Can Adam Smith Solve the Problem of Youth Unemployment in Europe?

Youth unemployment remains a serious problem in Europe. There is the tiniest glimmer of hope in that the number of young people under 25 unemployed in the Euro zone is 58,000 lower than it was a year ago. But that still leaves 3.4 million without a job. In Italy, the youth unemployment rate is 44 per cent, in Greece nearly 50 per cent and in Spain 53 per cent.

In principle, many of them could set up their own small businesses. A generation or two ago, this would not have been feasible. Economies were much more dominated by capital intensive industries. An unemployed steel worker, for example, could hardly set up a plant in his backyard. Massive industrial plants relied upon what economists call increasing returns to production to generate their efficiencies. In other words, the more a factory made, the lower would be its unit costs of production. But the key feature was the initial investment required to start the process in the first place.

In the modern service oriented economy, the capital requirements to set up a business are minimal.  We are moving back in part to an economic structure which existed before the Industrial Revolution. Then, most producers were peasant farmers or specialist master craftsmen. If they employed anyone at all, it was on a small scale.  It was the world described by the great early economists such as Adam Smith.

This is by no means a matter of pure historical curiosity. It led to a theoretical concept which still underpins a great deal of modern economic theory, albeit now heavily disguised by advanced mathematics. This is the idea known as Say’s Law. Put simply, it says that supply creates its own demand. A fully functioning market economy should never have any persistent involuntary unemployment, it pulls itself up by its own bootstraps. All that the unemployed have to do is to set up in business, and the market mechanism will take care of the rest.

The boom in self-employment and flexible hours working in the UK is entirely consistent with what appears on the face of it to be a highly abstract and unrealistic view of the world. But all scientific theories have to make assumptions and simplifications, the question is how realistic they are. For most of the 250 years since Adam Smith was writing, Say’s Law did not apply because of the structure of production. It is starting to become relevant again. Anyone who can read and write and has access to a computer can, for example, create an internet based business.

Part of Europe’s youth unemployment problem is cultural. They rely on the state for solutions. But the constraint of needing some capital to start a business might bite at a very low level. One policy to overcome this could be just to give Europe’s young unemployed a one-off payment of a few thousand Euros. Most of the money would be wasted, but some of them might take the chance to try and shape their own future.

Paul Ormerod

As Published in City AM, 14th January 2015

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