by Economics textbooks transmogrifying truth — wages and unemployment A couple of weeks ago yours truly was sent a copy of the new edition of Chad Jones intermediate textbook Macroeconomics (4th ed, W W Norton, 2018). There’s much in the book I like, e. g. Jones’ combining of more traditional short-run macroeconomic analysis with an accessible coverage of the Romer model — the foundation of modern growth theory — and DSGE business cycle models. Unfortunately it also contains some utter nonsense! In chapter 7 — on “The Labor Market, Wages, and Unemployment” — Jones writes (p. 184): The point of this experiment is to show that wage rigidities can lead to large movements in employment. Indeed, they are the reason John Maynard Keynes gave, in The General
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Economics textbooks transmogrifying truth — wages and unemployment
A couple of weeks ago yours truly was sent a copy of the new edition of Chad Jones intermediate textbook Macroeconomics (4th ed, W W Norton, 2018). There’s much in the book I like, e. g. Jones’ combining of more traditional short-run macroeconomic analysis with an accessible coverage of the Romer model — the foundation of modern growth theory — and DSGE business cycle models.
Unfortunately it also contains some utter nonsense!
In chapter 7 — on “The Labor Market, Wages, and Unemployment” — Jones writes (p. 184):
The point of this experiment is to show that wage rigidities can lead to large movements in employment. Indeed, they are the reason John Maynard Keynes gave, in The General Theory of Employment, Interest, and Money (1936), for the high unemployment of the Great Depression.
A serious editor — who really checked the facts — would immediately find that although Keynes in General Theory devoted substantial attention to the subject of wage rigidities, he certainly did not hold the view that wage rigidities were “the reason … for the high unemployment of the Great Depression.”
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 etc. etc.
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.
Unfortunately, Jones macroeconomics textbook is not the only one containing this kind of utter nonsense on Keynes. Similar distortions of Keynes’s views can be found in, e. g., the economics textbooks of ‘New Keynesian’ economists like Greg Mankiw and Paul Krugman. How is this possible? Probably because these economists have but a very superficial acquaintance with Keynes’s own works, and rather depend on second-hand sources like Hansen, Samuelson, Hicks and the likes.
Fortunately there is a simple solution to the problem. Keynes’s books are still in print.
Read them!
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.