David Andolfatto and the Chicago dismissal of ‘involuntary unemployment’

15 Mar, 2015 at 13:42 | Posted in Economics | 3 Comments

David Andolfatto doesn’t like it when I say that some unemployment is involuntary. Here is my response:

David

I am happy with the way you characterize my beliefs in the first paragraph of your blog. Unemployment is clearly not Pareto optimal.  Everything you say after that is at best misleading and at worst dismissive of everything we (at least some of us) learned from Keynes.

types-of-unemploymentThe idea of involuntary unemployment was introduced by Keynes in the General Theory. But you already knew that. It is defined as a situation where (in modern language) the ratio of the marginal disutility of work to the marginal utility of consumption is not equal to the real wage. That seems a pretty accurate description of the equilibrium outcome of labor search models.

Bob Lucas cast a spell over the profession in a series of papers in the 1970s. You are accurately summarizing Bob’s view. That view was tied to a three decade long campaign by economists predominately located in Chicago, Minnesota and Rochester (at the time) to discredit Keynesian economics. Tom Sargent reputedly advised his students not to read the General Theory. That was a tragic mistake and we are still suffering from the consequences.

You are right to assert that the important distinction is between equilibria that are Pareto optimal and those that are not. You are wrong to assert that the term ‘involuntary unemployment’ has no useful meaning.

I accept your categorization of the allocation of time between three competing ends. Every family, and every member of that family, chooses every day whether they will choose to participate in the labor force. As long as they are in the labor force, they may be employed or unemployed. Those who are unemployed do not choose that state. They must wait for a job offer to appear. In some states, that job offer may take a couple of days to arrive. In others, it may take a couple of years. The activity of waiting for a job, even when it involves active search, can meaningfully be called involuntary unemployment.

The dismissal of ‘involuntary unemployment’ from the lexicon of the modern economist was introduced as part of a deliberate attack on Keynesian economics. It is time to roll back that attack. As I have shown here, ‘involuntary’ unemployment is a useful way of distinguishing unemployment that is part of a social optimum, from unemployment that is not.

Roger Farmer

 

There are unfortunately a lot of mainstream economists out there who still think that price and wage rigidities are the prime movers behind unemployment. What is even worse — I’m totally gobsmacked every time I come across this utterly ridiculous misapprehension — is that some of them even think that these rigidities are 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 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.

J M Keynes General Theory

 

3 Comments

  1. “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?)”

    Well David Andolfatto obviously denies it. He really, really, does not want people to use the terms “involuntary” and “unemployment” together. Its just not useful, according to him, because it really doesn’t exist.

    Keep in mind that I might be some liberal full employment type pushing some ridiculous agenda. And that I’m probably too stupid to take part in high level economic discussions with actual economists, but this is how I understand his argument.

    For Andolfatto it comes down to every individual always exercising their individual choices. If that individual has an opportunity to take any employment, what-so-ever that may be, then it cannot be said that they are involuntarily unemployed. He assumes that the real job market works such that an unemployed person can always find some employment in short order if they just lower their asking price enough. This has to be true because it is obvious that there are more jobs that could be done than there are people to do them. So until a person is willing to set their asking price down to zero, (or even some negative number I imagine), they are just unemployed persons who are not willing to supply their labor at the market price.

    Andolfatto finds it “interesting” that people get “riled up” about his explanations of how things work. I do too. I mean, why would anyone expect an economist, of all people, to explain unemployment in the actual economy, rather than in some imaginary economy? He clearly understands that his argument applies only to his imaginary world, so why would anyone get upset when he brings it up? Its all a very interesting intellectual discussion after all.

    Now if you are faced with a real world situation , such as a recession where you clearly observe the reality of millions of involuntarily unemployed persons, you have a choice. You can comfort yourself with the understanding that in David Andolfatto’s imaginary world, they would be exercising their free will. Or you can believe Keynes and your own lying eyes.

  2. There is an obsession with New Keynesians about sticky wages and how they explain why markets do not clear, but now the discussion seems to have moved on to “other frictions” and the use of “search models”.

    Stephen Williamson in his comments in his blog:

    “An employment contract, like marriage, requires that two people agree. If one would-be party to the contract does not agree, then it doesn’t happen. We could talk about people being involuntarily single, I suppose, but the relevant behavior we are interested in, I think, is the search behavior. An unemployed person is engaged in active search for employment. Old-fashioned ways of thinking about that – in competitive equilibrium environments – didn’t get very far, as those models are not equipped to think about search. Search models allow one to think about unemployment in a useful way. Those models are more enlightening about the determinants of unemployment, and how governments might help labor markets work more efficiently. But people in those models are always making choices. The unemployed are people who choose to search for work because they think there is light at the end of the tunnel – potentially they will find a job that will make them better off. So voluntary or involuntary doesn’t enter into the discussion. But that doesn’t mean that the outcomes are efficient, and there can certainly be a role for government.”

    http://newmonetarism.blogspot.co.uk/2015/03/lucas-and-his-critics.html#comment-form

    It would be interesting Professor Syll to hear your opinion about the usefulness of search models.

  3. The question of voluntariness goes back before Keynes. In fact, at one time unemployment was considered to be involuntary. Language has changed since then. In “The unemployment problem: Review.” Journal of the American Statistical Association, 18(138), 294-296 (1922), P. F. Brissenden makes the point that, in modern terms, voluntariness is fuzzy, a matter of degrees and types. At that time, to be out of work was to be idle. To be involuntarily idle was to be unemployed. But what, he asks of the person who cannot find work in his “regular craft” but is unwilling to take other work? Voluntarily idle or unemployed? He also points out that there are degrees of “different degrees of “work-shyness, ranging from the person who is shy in respect to any kind of work to the person who is shy in respect to none.”

    “Unemployment” was not a term before the 1890s. It came into use to describe the kind of idleness that was the result of such things as factory layoffs, which is why it referred to involuntary idleness.

    Language changes, but the question of voluntariness still matters, in terms of morals and politics. The political opposition to providing gov’t assistance to the unemployed rests largely upon the idea that unemployment is voluntary, and that the unemployed are responsible for their plight.


Sorry, the comment form is closed at this time.

Blog at WordPress.com.
Entries and comments feeds.