Political Economy: Economic Problems

Dangers of Unemployment

Unemployment is a problem because it means that some people in society are not making any money, which puts them in grave danger of tremendous poverty or worse. When unemployment rises to high levels, those without jobs may become hostile to the government, blaming it and their leaders for their situation. At such times, political shakiness or insecurity can result.

In extreme cases, governments have fallen due to their high rates of unemployment.

Example: During the Great Depression, unemployment was extremely high around the world—approaching 30 percent in some places. The large number of jobless people created tremendous instability in many countries, including Germany. There the high unemployment, along with hyperinflation, contributed to the rise of Nazism. The middle class was financially wiped out, and many citizens began to blame the new democratic government and saw the Nazi Party as a positive regime change.

Unemployment rates vary from place to place within a country. In the early years of the twenty-first century, for example, unemployment in Washington State was higher than in most other places in the United States because the Seattle-area economy is heavily dependent on high-tech industries, which underwent a serious slump around this time. Likewise, the closing of a factory can devastate the local economy even if the rest of the nation’s economy is strong.

Inflation

Inflation occurs when the prices of goods and services begin to rise. Analysts measure inflation as a percentage increase in price over the course of a year. So, if inflation is 10 percent, an item that costs $1 will cost $1.10 a year later. The official inflation rate is an average of price increases for all goods and services, so it may not apply exactly to any one given good.

Inflation also means that the currency becomes worth less. In the above example, one dollar is now worth less than it once was. Economists refer to this decrease as a decline in buying power, which is the amount of goods and services money can buy. In other words, if a person’s salary stays the same but inflation occurs, her buying power will go down. This person will be poorer because she can no longer afford the things she used to buy as the price of those goods increases.

Example: According to the Bureau of Labor Statistics, $1 from 1989 had the buying power of $1.73 in 2009. In other words, if a hamburger cost you $1 in 1989, you’d have to pay $1.73 for it today. This difference of $0.73 many not seem significant until you start purchasing more expensive items. A car that cost you $10,000 in 1989 would cost you more than $17,000 today, and a $100,000 home in 1989 would now cost you more than $170,000.

Excess Demand

In general, the basic law of supply and demand causes inflation. When the demand for something exceeds supply (what economists call excess demand), the price goes up. Excess demand and high inflation have a variety of causes:

A bad harvest
Shortages due to war
A natural disaster
Increased consumer desire (that is, more people wanting a particular good)
Increased consumer spending power

Other factors contribute to inflation too, such as when a company intentionally underproduces an item to drive up prices or when a government steps in to increase or decrease inflation. We cover the economic policies of governments later in the chapter, particularly in the sections on fiscal policy.

Dangers of Inflation

High inflation (defined as more than 5 percent in North America and Europe) can do the following:

Create economic turbulence
Exaggerate a person’s financial success or failure so that he becomes rich or poor very quickly
Increase the number of people who are at risk for poverty (if things cost more, then more people may be considered poor)
Cause political instability (historically, many authoritarian regimes have risen to power during periods of extremely high inflation)

Inflation Around the Globe

In the industrialized world, inflation has remained low since 1990. But severe inflation—called hyperinflation—does happen sometimes. In 1994, for example, inflation in Brazil was more than 3,000 percent. In the 1930s in some European countries, inflation was similarly high, and stories were told about people hauling money in a wheelbarrow to the store in order to pay for a single loaf of bread.

Balancing Unemployment and Inflation

All governments must balance the effects of unemployment with those of inflation. In most cases, reducing unemployment usually requires spending more money, which causes prices to increase. Similarly, reducing inflation often means re-ducing the amount of money spent, which usually increases unemployment. Balancing these goals is a difficult but necessary governmental task.

Recession and Depression

All governments want to avoid an economic recession, which is a period of decline in the economy. Recessions often are accompanied by high unemployment and, sometimes, high inflation. Even worse is a depression, an economic downturn that dips deeper and lasts longer than a recession.

Example: When the stock market crashed on October 24, 1929, the world fell into the Great Depression, one of the most severe economic downturns of the industrial era. Unemployment skyrocketed, reaching about 33 percent in the United States. Many people suffered from dire poverty, and some starved. The depression did not fully end in the United States until the nation entered World War II at the end of 1941.