Employment Theory

THE GREAT DEPRESSION of the 1930s in the United States and Europe presented an economic dilemma: classical economic theory, which held that employment levels would be maintained if supply matched demand, did not prove to be true. Unemployment was rampant and persisted through several years of that decade. It became abundantly clear that the classical economic theory was in need of close scrutiny. The eminent economist John Maynard Keynes provided the new perspective needed in his seminal work, The General Theory of Employment, Interest, and Money, published during the height of the Depression in 1936. Keynes rightly predicted that the publication of his book would cause a revolution in the way economists would deal with questions regarding the aggregate economy.

Keynes correctly concluded that the operation of the economy and the maintenance of healthy levels of employment depended on the intervention of the government in the creation of public works and the use of deficit spending to create more jobs and increase purchasing power. Keynes argued that the knowledge of government in economic matters was superior to that of the market. This was especially true, Keynes suggested, because of the uncertainty that existed in the aggregate market. He concluded that the classical economic explanation of employment couched in a balance between supply and demand was simplistic at best.

[Page 307]The experience of the Depression years proved the classical theory to be wrong. Despite the frequent existence of a balance between supply and demand during the Depression period, employment levels remained excessively low. Keynes concluded that low levels of employment resulted from discrepancies in the factors of savings and investments, which in turn result in economic instability.

Keynes proposed that any shortfall in private investment (caused by higher-than-average rates of saving) could be countered by governmental financing through deficit spending. Keynes introduced “standardized national income accounting,” a concept that eventually led to the introduction of the Gross National Product, a standard measure in economics today. Following World War II, Keynes was instrumental in the creation of a new currency system and was one of the founders of Bretton Woods accord, an institutional predecessor to the World Bank and the International Monetary Fund (the primary institutions in the relief of poverty around the world today).

Keynes pointed out that a firm that was unable to increase investment due to low product demand could be assisted by government spending to stimulate demand for the product, which would alleviate the economic disequilibrium and expand the economy. Demand in the private sector could be increased, according to Keynes, by either government financial intervention or the lowering of taxes. Keynes insisted that fiscal policy would be the most effective approach to flagging economic demand. The term managed capitalism has been used to characterize the Keynesian theory, as evidenced by the expanded role of government in stabilizing the economy, but not taking full, literal control of it.

The work of Keynes laid the foundation for the field of macroeconomics, the subdiscipline that deals with overall economic questions and governmental use of fiscal policy (spending, taxes, and deficits). The government becomes a key player in striving toward maximizing employment. In times of faltering economic conditions, the government could move to reduce taxes, increase spending, create public works programs, or some combination of these approaches, in order to increase purchasing power and stimulate economic demand.

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