More on wages and employment

So my last post has led to a few comments on the relation between changes in real wages and employment. As my students are probably tired to hear real wages tend to be pro-cyclical, a well established empirical regularity. This poses a problem, not only for mainstream accounts of the labor market (and hence for the conventional views on the minimum wage), but also for Keynes' own views.

Keynes was forced to deal with those issues early on, as a result of the empirical research by Dunlop and Tarshis, and his answer in his famous 1939 paper (often published together with the General Theory, GT) "Relative Movements of Real Wages and Output." He said then:

"The only solution was offered by Dr Kalecki in the brilliant article which has been published in Econometrica. Dr Kalecki here employs a highly original technique of analysis into the distributional problem between the factors of production in conditions of imperfect competition, which may prove to be an important piece of pioneer work."

In other words, he suggests that some sort of constant returns, or increasing returns to scale, and, hence a mildly positively sloped labor demand curve could possibly explain the empirical regularity. Note also that Keynes had already in chapter 2 of the GT argued that the labor supply curve made no sense (two reasons one fundamental, and the other non-fundamental; see here). He says:

"the contention that the unemployment which characterises a depression is due to a refusal by labour to accept a reduction of money-wages is not clearly supported by the facts... A fall in real wages due to a rise in prices, with money-wages unaltered, does not, as a rule, cause the supply of available labour on offer at the current wage to fall below the amount actually employed prior to the rise of prices."

However, even if one gets rid of the labor supply curve, and determines employment in the market for goods, as a function of demand, as Keynes does, as it is clear from his reply to Dunlop and Tarshis the real problem with the conventional marginalist story (and Keynes' own) is on the acceptance of the marginal productivity of labor (MPL) as the source for labor demand.

One possible neoclassical response would be to suggest that real (supply side) shocks, which change the MPL upwards and downwards, is the main cause of fluctuations in output and employment. So Real Business Cycles (RBC) is the solution. In this case, pro-cylcial real wages can be explained by the mainstream. The main critique coming from other mainstream authors about this possibility, is that, since the real wages are only mildly pro-cyclical, a shock to the MPL would lead to small changes in the real wage only if labor supply is very elastic. In other words, workers labor supply would have to be very sensitive to changes in real wages, and, yet, the empirical evidence is that the number of hours worked does not change much with variations of the real wage.

Besides, there is the question of whether one can really assume that business cycles are explained by real shocks. Note that Lucas, who has for the most accepted the RBC interpretation of the working of the economy, still argues that the Great Depression is most likely explained by a demand shock (for him a monetary contraction a la Friedman).

That is why the capital debates, which undermine the rationale for the marginalist labor demand curve, is relevant for solving the pro-cyclicality of real wages conundrum. The capital controversies suggest that there is no reason to expect that firms buy more of a relatively cheap 'factor of production,' implying an inverse relation between remuneration and intensity of use. Once this notion is rejected, the problem of pro-cyclicality is easy to explain.

Classical (not neoclassical, but the old classical political economists and Marx) presumed that the real wage was determined by the relative bargaining power of workers and capitalists, and it is expected that in a boom, with low unemployment, workers would have the upper hand, and would be able to demand higher wages. So there is no need to resort to real shocks to explain this empirical regularity.

Thatcher, Cameron and Real Wages

Real wages are pro-cyclical, a well established regularity that led Keynes to accept (after evidence presented by Tarshis and Dunlop) that his marginal decreasing productivity demand for labor might be wrong, and that Kalecki seemed to be right (see his article here; subscription required).

The graph below (source here) shows how much real wages have fallen in this and previous recessions in Britain.

Note that in the following one, real wages fell less (so far) than during Thatcher, but the decline has been way longer than with the Iron Lady.

EPI's The State of Working America 2012

The last edition of the Economic Policy Institute State of Working America is out. A lot of data and more importantly serious and rigorous analysis. Here just want graph, which shows the relation between unemployment and changes in median wages from 1991 to 2011.

As you can see real wages are pro-cyclical, going up in a boom when unemployment falls, and down in a recession. We know that since at least Tarshis and Dunlop critique of Keynes in the 1930s. One more reason why full employment is an important policy goal.

Lorie Tarshis on National Debt

Tarshis was a student of Keynes, and the author of an early textbook (published in 1947, a year before Samuelson's more well known manual), which included the main elements of Keynesian economics (Colander and Landreth discuss the reception of the book here).  One of the last chapters of the manual deals with national (meaning public) debt.  Note that this was written when the debt-to-GDP ratio in the United States was around 120 percent. First, contrary to many economists today, he clearly distinguishes public and private debt, and notices that:

"Since it [the Federal Government] may either impose taxes, or borrow through its control of the banking system, there can be no question of the federal government going bankrupt."

Interestingly, at that time, even at the beginning of the McCarthyte Red Scare, he would not imagine the possibility of the debt-ceiling not being raised.  So default in domestic currency is impossible. Further, he argues that:

"Even though a high federal debt threatens neither bankruptcy nor an exhaustion of government credit, it does have certain other consequences. ... If the government collects taxes to pay interest on its debt, it transfers money from the tax payer to the bondholder ... the transfer is in the direction of those in the higher income brackets ... [that] generally reduces the propensity to consume."

For him, there are a few solutions for the contractionary bias of public debt financed by taxes.  Reduce the rate of interest, by having the Fed buy bonds, and borrow from the Fed.  Shift taxation from the poor to the rich, reducing Social Security taxes and increasing the marginal tax for higher income brackets.  Republicans are adamantly opposed to the second alternative, and are going to eliminate the first by not allowing the debt-ceiling to be raised.  The consequences are clearly contractionary, as a good manual, back in 1947, already showed.

PS: To have an idea of how strong anti-Keynesian ideas were among businessmen see the following letter in response to Leonard Reed's campaign against Tarshis's book.  Would also recommend Invisble Hands, by Kim Phillips-Fein.