Economics Essay 93: Shocks and Unemployment

 Explain how demand-side and supply-side shocks might increase unemployment in an economy.

To provide a comprehensive answer, let's begin by defining the key terms:

1. Demand-side Shock: A demand-side shock refers to a sudden and significant change in aggregate demand within an economy. It can result from factors such as changes in consumer spending, investment levels, government spending, or net exports. Demand-side shocks can have a significant impact on the overall level of economic activity.

2. Supply-side Shock: A supply-side shock refers to a sudden and significant change in the production capacity or cost of production within an economy. It can arise from factors such as changes in technology, input prices, regulations, or natural disasters. Supply-side shocks can disrupt the supply chain, production processes, and the overall productive capacity of an economy.

Now, let's explore how demand-side and supply-side shocks can lead to an increase in unemployment:

Demand-side Shock and Unemployment:

1. Reduced Aggregate Demand: During a demand-side shock, such as an economic recession or a decline in consumer spending, there is a decrease in aggregate demand for goods and services. This reduction in demand can lead to a decrease in production levels and, subsequently, to a decrease in labor demand. As a result, firms may reduce their workforce, leading to higher unemployment rates.

2. Decreased Consumer Confidence: Demand-side shocks often impact consumer confidence, causing individuals and households to cut back on spending. This reduction in consumer spending can directly affect businesses' revenues, forcing them to downsize or lay off workers to compensate for the decline in demand.

Supply-side Shock and Unemployment:

1. Disrupted Production: Supply-side shocks can disrupt the production process by affecting the availability of inputs, technology, or resources necessary for production. For example, an increase in oil prices can increase production costs for many industries, leading to a decrease in profitability and potential job losses.

2. Structural Unemployment: Supply-side shocks can also lead to structural unemployment, where changes in the economy's structure or industry-specific factors render certain skills or job roles obsolete. For instance, technological advancements or shifts in consumer preferences may reduce the demand for certain products, resulting in job losses in specific industries.

It is important to note that the impacts of demand-side and supply-side shocks on unemployment can vary in magnitude and duration depending on the specific characteristics of the shock and the resilience of the economy. Additionally, government policies and interventions play a significant role in mitigating the negative effects of these shocks on employment through measures like fiscal stimulus, monetary policies, and retraining programs to facilitate the transition of workers to new sectors.

Overall, both demand-side and supply-side shocks can contribute to an increase in unemployment by affecting aggregate demand, consumer confidence, production capacity, and industry structures. Understanding these dynamics is crucial for policymakers to implement appropriate measures to support employment and promote economic recovery during times of economic turmoil.

Economics Essay 44: Economic Recovery from Shocks

Discuss the extent to which economies are likely to recover quickly from negative demand side shocks in reality.  

The speed and extent of economic recovery from negative demand-side shocks in reality can vary depending on the following factors:

1. Magnitude and Duration of the Shock: The severity and duration of the negative demand-side shock can significantly impact the recovery. For instance, the global financial crisis that started in 2008 originated in the United States with the collapse of the subprime mortgage market. The magnitude of the shock and its ripple effects led to a prolonged and challenging recovery for many economies worldwide. Countries heavily reliant on exports and with large financial sectors, such as Ireland and Spain, faced protracted recessions and slow recoveries. In contrast, economies with strong policy responses, like Germany, recovered relatively quickly due to their diversified industrial base and robust fiscal stimulus measures.

2. Economic Structure and Diversity: The structure and diversity of an economy can influence its ability to recover from a demand-side shock. For example, the Eurozone debt crisis affected countries such as Greece, Portugal, and Spain. These economies faced high levels of debt, banking sector weaknesses, and structural rigidities, which hindered their recovery. The need for austerity measures and structural reforms to address underlying imbalances slowed down their recovery processes, resulting in extended periods of economic contraction and high unemployment rates. In contrast, countries with more diversified economies and robust policy responses, such as Germany, demonstrated a faster recovery.

3. International Factors: Economic recovery can be influenced by global factors such as trade relationships, exchange rates, and international financial conditions. The Asian financial crisis in 1997 provides an example of the varying speed of recovery following a negative demand shock. South Korea implemented timely and comprehensive policy responses, including structural reforms, bank recapitalization, and international financial assistance. As a result, it experienced a relatively quick recovery. In contrast, countries like Indonesia faced more significant challenges due to political instability and delayed policy actions, leading to a more protracted recovery period.

4. Policy Response: The effectiveness and timeliness of policy responses play a crucial role in shaping the speed of recovery. The COVID-19 pandemic serves as a recent example of a negative demand-side shock. Economies like New Zealand and South Korea demonstrated quicker recoveries due to their ability to control the virus and restore consumer confidence through targeted fiscal measures and support for affected sectors. In contrast, countries heavily dependent on tourism, such as Thailand and Spain, faced significant challenges due to the sharp decline in international travel.

