Increasing Returns and the Foundations of Unemployment Theory
Current approaches to macroeconomic theory divide, roughly, into two basic schools of thought. One approach, typically associated with 'rational expectations', views the economy as basically at or near Walrasian market clearing equilibrium, in which case it becomes very difficult to explain away convincingly the undeniable persistence, at times, of involuntary unemployment. Another approach views the underemployed economy as being in a state of temporary fixed price disequilibrium, in which case, aside from having to repress suspicions that the essence of effective demand failure might not have to do with prices fixed at 'wrong' values, there is a lot of rationalising to be done about why profitable adjustments are so slow. This paper argues that something like an internally consistent theory of steady state involuntary unemployment is possible, and even plausible. The cornerstone of this third approach is increasing returns to scale, which blocks unemployed agents from breaking out of a low level equilibrium trap unless there is overall coordination or stimulation. A simple model is presented which contains the basic ideas.