened more inflation. (13)

The Germans' employment record in the 1970's was actually worse than the average 3.2-percent unemployment rate suggests. Only in Germany did the number of persons employed decline during the 1970's; the labor force participation rate of persons 15 to 64 years old also dropped. (14)

"End of the Keynesian interlude." One of the last chapters of Scharpf's book is aptly titled, "End of the Keynesian Interlude."(15) In each of the four countries he examines, unemployment rose after 1979; employment receded in three of them. (In Sweden, employment rose only slightly.(16) The institutional differences that underlay any earlier policy successes no longer mattered so much.

What were the reasons? The sharply restrictive credit policies of the Federal Reserve initiated in 1978 (and intensified in 1979, partly to counteract the inflationary effects anticipated from the doubling of world oil prices that year) caused interest rates to rise steeply worldwide. Scharpf shows that unemployment consequently rose (especially in the United States), economic growth diminished, and inflation abated. While, as Scharpf writes, "the monetarist cure took," that cure "was a catastrophe and the fiscal expansion after 1982 a mixed blessing for the European OECD countries."(17)

The steep rise in interest rates in the United States compelled parallel rate hikes in at least the other key OECD member countries, which were linked by international capital markets. In France, for example, the socialist government lowered interest rates in 1981 as part of its Keynesian employment policies, but it could not halt the flight from the franc until it reversed course. High interest rates constrained investment, as profitability had to exceed real interest rate levels of 6-8 percent in the United States; high-yielding financial instruments thus easily diverted funds from more productive investments.

Autonomous national economic policy, on which the Keynesianism of the four social democratic countries had been predicated, was thwarted by the globalization of capital markets, the continued dominance of the dollar and the rise of international monetarism--the rigid linkage of interest rates to price stabilization--as guide to policy.

Thus, Scharpf maintains, the "terms of trade" between capital and labor shifted in favor of capital. He faults proponents of social democracy for not recognizing or accepting this shift. To have done so would have entailed accepting lower wage increases--perhaps even settling for cuts--to safeguard the commitment to full employment and welfare state institutions. In other words, Scharpf says that social democracy should have retreated from its traditional goal of redistributing income from capital to labor.

If, as Scharpf writes, "an increase in profits was to be had only through redistribution to the disadvantage of workers,"(18) and if such an increase was the only means available to sustain high employment, Scharpf's data (as well as data published subsequent to his book) do not fully bear him out. True, real wages and employment dropped, and unemployment rose in all four countries. But gross capital formation as a percent of GDP receded in all four countries,(19) even though expectations of larger profits should have stabilized this ratio. Rates of return on capital in the business sector declined in Germany and Austria between 1975-79 and 1980--87; they rose slightly in the United Kingdom. Only Sweden saw higher returns, as higher import prices from devaluation of the krona were not offset by wage hikes.(20) These profitability figures do not give clear evidence of Scharpf's redistribution from labor to capital, although there may well have been a shift of capital and earnings premiums away from the countries he studied.

Structural unemployment

Both Scharpf and Cornwall neglect structural unemployment as one of the growing barriers to applying Keynesian aggregate-demand policies. The difficulties of relieving structural unemployment-whether discussed in terms of obsolete or inadequate skills and education, or in terms of declining industries and regions-have been argued since the 1950's, especially in the United States. Training, worker relocation, and other active labor market policies have been recurrently proposed but often not resolutely pursued. Only in Sweden have these policies been high on the employment policy agenda, where Scharpf says they truly contributed to reducing joblessness.

Yet, global capital markets and newly mobile capital have probably deepened the problem of structural unemployment in the OECD countries. This mobility has not just meant shuffled investment funds and currency speculation. It has also meant extending supplier networks beyond national borders and shifting some important mass production facilities or whole industries away from their former core regions.

It is hard to see how effectively Keynesian policies can deal with global capital markets. These policies rely not only on national borders far less porous than they have become over the past 20 years, or on mass consumption, but also on the income derived from mass production systems within the same borders in which mass consumption takes place. The preconditions of Keynesianism thus have disintegrated.

Scharpf discusses, but also dismisses, the possibilities of international coordination of Keynesian policies advocated by leading social democrats. He believes that the barners to such coordination cannot be overcome. Thus, he is as consistent in his argument that Keynesian strategies have ceased being realistic as Cornwall is in his assertion that there are no alternatives to them in alleviating unemployment.

Although one argument is the reverse of the other, both derive from a focus on macroeconomics. The microeconomics of structural employment problems is ignored by both authors, yet it may now be the more urgent field of analysis.


1. John Cornwall, The Theory of Economic Breakdown: An Institutional-Analytical Approach (Cambridge, MA, Basil Blackwell, 1990), 256 pp. $49.95 (cloth).

2. Fritz W. Scharpf, Crisis and Choice in European Social Democracy, Translated from the German by Ruth Crowley and Fred Thompson. (Ithaca, NY, Cornell University Press, 1991). 303 pp. $17.95 (paper).

3. Scharpf, pp. 5-6; Comwall, some of whose arguments parallel Scharpf, pp. 1-4.

4. Scharpf, p. 7.

5. Cornwall, pp. 4 and 5.

6. Ibid.,p. 41

7. Ibid., p. 235.

8. Ibid., pp. 48 and 50.

9. Ibid., p. 57

10. Scharpf, p. 243.

11. Ibid., p. 179.

12. Ibid., pp, 119 and 122.

13. Ibid., pp. 210 and 133.

14. Ibid., p. 48.

15. The original German title of Scharpf's book reads, "The End of the Keynesian Strategy."

16. Scharpf, p. 239.

17. Ibid., p. 239.

18. Ibid., p. 251,

19. Ibid., p. 250.

20. OECD data.
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Author:Brand, Horst
Publication:Monthly Labor Review
Date:Dec 1, 1992
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