LARS P. SYLL

Adam Smith, moralen och girigheten

Tisdag 19/2 21:03 — 21.37 sänds i Sveriges Radio P1 ett första program i en serie om nationalekonomins historia:

Adam Smith gjorde national-ekonomi till modern vetenskap 1776 med boken Nationernas välstånd.

Hans tes är att egennyttigt handlande, den så kallade “osynliga handen”, på sikt gynnar hela samhället. Professor Lars Pålsson Syll ger sin syn på denna teori.

Macroeconomics that excludes all that is interesting

In Athreya’s world, and that of a large part of the academic macroeconomics profession, macroeconomics does indeed begin with Walras, and the first modern development in the field was the formalization of Walras’ model by the economic theorists Arrow, Debreu and MacKenzie in the 1950s. The big subsequent development is the integration of growth theory into the static ADM framework to generate the modern dynamic stochastic general equilibrium (DSGE) models. Keynes’ 1936 ‘essay’ is treated as a curiosity, too vague and wordy to permit any real analysis.

This has the odd effect that many of the leading Keynesians of the postwar era … are given respectful cites for their work on growth theory, even as … their macroeconomic work is dismissed as being too silly even to be refuted … Real macro (that is, Walrasian GE applied to issues like the business cycle) begins, in this analysis, with Robert Lucas in the late 1970s.

All this gives me a bit more insight into the apparent convergence in macroeconomics in the early years of this century, and its breakdown in 2008. The New Keynesians understood themselves as having met their New Classical colleagues halfway, with DSGE models which were Keynesian in character, at least in the short run, while meeting the demands for rigorous microeconomic foundations. Meanwhile, the New Classical school were quietly snickering whenever Keynes’ name was mentioned, but were prepared to concede the possible existence of largely unspecified market “imperfections”, whose only role in practice was to justify a policy of inflation targeting.

The crisis that erupted in 2008 destroyed this spurious consensus. On any kind of Keynesian view, New or Old, the combination of high unemployment and zero interest rates implied that the economy had been driven into a Keynesian liquidity trap, with a need for fiscal stimulus on a massive scale. By contrast, for the New Classicals, a disaster of this kind could only be the result of government failure (or, in places where they still mattered, the pernicious actions of trade unions). Since this was implausible, New Classical economists have generally preferred to reassert dogma without too much attention to facts.

Broadly speaking, as far as academic macroeconomics is concerned, DSGE has won the day, not so much by force of argument as by maintaining control of the criteria for publication of journal articles in the field: it’s OK to assume full employment, and ignore inflation, but not to omit rigorous microfoundations for your model …

The result is that there is almost zero intersection between Big Ideas in Macroeconomics and what I would think of as macroeconomics. It’s not so much that I think Athreya is wrong is that we are talking past each other. As Charles Goodhart said of DSGE, Athreya’s version of macro excludes everything in which I am interested.

John Quiggin

Wage rigidities and how real labour markets work

Bewley found little evidence to support many popular labour economic theories. He mentions that he “found no support for real business cycle theory. During hundreds of hours of contact with businesspeople, I never heard one description of an exogenous productivity decline.” Lucas-Rapping theory of unemployment (that it is caused by workers voluntarily quitting their job) is found to have little basis in reality. Unemployment is primarily caused by layoffs and quits actually decline during a recession. Nor do workers quit rather than accept a pay cut as they are never given the choice. Unemployment is an unpleasant situation that no one chooses; rather most unemployed were desperate for work. The main theories of strikes were also found to be inaccurate. Strikes do not occur as there is information asymmetries over the financial health of the company (which is usually known) or to test the profitability of the firm (unprofitable firms were as reluctant to compromise as profitable ones which had greater resources to fight the strike).

Bewley finds that most labour economic theories are inaccurate and fail due to unrealistic assumptions. The only exception to this is the morale model of Solow and Akerlof. Bewley criticises the traditional economic view of people being self-interested and having to be either bribed or coerced into performing tasks. Instead he found that employers ascribed different motivations to their staff. Instead they focused on building good relationships with their employees and encouraged them to take pride in their work and to enjoy their job. They want their employees to show initiative and to perform tasks without having to be constantly told to do so. They felt that treating workers like just another expense like equipment would be counterproductive. As intuitive it may be to ordinary people, it is surprising to economists that people resent being treated like machines whose only purpose is to make money.

In conclusion, Bewley has written a fascinating book that contains many insights in how labour markets work in reality. It reveals major holes in economic theory beyond the simple belief that wages adjust until they are in equilibrium.

Robert Nielsen

[h/t Lord Keynes]

Why are wages sticky?

The stickiness of wages seems to be one of the key stylized facts of economics. For some reason, the idea that sticky wages may be the key to explaining business-cycle downturns in which output and employment– not just prices and nominal incomes — fall is now widely supposed to have been a, if not the, major theoretical contribution of Keynes in the General Theory.The association between sticky wages and Keynes is a rather startling, and altogether unfounded, inversion of what Keynes actually wrote in the General Theory, heaping scorn on what he called the “classical” doctrine that cyclical (or in Keynesian terminology “involuntary”) unemployment could be attributed to the failure of nominal wages to fall in response to a reduction in aggregate demand. Keynes never stopped insisting that the key defining characteristic of “involuntary” unemployment is that a nominal-wage reduction would not reduce “involuntary” unemployment. The very definition of involuntary unemployment is that it can only be eliminated by an increase in the price level, but not by a reduction in nominal wages.