These examples highlight the diverse outcomes and factors that influence the speed and extent of recovery from negative demand-side shocks. The severity of the shock, policy responses, structural factors, and external conditions all play crucial roles in shaping the recovery trajectory of economies.

Economic Essay 43: Equilibrium and Demand Side Shocks

Explain the process by which neo-classical economists argue that the economy can adjust to long-run equilibrium following a negative demand side shock. Use a diagram to support your answer.

In response to a negative demand-side shock, an economy can adjust through various mechanisms. Here's a simplified explanation of the adjustment process:

1. Decreased Demand: A negative demand-side shock occurs when there is a reduction in overall demand for goods and services in the economy. This can happen due to factors such as a decline in consumer spending, investment, or exports.

2. Reduced Output and Employment: As demand decreases, businesses experience a decline in sales and may respond by reducing production. This can lead to lower output levels and potentially result in layoffs or reduced hiring, leading to higher unemployment.

3. Price Adjustments: In response to the reduced demand, businesses may lower prices to stimulate demand and attract customers. Lower prices can incentivize consumers to spend more, which helps increase aggregate demand.

4. Resource Reallocation: The adjustment process may also involve resource reallocation. Industries or sectors that were more severely affected by the demand shock may reduce their production and reallocate resources to areas with relatively higher demand.

5. Wage and Price Flexibility: Neo-classical economists emphasize the role of wage and price flexibility in the adjustment process. They argue that in a flexible labor market, wages can adjust downward, allowing firms to reduce labor costs and adjust production levels accordingly.

6. Market Rebalancing: Over time, as prices and wages adjust, the economy moves towards a new equilibrium. Lower prices and wages make goods and services more affordable, stimulating demand. As demand starts to recover, firms increase production, leading to a gradual adjustment and stabilization of the economy.

It's important to note that the adjustment process can vary in speed and effectiveness depending on the specific circumstances, market conditions, and policy responses. Additionally, the adjustment process may be influenced by factors such as the level of government intervention, the presence of rigidities in the labor market, and the availability of fiscal and monetary policy measures to support the economy during the adjustment period.

Understanding the Agnipath protest

--- Another view

Shekhar Gupta in The Print

The opposition to the Modi government’s ‘Agnipath’ scheme is being led by the articulate community of senior veterans on social and mainstream media, and by India’s dangerously burgeoning population of jobless youth. Especially in the Hindi heartland.

Counterintuitive though it is, we have to also note that these young people understand the nub of the ‘problem’ with Agnipath way better than the senior veterans do.

Most of the veterans are outraged because — among many things that they see as wrong with Agnipath — they think the Modi government is using the armed forces for employment generation.

The young see Agnipath as the opposite. They see it as an armed forces jobs destroyer, not generator. How, we will explain now. And why the very reason they are primarily angry makes a scheme like Agnipath good, we will explain as this argument unfolds.

First, the jobless young. They understand better not only because they know their politics better than venerable, well-meaning seniors with decades in uniform. They do as they come from the hyper-politicised and polarised heartland. They also know the hopelessness of the job market.

They see the absence of opportunity where they live and feel their own lack of skills needed for jobs in distant, booming growth zones. A government appointment whether in the railways, state government, police, anywhere is the only lifetime guarantee of a safe, well-paying job. The armed forces are by some distance the best.

We must not judge them because they “look like lumpen”, burn trains and battle with police. They are every bit as virtuous and deserving of our understanding as the millions of the best-educated who slog year after year paying enormous sums financing the booming ‘competition academy’ industry for those few UPSC jobs.

For the less resourceful or educated, for mere matriculates, an Army recruitment rally means the same thing as the big UPSC for those whose pictures you see in the full front-page advertisements in leading dailies from Unacademy, Byju’s, Vision IAS etc etc. They prepare just as assiduously for Army recruitment. How, ThePrint reporter Jyoti Yadav told us in this report from the rural heartland. 

The less privileged now see Agnipath as their own version of the UPSC being taken away. See it this way. Presume that UPSC exams weren’t held for two years because of Covid while millions prepared in hope. Now you announce that the recruitment for the All India Services will only be for four years and only one-fourth will get the full tenure.

Further, for like-to-like comparison, suppose you also set a new, lower maximum age limit to ensure our civil services remain youthful, and tough luck for those who grew too old in the past two years waiting. By the way, this is precisely why the government has now made its first Agnipath rollback and given this “one-time” maximum age relaxation to 23 years from 21.

