The increase in expenditure can also have an adverse affect upon the labour market in general. With an increase in spending in education there can be a workforce with more and/or improved skills than there is currently. Lately there has emerged a plan to be in place by 2013 which raises the school leaving age from 16 to 18. This is aimed at preventing children from leaving school with little, or no, qualifications/skills. To fund this, there obviously must be a large increase in spending, however in the long run, the students which leave school will not only have the choice of low-paid work which does not require any skills and is low in demand, but they have the choice of careers in areas in which skills are needed and with a higher wage. Therefore unemployment is reduced due to an increase in skilled workers (resulting in more supply for skilled work (work that is in far more demand than unskilled work) and also because of an expansion of public sectors (creating more jobs). Thus in both these cases, it is safe to assume that due to an increase in public spending, unemployment is alleviated.
However, there are two large problems with the increase in public spending. Firstly there is the problem of a budget deficit. This is caused by spending more than earned from taxes. And putting it simply, the more of a deficit in the budget, the more debt the country gets into. At low levels of income, a budget deficit will occur. The low income suggests that the taxes are lower than should be and/or not enough output is being produced. Therefore, although this may be a problem, the solution is to increase government spending. With the increase of government spending, output (and thus income) will increase bringing the country into a budget surplus. It would not be sensible to leave output as it is and greatly increase taxes as it would not be popular with the people, and may cripple living standards and purchasing power. Therefore a budget deficit is a double edged sword in this sense because although there is a negative point with national debt, it does have a good side. The lack of output forces the government to act and the way to do this is my increasing government spending, thus the deficit spurns economic growth. This is known as Verdoorn’s Law.
Secondly, as spending can include the raising of wages (to entice workers and to meet union demands) the increase can (in the long run) cause unemployment as opposed to alleviating it. This is because the public sector itself has around 6 million employees Therefore if the average wage increases in the public sector, the private sector will follow suit and increase their wages in order to compete for workers. This will cause less demand for labour because with the increase in wages, the margin for profit will become much diminished. In other words, employers will not be able to afford so many staff and thus, as well as redundancies to save money, employers will no longer look for more staff leaving many people out of work. An example of this is in the United States of America. In the three states with the highest minimum wage (Washington, Alaska and Oregon) are the highest levels of unemployment in the country. Therefore it is safe to assume that a higher standard of wages would result in unemployment.
As another method of fiscal policy to ease unemployment, tax could be increased or decreased. An increase in tax would result in goods being more expensive (Value Added Tax). This increase in value of goods will mean that people will need to work more to purchase the same goods as before the tax rise. For people who are unemployed, this may attract them into employment as living standards will lessen causing something of an incentive to work. Therefore many people not seeking work will have a ‘push’ in order to urge them to hunt for work.
Alternatively the taxes could be decreased. The lessened taxes would make goods cheaper and income tax will be lowered therefore giving labourers more earnings and, due to the lowered VAT, letting them buy more for their money. This acts well in that the increased spending power of the labourer will result in more demand and with an increased demand comes increased supply as firms try to meet demands for more profit. In order to increase supply, the firms must invest in more labour. Therefore with the increase in demand for goods comes the increase in demand for labour in order to meet equilibrium supply and thus unemployment is cut. As this would be an increase in demand across the board, it would be safe to suggest that unemployment would decrease dramatically. This can be seen in the US between 1995 and 2005. In New York for example, the state and local tax is 13.86% and has an employment of 4%, yet in a state with lower tax, say South Dakota with 8.35%, unemployment is 3.2%. Not only is it clear to understand from this that lower taxes result in a cut in unemployment, we can see that it spurns economic growth as South Dakota has 13.5% growth in employment compared to a measly 8.1% in New York. This is also supported by Friedman’s Permanent Income Hypothesis, which states that the higher earners have a lower propensity to consume, but also insinuates that everyone will consume the same proportion of their household income, therefore meaning that if taxes where cut, more money would be coming into the home meaning more spending power. Although the percentage will stay the same, the amount spent will rise.
On the other hand the reduction in taxes could cause problems as well as solve them. According to Modigliani’s Life-Cycle Hypothesis, the mid-point in life when people are in adulthood and in full-time work is a time when people tend to have a higher propensity to save and a lower propensity to consume. Thus we can understand from this that the group with the largest spending power will, with their extra funds, save more as opposed to earn.
Overall, there are problems occurring with certain aspects of fiscal policy, such as an increase in unemployment in the long run with a higher minimum wage and a budget deficit. On the flip side however, the budget deficit would in fact spurn an increased output and therefore increased employment. And the pool of skills that would be available would greatly increase with the extra funding in education. Therefore, although the government could use fiscal policy well, there would be problems, but the main thing is that the fiscal policy can greatly cut mass unemployment and thus we can understand that the problems must be incurred as unemployment is the greater of the evils.
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