6. Credit Expansion as the Cause of Massive Unemployment

The direct cause of massive unemployment is labor market inflexibility. In fact state intervention in the labor market and union coercion, made possible by the privileges the legal system confers on unions, result in a series of regulations (minimum wages, entry barriers to maintain wages artificially high, very strict, interventionist rules on hiring and dismissal, etc.) which make the labor market one of the most rigid. Furthermore due to the artificial costs labor legislation generates, the discounted value of a worker's real marginal productivity tends to fall short of the total labor costs the entrepreneur incurs (in the form of monetary costs, such as wages, and other costs, such as subjective inconveniences) in hiring the worker. This leads to markedly high unemployment, which will affect all workers whose expected marginal productivity yields a discounted value lower than the cost involved in employing them. Therefore they will either be dismissed or not hired at all.

Whereas the direct cause of unemployment is clearly that indicated above, the indirect cause is still inflation; more specifically, credit expansion initiated by the banking system without the backing of real saving. Credit expansion is ultimately what gives rise to massive unemployment, since it instigates the entire process of widespread discoordination and malinvestment described. It does so by extensively allocating original means of production to parts of the productive structure where they do not belong, considering that entrepreneurs attract them to lengthen and widen the capital goods structure, without realizing that in doing so they commit a serious, large-scale entrepreneurial error. When the crisis hits and the errors come to light, new massive transfers of original factors of production and labor from the stages furthest from consumption to those closest to it will be necessary and will require an especially flexible labor market, one free of any institutional or union restrictions or coercion. Therefore those societies with a more rigid labor market will experience higher and more sustained unemployment upon the inevitable exposure of the entrepreneurial errors provoked in the productive structure by credit expansion.¹⁸

Thus the only way to fight unemployment is, in the short term, to make the labor market more flexible in every sense, and in the medium and long term, to prevent the initiation of any process of artificial expansion which arises from the banking system's granting of loans in the absence of a prior increase in voluntary social saving.