Price stickiness and unemployment
from Lars Syll
There are unfortunately a lot of neoclassical 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, unemployment, 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
as I demonstrate in my book THE KEYNES SOLUTION: THEPATH TO GLOBAL ECONOMIC PROSPERITY, by direct quotes from Paul Samuelson, he [Samuelson] could not understand THE GENERAL THEORY so he just assumed it was a Walrasian system with fixed wages and prices [despite a chapter in the GT entitled CHANGES IN MONEY WAGES].
So that self proclaimed Keynesian, Paul Samuelson, is responsible fro this foolish nonsense and in an important sense Samuelson is responibler for aborting the Keynes Revolution in economic theory. A revolution that I, almost alone, am trying to resurrect.
Paul Davidson
Rents and land prices are definitely sticky-downwards. Look at the number of vacant commercial properties in prime locations and ask why their owners have not dropped the asking rents to market-clearing levels? And then ask what the effect of this is on business recovery?
Yes, but land does not feature in Keynes’ works, nor any other lauded economist after him. No wonder we’re in a mess. Until economists put this passive but important element back into their analyses we’ll keep on creating crises.
The question is whether the labor market would clear if there were flexible wages and prices of producible goods. The classicists say yes and Keynes, in his General theory chapter 19 explaimns why even if prices were flexible , automatic movement to full employment is not assured!
Land, by definition, is not a producible good and therefore whether the privce of land is flexible or not will not affect employment .
There is a further problem. The labour market cannot clear because of the taxation of labour. The gross cost of entry-level labour is around 80% higher than real net pay ie after allowing for sales taxes. That is the figure for the UK. In other countries such as Sweden the situation is even worse. Labour cannot price itself into work at a level that enables it to keep body and soul together.
“Land, by definition, is not a producible good and therefore whether the privce of land is flexible or not will not affect employment .” Er, so if shops close because the rents are too high, that doesn’t affect employment?
rent will be too high only if another renter wants thids factory space to produce something of greater value.
But when an empty factory or shop or office remains vacant because there is no cost to keeping out of use… Or perhaps there are no empty properties at all.
therre is always a cost of keeping office space, factory, etc vacant. Obviously if nothing else there are real estate taxes == also maintenance costs, electricity, and other utilities, etc.
The property may be vacant because there is no one willing to rent — after all for property, everything is location, location, location!!
No sense renting a shop that is on some side street far from the main shopping streets of a town– Why?
even a factory that is now far from easy transportation to move goods in annd out, etc.
I guess you’ve never seen an empty shop or two in a high street. Where I live the branch of a major bank closed and remained vacant for 8 years until an empty property tax came into force.
An attribute of land is that it is not consumable. It can therefore be used continuously for variable purposes. A period of vacancy of useful land represents a permanent loss to the economy and society as a whole.
The land market is dysfunctional. It does not allocate to best use. About time macro economists started to recognise this.
Paul, you can’t be serious? Is the “law” of equalisation of supply and demand not a law, or does it not apply to demand for rent when the supply of undemanded property goes up? Here’s another thing. On our UK Midlands News the other day it came out that the rent being charged merely for use of long-existing shops was four times the business rates needed for supply of services. And they were worried about the business rates going up 3%?
If a site is vacant then the rent asked is by definition too high, since it is above the market-clearing level.
Henry Law, not clear as to what you mean by the gross cost of entry level labor is 80 per cent higher. Higher than what?? a living wage? A subsistence wage? what?
To purchase £100 worth of good you must earn around £110 due to taxes on goods and services. For an employee to end up with £110 in take home pay, the employer incurs a gross labour cost of around £180.
It is rare to find commercial premises that no-one would take if the price were right. Who is letting out premises at next to zero rent to a tenant who will pay the property taxes? And if there were no takers on those terms is would indicate that taxation is pushing the property below the margin. But how many genuinely sub-marginal properties are there, for that is what you are really referring to?