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Abstract
The employer of last resort (ELR) is a policy proposal designed as an alternative to using unemployment as the primary mean to control the value of the currency. This paper complements the analysis at the theoretical level and provides an estimate of the potential economic effects of an ELR program on the Argentine economy. According to the simulations within the historical economic cycle, the ELR (1) would permanently eliminate involuntary unemployment, (2) by setting an effective minimum wage equal to the poverty line, it would eradicate poverty—at least that originating in insufficient labor income—, (3) if combined with a quantity rule for non-ELR public spending, the policy could influence the size of the program and, thus, attempt to offset the acceleration (or deceleration) of inflation with respect to the target. In addition, the ELR would prevent the so-called “external constraint” from implying (as it currently does) involuntary unemployment (and poverty). In a sense, and as the simulated scenarios pretend to illustrate, an ELR would, at least, replace the tradeoff between the “two evils” (unemployment and inflation) by another between inflation and the proportion of ELR employment.
Notes
1 In fact, employment programs such as the Jefes y Jefas de Hogares Desocupados (Jefes) Plan, implemented in Argentina at the beginning of 2002, have been quite decentralized in their operations. The Jefes was considered by several authors to be a partial employer of last resort (see, for example, Tcherneva and Wray Citation2005). In relation to this, an anonymous referee suggested deducting the amount of spending in this program—and similar ones—from the total public expenditure, so as to depart -at the time of carrying out the simulations- from a series of “net from Jefes” public expenditure. The main reason why this path was not followed is that the Jefes was a program with substantial differences with respect to the ELR: it was not open to anyone who wanted to work at the wage set by the government—it was restricted to the heads of households with specific characteristics—; it was not permanent –it´s registration was for a limited time—; and, it did not pay a living wage –the poverty line exceeded the wage of the program—. Anyway, in scenario 2—as we will see in detail—, a “quantity rule” is assumed for public spending not destined for the ELR that results in a, generally, less expansive trajectory -with respect to the baseline scenario—. It could then be interpreted that, in this scenario, programs such as the Jefes, the unemployment insurance—and similar ones—would have been eliminated.
2 Reality is that there are not many other macroeconometric/structural models for Argentina. One that has been built by the government around ten years ago is the MME (Panigo et al. Citation2009). The MME is a cumulative causation model (of simultaneous, dynamic and non-linear equations that does not impose terminal conditions on the variables of interest), with markets in disequilibrium and stock-flow consistency, where macroeconomic risk acquires first order relevance, as does the fiscal gap, the use of installed capacity and the external gap. The main reason why I did not rely on it to perform the simulations in this paper is related to data availability: some series were not publicly available.
3 Average exchange rate in the base year (2004) equal to 2.925 pesos for dollar.
4 For the estimation of the equations, AW = (WF.JF + WU.JU) / L1. As it is assumed, regardless of the scenario, that the unemployed participate in the ELR program, the I-14 definition was used in the simulations.
5 Strictly speaking, ΔA is equal to the balance of the financial account (including the variation of international reserves) net of the balance of the capital account. Since a base value of zero is taken for A in 1992:4, the series has an error every period that is constant (the difference between the true value of A in the base period and zero). It is important to note that A measures the net position of foreign assets of the country vis a vis the rest of the world.
6 Excess labor is measured as follows. First Y/J is plotted for the sample period. Straight lines are drawn between the peaks (interpolation between peaks, defining a peak as an observation greater than the previous and the subsequent). Assuming that potential labor productivity (LAM) is on these lines, then Y/LAM is the minimum number of workers required to produce Y, which is denoted as JMIN in the model. The effective number of workers, J, can be compared with JMIN to measure the amount of excess labor (Fair Citation2018, 421–422).
7 These definitions assume that Argentina is a price taker with respect to its exports and imports.
8 The over-identification test consists of regressing the 2SLS residuals in the first-stage regressors and computing the R2. Then TxR2 is distributed as a chi-square with q degrees of freedom, where T is the number of observations and q is the number of regressors of the first stage minus the number of explanatory variables in the equation being estimated. The null hypothesis is that no regressor of the first stage is correlated with the error term. If TxR2 exceeds the specified critical value, the null hypothesis is rejected and it is concluded that at least some first-stage regressor is not predetermined (Wooldridge Citation2000).
9 As Mosler (Citation2014) points out: “The spot and forward price for a nonperishable commodity imply all storage costs, including interest expense. Therefore, with a permanent zero-rate policy, and assuming no other storage costs, the spot price of a commodity and its price for delivery any time in the future is the same. However, if rates were, say, 10%, the price of those commodities for delivery in the future would be 10% (annualized) higher. That is, a 10% rate implies a 10% continuous increase in prices, which is the textbook definition of inflation!”
10 As is the case in the FM: “The price and wage equations in the model have dynamic properties quite different from those of the NAIRU model…The NAIRU view of the relationship between inflation and the unemployment rate is that there is a value of the unemployment rate (the NAIRU) below which the price level forever accelerates and above which the price level forever decelerates.” (Fair Citation2018, 150). The NAIRU dynamic is strongly rejected by the data (results of this test are available upon request).
11 A restriction was originally imposed on the wage equation: given the coefficients estimated in equation 4, the restriction was imposed on the coefficients of equation 5 such that the real wage does not depend on the nominal wage or the price level separately (Fair Citation2018, 99–100). However, the restriction was rejected by the data.
