Economic View: Throwing government money around won't cut unemployment

The Keynesians are fighting back. A campaign is being waged, mainly within the Labour Party, against what has become the policy consensus on the causes of and cures for unemployment. It is taking place under the cover of obscurity provided by the debate about the European single currency and its effect on jobs.

At an Employment Policy Institute seminar this week, Christopher Allsopp, an economist from New College, Oxford, delivered a rousing attack on the notion that most European unemployment is due to structural problems rather than deficient demand. This notion is gaining ground rapidly among Continental politicians who observe that the deregulated British labour market finally seems to be fulfilling its jobs promise. This week's figures showed that claimant unemployment had fallen to a five-and-a-half year low, having declined in 40 out of the past 44 months.

The new orthodoxy therefore holds that the solution to mass unemployment requires deregulation, lower social costs for employers, greater competition, greater flexibility in the workforce and so on. An attempt to create jobs by stimulating the economy with extra government spending would be inflationary. It would also undermine the necessary progress on cutting budget deficits enshrined in the Maastricht Treaty.

Mr Allsopp's broadside begins with the reasonable observation that the pre-Maastricht policies risk creating a vicious circle. Slow growth leads to higher unemployment, a bigger government deficit - and the hunt for spending cuts that will slow growth even further.

The Maastricht deficit criteria are certainly being interpreted too strictly. The blanket 3 per cent of GDP ceiling does not make any allowance for the part of the budget deficit linked solely to the state of the economic cycle. With some potential EMU members clamping down on government spending when their economies are weak the results could be counter-productive. It would make more sense to have a cyclically-adjusted target.

However, the Keynesian counter-attack goes much further. Mr Allsopp denies the "orthodox" contention that government deficits are a problem at all, arguing that the size of the hole in government finances across Europe is caused by slow growth and high unemployment. Deficits are reacting passively to events elsewhere in the economy. The key to solving unemployment, and reducing the deficit, is therefore to stimulate private sector investment.

This view is echoed in a forthcoming book by Robin Marris, How To Save The Underclass*. It too diagnoses the cause of the unemployment problem as slow growth. Professor Marris's top policy recommendation is faster growth to be achieved by the payment of a higher wage for the low paid and lower interest rates. He also favours higher taxes and a more generous welfare state, to alleviate the situation of the underclass.

He agrees that the pre-single currency focus on budget retrenchment has compounded the problem of slow growth, and admires Kenneth Clarke, Chancellor of the Exchequer, for his lack of concern about the public sector borrowing requirement.

The notion that old-fashioned demand management policies will work in the Europe of the 1990s has a nostalgic appeal. But the argument that government deficits are just the result of slow growth and will vanish if growth increases is flawed. The key problem is that the parts of government spending that have mushroomed have been not mainly cyclical unemployment and social security payments but mainly structural spending on pensions, health and education. These are the luxury goods of the public sector - demand for them increases faster than national income rises. This does not mean there is no room for debate about taking a more relaxed attitude to demand management. But it does make the "orthodox" uncomfortable with the view that budget deficits will go away if only the government spurs growth.

As for whether more government spending would cut unemployment, it does not look promising that almost all of the job creation on the Continent since 1980 has been in the public sector, yet unemployment remains an appallingly high 11 per cent on average. The OECD countries have, incredibly, a higher share of their population working in the public sector than the former planned economies and far more than the inefficient governments of Latin America (8 per cent versus 7 per cent and 3 per cent respectively). Would the jobless rate really be lower if public sector employment were even more extensive?

The trouble with seeking to revive the policies dating from the 1970s is that the experience of the 1980s and 1990s has intervened. The structure of the economy has changed. The deindustrialisation that followed the oil price shocks has taken place - spending on public sector jobs will not recreate the lost parts of manufacturing industry.

It is one thing to argue that the Maastricht criteria are being over- rigidly interpreted and risk perpetuating slow growth on the Continent. It is quite another to use this as cover for suggesting a return to "tax and spend" more generally. It is going to be hard for the Keynesians to storm the citadel.

* How To Save The Underclass, by Robin Marris, to be published by Macmillan.