The neoclassical assumption of full employment requires balanced trade.

This post describes why the neoclassical assumption of full employment (that it is here now or soon will be) also requires the assumption of balanced trade: that the amount of money leaving a country is exactly the same as that reentering it. Several supporting sources are listed at the bottom.

UPDATE 10/2/2021: It doesn’t just require balanced trade, it requires no leakages of any kind. Any money that’s not spent in the domestic economy (such as by saving, investing, or purchasing something overseas) is a leakage. I will elaborate on this when I have the time. Meanwhile, the rest of this post remains accurate but I now realize is a bit too narrow.


This post was last updated January 6, 2021.

Disclaimer: I have studied MMT since February of 2018. I’m not an economist or academic and I don’t speak for the MMT project. The information in this post is my best understanding but I don’t assert it to be perfectly accurate. In order to ensure accuracy, you should rely on the expert sources linked throughout. If you have feedback to improve this post, please get in touch.

One of the core assumptions of neoclassical (which is currently mainstream) economics is that we are, right now or soon will be, at full employment*. To use the Modern Money Theory, or MMT, definition of the term, full employment means that everybody who wants a job has a job or, more specifically, there is no involuntary unemployment or underemployment.

(*See the appendix at the bottom of this post for more on the full employment assumption.)

The assumption of full employment requires several other assumptions in order to hold. The first is that people (households) are insatiable; this implies they want to spend every dollar of their income**. Because there is no savings; total, or aggregate demand is always maximized. This means that businesses always have a need to hire more people in order to meet the demand and, hence, we are always, right now or soon will be, at full employment.

(**The only way households don’t spend [the only way they save] is when a bank raises their interest rates. The incentive for not spending is to earn high interest on, for example, a bond from the bank. In other words, the decision to consume or not consume is not made by people, but by banks. Secondarily, it also means that people never save cash, but only bonds, which are less liquid [less-easily spent].)

Another critical condition of full employment is that all spending in the economy is done at companies within the same country. If someone buys a product or service in another country, then that money is not spent here. This causes aggregate demand in this country to decrease by exactly that amount. This means those companies have less need to produce and less need to retain their workers or hire more.

So, if a single dollar more leaves the country then comes back in, then the assumption of full employment is put in jeopardy. Therefore, balanced trade is necessary in order for the mainstream assumption of full employment to be possible. In other words, without balance trade, then each country is no longer a self-contained, hermetically-sealed bubble, and because of it, mainstream economics falls apart.

Underneath balanced trade is another critical assumption: the only reason people (all people, in all countries, at all times) want money only because they want more stuff: products and services. They have no desire to accumulate financial assets, such as cash, stocks, or bonds. This is an extension of how people are insatiable and want to spend all of their income. It is also essentially an expression of the myth of barter, or CMC’ (pronounced “see, em, see, prime”, which means commodities are sold to obtain money which is then used to purchase even more commodities). In this view, money is merely a tool to achieve the ultimate goal, which is to obtain more commodities, or stuff.

Marx’s monetary theory of production, or MCM’ turns the myth of barter on its head: money is used to purchase commodities, which are then sold in order to obtain even more money. Commodities are merely a tool to achieve the ultimate goal, which is to obtain more money (or, more broadly, financial assets). The monetary theory of production is subscribed to by Post Keynesianism and Modern Money Theory, or MMT, and is also supported by the overwhelming historical and anthropological records.

(As a point of logic, the assumption that people only desire stuff also means that the purchase and exchange of financial assets is merely in service of obtaining that stuff. According to John Harvey and as stated throughout his textbook [Harvey, 2009], this is contradicted by the world in which we actually live. In reality, only between 1.5-8% of all international transactions are for physical goods and services. The rest – well over ninety percent – are for financial assets.)

Post Keynesianism (and MMT), tempestuous seas, and the circle of life

Both CMC’ and MCM’ have the same pattern: Money, then stuff, then money, then stuff, repeating forever. The difference is the choice of which element in the pattern is focused on, emphasized, and considered as the natural state. The natural state being the one that is here now, or soon will be, regardless what one does or does not do – if only there were there no meddling outside influences such as governments. In his 1923 book, A Tract on Monetary Reform, John Maynard Keynes makes the following analogy:

But this long run is a misleading guide to current affairs. In the long run we are all dead. Economists set themselves too easy, too useless a task if in tempestuous seasons they can only tell us that when the storm is long past the ocean is flat again.

Mainstream economics believes fully-calm seas (maximized aggregate demand and full employment) to be the natural state. In reality (the world in which we actually live), calm seas are not the norm but the exception. This is what Keynes calls the special case. During the Great Depression, telling people that full employment was “soon to return” was no comfort to the millions desperate and waiting for hours in line, day after day, for a loaf of bread – in literal bread lines.

Economic theories must first recognize that recessions and depressions are possible. (This is related to Minsky’s financial instability-hypothesis.) It should then prevent and mitigate them as much as that’s possible. The primary job of economics, however, is when recessions inevitably occur, to help people – actual human beings – survive and recover. Denying even the possibility of recessions (or that they are somehow not natural) is clearly not conducive to helping those who must endure its consequences. When a recession or depression does occur, how many suffer and die before it ends? And of those who do suffer, how far away are the vast majority from the levers of power?

Appendix: More on the mainstream assumption of full employment

From Harvey, 2009, page 14:

[It] is commonly assumed [in neoclassical economics] that there is a strong tendency towards continuous full employment. The simplest version of this premise argues that demand can never fall short of total supply because [as it is also assumed,] the reason d’etre for supplying goods and services is to spend the income so earned. if that is so, then involuntary unemployment (beyond fictional and structural) falls to zero….

Here’s a response I got to the original version of this post, from a layperson MMTer who was originally trained in mainstream economics:

When I learned economics, 50 years ago, the initial assumption of the model was a closed economy (no foreign trade), and that leads inevitably to the conclusion of stability at full employment, with savings = investment (i.e., whatever consumers didn’t spend was spent by business for things that would not be immediately consumed). Any disturbance to the system would be met by a countervailing force that would return it to stability.

Building on that model by adding a foreign sector and a government sector negated the founding assumption, but economists still believed that the conclusion would hold. It doesn’t, and that is why disturbances lead not to a return to stability, but to continued volatility, a cyclic phenomenon of excess in both directions, with peaks and troughs at levels of “unsustainability”. (Which cyclicality is, by the way, found in all respects of nature and human behavior, from the rotation of the earth to financial markets.)

So full employment is not itself an assumption in classical economics, it is a logical and mathematically correct conclusion dictated by the simplifying assumption of a closed economy. Removing the assumption invalidates any conclusions based on it, and therefore adjustments must be made to the model to account for that change. Until MMT, they have not been made.

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This post is based on my preparation for and conversation with Texas Christian University economics professor and Cowboy Economist, John Harvey, on the topic of exchange-rate determination [parts one and two]. It is secondarily based on my interviews with University of Missouri, Kansas City economics PhD. candidate Sam Levey [parts one and two], and a joint interview with German PhD. economist Dirk Ehnts and Danish PhD. student in Innovation and Public Policy with an MA in International Political Economy and Political Science, Asker Voldsgaard.

Top image: From dimitrisvetsikas1969 on Pixabay (license)