Keynes devoted three entire chapters (19-21) in the General Theory to making, and mathematically proving, that argument … My point is simply that the sticky-wages explanation for unemployment was exactly the “classical” explanation that Keynes was railing against in the General Theory.

So it’s really quite astonishing — and amusing — to observe that, in the current upside-down world of modern macroeconomics, what differentiates New Classical from New Keynesian macroeconomists is that macroecoomists of the New Classical variety, dismissing wage stickiness as non-existent or empirically unimportant, assume that cyclical fluctuations in employment result from high rates of intertemporal substitution by labor in response to fluctuations in labor productivity, while macroeconomists of the New Keynesian variety argue that it is nominal-wage stickiness that prevents the steep cuts in nominal wages required to maintain employment in the face of exogenous shocks in aggregate demand or supply. New Classical and New Keynesian indeed!

David Glasner

That’s absolutely correct. There are  — as Glasner notes — unfortunately a lot of neoclassical economists out there, who still think that price and wage rigidities are the prime movers behind unemployment. And I’m totally gobsmacked every time I come across the even more ridiculous misapprehension that these rigidities should be the reason John Maynard Keynes gave for the high unemployment of the Great Depression. This is of course pure nonsense. For although Keynes in General Theory (1936) devoted substantial attention to the subject of wage and price rigidities, he certainly did not hold this view.

Since unions/workers, contrary to classical assumptions, make wage-bargains in nominal terms, they will – according to Keynes – accept lower real wages caused by higher prices, but resist lower real wages caused by lower nominal wages. However, Keynes held it incorrect to attribute “cyclical” unemployment to this diversified agent behaviour. During the depression money wages fell significantly and – as Keynes noted – unemployment still grew. Thus, even when nominal wages are lowered, they do not generally lower unemployment.

In any specific labour market, lower wages could, of course, raise the demand for labour. But a general reduction in money wages would leave real wages more or less unchanged. The reasoning of the classical economists was, according to Keynes, a flagrant example of the “fallacy of composition.” Assuming that since unions/workers in a specific labour market could negotiate real wage reductions via lowering nominal wages, unions/workers in general could do the same, the classics confused micro with macro.

Lowering nominal wages could not – according to Keynes – clear the labour market. Lowering wages – and possibly prices – could, perhaps, lower interest rates and increase investment. But to Keynes it would be much easier to achieve that effect by increasing the money supply. In any case, wage reductions was not seen by Keynes as a general substitute for an expansionary monetary or fiscal policy.

Even if potentially positive impacts of lowering wages exist, there are also more heavily weighing negative impacts – management-union relations deteriorating, expectations of on-going lowering of wages causing delay of investments, debt deflation et cetera.

So, what Keynes actually did argue in General Theory, was that the classical proposition that lowering wages would lower unemployment and ultimately take economies out of depressions, was ill-founded and basically wrong.

To Keynes, flexible wages would only make things worse by leading to erratic price-fluctuations. The basic explanation for unemployment is insufficient aggregate demand, and that is mostly determined outside the labor market.

The classical school [maintains that] while the demand for labour at the existing money-wage may be satisfied before everyone willing to work at this wage is employed, this situation is due to an open or tacit agreement amongst workers not to work for less, and that if labour as a whole would agree to a reduction of money-wages more employment would be forthcoming. If this is the case, such unemployment, though apparently involuntary, is not strictly so, and ought to be included under the above category of ‘voluntary’ unemployment due to the effects of collective bargaining, etc …
The classical theory … is best regarded as a theory of distribution in conditions of full employment. So long as the classical postulates hold good, unemploy-ment, which is in the above sense involuntary, cannot occur. Apparent unemployment must, therefore, be the result either of temporary loss of work of the ‘between jobs’ type or of intermittent demand for highly specialised resources or of the effect of a trade union ‘closed shop’ on the employment of free labour. Thus writers in the classical tradition, overlooking the special assumption underlying their theory, have been driven inevitably to the conclusion, perfectly logical on their assumption, that apparent unemployment (apart from the admitted exceptions) must be due at bottom to a refusal by the unemployed factors to accept a reward which corresponds to their marginal productivity …

Obviously, however, if the classical theory is only applicable to the case of full employment, it is fallacious to apply it to the problems of involuntary unemployment – if there be such a thing (and who will deny it?). The classical theorists resemble Euclidean geometers in a non-Euclidean world who, discovering that in experience straight lines apparently parallel often meet, rebuke the lines for not keeping straight – as the only remedy for the unfortunate collisions which are occurring. Yet, in truth, there is no remedy except to throw over the axiom of parallels and to work out a non-Euclidean geometry. Something similar is required to-day in economics. We need to throw over the second postulate of the classical doctrine and to work out the behaviour of a system in which involuntary unemployment in the strict sense is possible.

Added 17:00 GMT: Lord Keynes has a great piece on the issue here [h/t Phil Pilkington]