At last — a real-world economics textbook

5 Oct, 2017 at 15:57 | Posted in Economics | 1 Comment

macro In the real world, where issues of motivation, labor relations, and power are also important, the classical idea that [regulations, labor union activities, and public ‘safety net’ policies] cause substantial unemployment can be called into question …

Alternative explanations of the working of labor markets suggest a different perspective …

While some Keynesian theorists emphasize sticky wages, Keynes’s critique of classical views actually went much further. In more general terms, the Keynesian perspective challenges the entire classical assertion that unemployment results mainly from wage levels that are too high … To Keynes and his followers, fixing the problem of unemployment in a recession or depression is not just a matter of making labor markets work more smoothly​. Rather, total demand for goods and services in the economy has to increase in order to stimulate hiring. In this analysis, falling wages would not improve labor market conditions but would make things worse, because workers would have less money to buy goods and services, leading to lower levels of business sales and further layoffs.

At last — a macroeconomics textbook where you get the impression that the authors when they write about Keynes also actually has read him. Highly recommendable!

There are unfortunately a lot of mainstream economists — and textbook authors — out there who still think that price and wage rigidities are the prime movers behind unemployment. What is even worse 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 were 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 delays 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.

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 … 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.

1 Comment

  1. “The basic explanation for unemployment is insufficient aggregate demand, and that is mostly determined outside the labor market.”

    Create more sales jobs selling oversupply to those who don’t know they don’t need it? “Dig a hole and fill it up again”, because the physical work is good for you and the rush from controlling you is good for me?

    “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”

    The problem is that the market miscalculates productivity, over-rewarding sales because they produce the dollars. Jobs become a purely social phenomenon, a way of controlling others. Automation should get rid of the need to work.


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