Here is the essential point of difference between Keynes’s involuntary unemployment and disguised unemployment as applied to an under-developed economy. Originally, no doubt, disguised unemployment was conceived by Mrs Robinson as an extension of the Keynesian concept of involuntary unemployment. Thus a decline in demand for the product of the general run of industries leads to a diversion of labour from occupations in which productivity is higher to others where it is lower.
The cause of this diversion, a decline in effective demand, is exactly the same as the cause of unemployment in the ordinary sense, and it is natural to describe the adoption of inferior occupations by dismissed workers as disguised unemployment. In the context of an under-developed economy, however, the concept of ‘disguised unemployment’ takes on a distinct property. As applied there, it is to be explained not in terms of a ‘decline in effective demand’ but in terms of a shortage of capital relative to the current size of population. In the rural sector, there is surplus labour pressing on a limited stock of land.
And since the mode of production is family-oriented and pre-capitalistic, the labourer enjoys a living which is set by average productivity, even though the marginal productivity may turn out to be zero. Under-developed economy have to face the unemployment.
On the other hand, there is not enough outlet for this surplus labour in the urban sector where shortage of capital is already depressing the real wage rate down to the subsistence level of workers.
We have thus the spectacle of an ‘unlimited supply of labour’ at current real wage rate which is too low to permit a cut without impairing the efficiency of labour. The situation calls for an accelerated rate of investment towards capital formation.
The additional investment, however, has to be financed, as far as possible, by additional savings, contrary to Keynes’s prescription. Deficit-financing, in so far as it is not adequately matched by increased output of wage-goods, tends to raise the prices of wage-goods. And if this happens, there are two alternatives open to the economy, neither of which is palatable. It may keep the money wage rate constant, in which case the real wage rate comes down below the permissible level.
Alternatively, it may keep the real wage rate constant and let money wages rise, in which case it opens the door to an inflationary spiral. It cannot too often be repeated, therefore, that if in such economies deficit-financing is to be resorted to beyond the safety limit provided by the price index of wage-goods, the state must not hesitate to adopt the policy of price control and rationing, be it a little anti-liberal. So the unemployment is sensitive issue.