Why cutting public sector jobs doesn’t cause unemployment to skyrocket

WHILE visiting an Asian country in the 1960s, Milton Friedman observed a canal being built. As he walked around, he became perturbed by the lack of tractors or modern machinery. Instead, there were hundreds of men digging with shovels.

Turning to the government representative accompanying him, Friedman asked, “Why are there so few machines?”. “You don’t understand,” the bureaucrat replied. “This is a jobs programme.” To which Friedman paused, before replying: “Oh, I thought you were trying to build a canal. If it’s jobs you want, then you should give these workers spoons.”

The moral of this tale is, of course, that it is relatively easy to “create jobs”, as long as you’re willing to go against the grain of human progress. But this doesn’t mean that public jobs will be worthwhile or that they don’t come at a significant cost.

This story came back to me last week when I discussed youth unemployment with Will Hutton in a live TV interview. Hutton said that he believed the state should act as some sort of “employer of last resort”. The rationale would be to prevent unemployment and the erosion over time of general workplace skills.

Left wing commentators used this sort of reasoning when opposing some of the coalition’s spending restraint. Making public sector workers unemployed, it was said, when the private sector was struggling, would cause a double whammy on the unemployment figures – directly (due to the layoffs), and indirectly (due to the lower spending power of public sector workers).

Yet all of the evidence suggests this is wrong. Last week the Office for National Statistics showed that private sector employment grew by 708,000 between March 2012 and March 2013, more than doubly offsetting the 308,000 fall in public sector employment. Meanwhile, Giulia Faggio and Henry Overman showed in 2012 that high public sector employment in the UK regions changed the composition of employment, but ultimately led to crowding out of private sector jobs in the medium term.

A new IMF Working Paper by Alberto Behar and Junghwan Mok tests the left wing idea directly. Examining the effect of public sector employment across countries on both private sector employment and unemployment, controlling for other factors, it concludes that “a rise in government hiring would be offset by decreases in private employment, resulting in no change in overall unemployment”. Symmetrically, cutting the number of public sector employees would, for most countries, increase private sector employment.

This result is what most right-leaning economists would expect. After all, the government doesn’t have its own money. Increasing public sector hiring will, in turn, eventually lead to higher taxes or higher interest rates. Meanwhile, competition from the public sector, which at the moment provides more job security and higher-than-average wages, undermines private sector job take-up. And there’s also plenty of evidence that higher public spending lowers the productive growth rate of the economy in the medium term.

So while we need a certain number of public sector workers to provide and administer public services, the left wing argument that the government should “solve” unemployment by hiring is just wrong. In fact, more public jobs would increase the fiscal burden, retard the long-run growth rate of the economy, and wouldn’t actually reduce unemployment.

Ryan Bourne is head of economic research at the Centre for Policy Studies.

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