Much bigger riots might break out in the same zones of the heartland if UPSC were disrupted like this. And you know what, our middle-/upper middle-class/elite public opinion will be entirely sympathetic to them. Even more than they might have been to the anti-Mandal protests and self-immolations in 1990. The “debates” on prime time and social media (which the Modi government takes much more seriously than people like us) would sound very different from what they do at this point.

I am not supporting the ongoing Agnipath protests or dismissing concerns over these as mindlessly elitist. These are a distressing, dangerous alarm for India. That our demographic dividend is becoming a wasteful disaster with crores of unemployed young seeing a government job as the holy grail.

No government can produce this many jobs. And certainly not in the armed forces, whose balance sheets and budgets are already an HR disaster. However flawed Agnipath might be, our armed forces need radical reform. But we need to understand these angry young people’s concerns.

Senior veterans erred instinctively into seeing this as a job-creating extravaganza exploiting the armed forces. It’s the opposite. Since India hasn’t held any recruitment rallies for more than two years, a “shortfall backlog” of at least 1.3 lakh has built up. It’s a cut of about 10 per cent from the pre-pandemic strength of the armed forces.

Here’s the math. Since only about 45,000 ‘Agniveers’ will be recruited now per year (compared to the usual 60,000 at full-tenure recruitment rallies), and only one-fourth will be retained after four years, this supposed shortfall will only rise. The most elementary calculation shows that at the current rate of 50,000-60,000 retirements each year, by 2030 the armed forces will field about 25 per cent fewer personnel than they did before the Covid break.

This will be a deliberate, substantive downsizing and a desirable outcome fully in tune with the global trend. The US military heavily cut its manpower and is reducing further, diverting dollars to standoff weapons and artificial intelligence. The Chinese PLA has been similarly downsizing. Agnipath can be fine-tuned, reinvented, renamed and relaunched. But something like it is needed.

Contrary to being a wasteful job-generating extravaganza, a tour of duty approach is to cut jobs, wages and pensions. The same money can go into drones, missiles, long-range artillery and electronics and minimising casualties in battles of the future. Even proper assault rifles in a resource-starved military machine. 

As respected former Army commander Lt. Gen. H.S. Panag pointed out in this article, an idea like Agnipath is well-intended, necessary and could do with improvements. But it is yet another rude reminder to the Modi government that however overwhelming, electoral popularity doesn’t empower them to enforce shock-and-awe change, no matter how virtuous. They’ve seen it with the now repealed farm laws, stalled labour codes and withdrawn land acquisition bill.

A big change has to be reasoned out, public opinion prepared. People respond to abrupt change in their hundreds of millions, have anonymity and safety in numbers unlike the few hundred fawning ruling party MPs, a few score of ministers or a dozen chief ministers.

Whether it’s land acquisition for job-creating industry and infrastructure, labour and farm reform to unleash new forces of entrepreneurship, or modernising the armed forces, you have to evangelise your ideas to people patiently. Allow a robust debate in public and Parliament instead of dismissing anyone disagreeing as anti-national or bought out by some evil force. It’s an ordinary, normal and inevitable exercise in the same democracy that gifts you extraordinary electoral power.

Finally, we need to look at the geography and politics — or shall we be cheeky and say geopolitics — of these protests. Geography first.

If you map the nearly 45 places where rioting has broken out, there will be a hornet’s nest of sorts in Bihar, eastern Uttar Pradesh, Bundelkhand, southern Haryana and Rajasthan.

We can safely classify these as India’s primary low-wage migrant labour exporting zones. Check out, for example, where the mostly poorly paid and security guards doing daily double shifts in your neighbourhood come from.

At least so far, this spark mostly hasn’t travelled South barring Secunderabad-Hyderabad. Let’s hope and pray it stays that way. Unlike the heartland, the south-of-Vindhyas states have their birth rates, education levels, investment and job creation much more sorted. It doesn’t mean that Indians there are any less patriotic.

And now the politics. With the farmers’ protests the epicentre was Punjab, the state least impressed with the Modi phenomenon in all of India as repeated elections from 2014 onwards have shown. This current anger comes almost entirely from BJP/NDA-run states, from the very core of the Modi-BJP base. It’s safe to presume that a vast majority of these angry young people are loyal Modi voters.

The lesson is, there is more to democracy than electoral popularity. You need to keep reasoning with your constituents all the time. Especially on why some drastic change they fear might be good for them. People have an immune system that detests and fears sudden change plonked on their heads.

The Modi government’s biggest flaw over these eight years has been its disinclination to accept the limitations of electoral majorities. This has already ruined land acquisition and farm reform and stalled the labour codes, and it will be tragic if the armed forces’ downsizing and modernisation is derailed too.