12 There is a potentially destabilizing effect if the increase in employment and wages (as a result of the ELR program) reduces the labor supply, since this lower labor participation would deepen the reduction of the unemployment rate and the increase in the price level. The effect on the price level would then feed the determination of the average wage of the non-ELR employees. A reduction in the labor supply can encourage wage demands by accelerating the fall in the unemployment rate. However, the quantitative impact in the simulations is negligible (changes in the labor participation rate practically do not affect the unemployment rate). On the other hand, this effect could be counteracted by the counter-cyclical nature of the ELR spending.
13 Econometric simulations are subject to the Lucas´s critique (Lucas Citation1976). In this regard, Fair (Citation1994, 13) argued that “the logic of the Lucas's critique is certainly correct, but the key question for empirical work is the quantitative importance of this criticism". An attempt was made to capture variable relationships over time in the equations (break in the constant and/or break in the trend) (Fair Citation2018, 6–8). Controlling for the rest of the regressors, no variable effects were found over time.
14 ELR participants could come from those: i) employed (those who earn less than the program´s wage); ii) unemployed (although not necessarily every unemployed would join); iii) out of the labor force. As discussed, we assumed that full-time employees remain in their non-ELR jobs and their wages are increased until the ELR wage is the effective minimum wage of the economy. Further, we assumed that every under-employed and unemployed would join (and none from out of the labor force). It is difficult (and certainly not the goal here) to estimate the exact number of participants.
15 Defining the poverty line is “political”, but once established it makes no sense to set WELR below it. Since the second quarter of 2016, the National Institute of Statistics and Censuses (INDEC) modified the methodology for measuring absolute poverty (see Mario (Citation2017b) for more details). The value of the poverty line was, in the second quarter of 2019, 9814.25 pesos. Using the PY variable, this value was deflated to calculate the value of the poverty line in the second quarter of 2003—the relevant value at the time of the ELR implementation—. Through this procedure, a value of 318.78 pesos for a poverty line was obtained for 2003:2.
16 Fullwiler (2005), simulating the ELR for the US, indexes WELR to an inflation target of 2.5 percent per year. The problem is that—even assuming that the initial WELR is a living wage—if inflation exceeds the target, there would be no mechanism to ensure that WELR remains a living wage.
17 Not few economists presume that low rates are inflationary and the cause of currency depreciation, through a variety of channels. The problem with this argument is that it relies on the assumption that lower rates encourage borrowing to spend. At a micro level this seems plausible. But it breaks down at the macro level. For every peso borrowed in the banking system, there is a peso saved, so any reduction in interest costs for borrowers corresponds to an identical reduction for savers. That is, changing rates shifts income from one group to another. The net income effect is zero. The non-government sector, however, is a large net saver, as government is an equally large net payer of interest on its outstanding debt. In other words, the non-government sector is a net holder of government securities, which means there are that many more pesos saved than borrowed. Therefore, rate cuts directly reduce government spending and the non-government sector´s net interest income. As Mosler (Citation2014) points out: “In fact, theory and evidence points to the reverse—higher rates tend to weaken a currency and support higher levels of inflation”. In our model, as a matter of fact, the interest rate was not significant in spending equations (consumption and investment), but (as was discussed), was highly significant in the price equation—and affected the exchange rate through the impact of domestic prices on imports—.
18 In a previous version of the paper, a scenario was presented in which the application of the ELR was so expansive that the pool of workers was substantially reduced (even becoming negative). This was pointed out by an anonymous referee as something desirable as it reduced “the need for program financing". It is essential to have a quantity rule for non-ELR spending, although—as it was emphasized—more or less restrictive rules could be imposed vis a vis the one used here. The smaller the ELR pool, the lower the influence of WELR on non-ELR wages. In the extreme, “If the entire pool of ELR workers were absorbed in the private sector, then the market price necessary to maintain a small buffer stock of ELR workers would have risen above $12,500 [the WELR, AM], and the value of the currency would have been redefined downward (this is equivalent to the government losing its buffer stock of gold under a gold standard)“ (Mosler Citation1997–8, 179).
19 It should be noted that this is a “real” non-ELR expense (in millions of pesos of 2004). When spending on the ELR, the government sets the price and lets the quantity float (spends with a price rule). In the remaining expenses, the government sets the quantity of pesos (say, the budget) and pays market prices (it spends with a quantity rule).
20 Of course, more or less restrictive rules could be proposed for the evolution of non-ELR spending; the point is to show what is usually a misunderstanding about the design of the program, that is, that the ELR is not necessarily expansive in net terms. In short, the program allows for full employment to be sustained regardless of the level of effective demand (Mitchell and Wray Citation2005).
21 Indexation can drive up prices, but that could serve the public purpose. Referring to the “great inflation”, Mosler (Citation2010, 7) analyzes two possible outcomes: “The first was for it to somehow be kept to a relative value story, where US inflation remained fairly low and paying more for oil and gasoline simply meant less demand and weaker prices for most everything else, with wages and salaries staying relatively constant. This would have meant a drastic reduction in real terms of trade and standard of living…The second outcome, which is what happened, was for a general inflation to ensue, so while OPEC did get higher prices for its oil, they also had to pay higher prices for what they wanted to buy.”
22 Strictly speaking, these are effects on public consumption and not on the fiscal result. In fact, one limitation of the model, in its current version, is the absence of an equation for tax receipts. It is expected that, in addition to directly increasing spending, the ELR, through its effect on GDP, influences tax collection.