Home > Graphics, upward income redistribution > Labor surplus vs. efficiency wages in th United States

Labor surplus vs. efficiency wages in th United States

from David Ruccio



The current situation—what I continue to refer to as the Second Great Depression—presents a real problem for mainstream economists.  Corporate profits (and, with them, the stock market and salaries at the top end of the income distribution) continue to soar while workers’ wages stagnate (based on high levels of unemployment and a declining value of the federal minimum wage).

Clearly, the modeling tools of mainstream economics are useless in analyzing these trends. For example, the only way you can get involuntary unemployment in a neoclassical world is for wages to be too high (that is, above the equilibrium wage rate), such that the quantity supplied of labor is greater than the quantity demanded of labor.

This has forced an economist like Paul Krugman to look elsewhere and to stumble on a tradition that looks a lot more like Marx and Kalecki than traditional neoclassical (and, for that matter, Keynesian) economics. In this alternative tradition, there’s a fundamental conflict between labor and capital, the Reserve Army of labor regulates the level of wages, and corporations prevent the state from enacting the kinds of stimulus measures and social programs that would decrease the economy’s dependence on the “state of confidence” of private employers and investors.

The question is, how does one model fundamental features of the Second Great Depression in this alternative tradition? Krugman seems to think he can do it in with an efficiency-wage model. But, remember, that model was invented to make sense of situations in which firms offer wages above the equilibrium wage rate (in order to purchase worker loyalty, decrease “shirking,” and increase effort) and, by extension, firms choose not to decrease wages in the face of massive unemployment.

But the problem, as I’ve explained before, is not downwardly rigid nominal wages but upwardly rigid real wages. That is, even as the economy recovers, firms are not willing to bid up the prevailing wage rate. As a result, real wages remain constant while, with increasing productivity and economic growth, corporate profits rise. The real coordination failure is exactly the opposite of the one posed in the efficiency-wage story: each employer actually wants to pay the lowest wages possible, while hoping that all other employers offer higher wages, in order to buy back the goods and services being produced. All you need to do is work through Nick Rowe’s attempt to use an efficiency-wage model to make sense of Krugman’s problem to realize it’s probably not going to get us very far.

So, if the efficiency-wage model is a nonstarter, where else might we look? One possibility, it seems to me, is the labor-surplus model first developed by W. Arthur Lewis. I understand, the purpose of that model was quite different; it was designed to make sense of “dual economies” in which peasant workers trapped by “disguised unemployment” and receiving a “subsistence” wage (equal to the average product of labor) in the “backward,” noncapitalist rural/agricultural sector could be induced via a higher “industrial” wage rate (equal to the marginal product of labor) to move to the “modern,” capitalist urban/manufacturing sector, which would absorb them as long as capital accumulation increased the demand for labor.


That’s clearly not what we’re talking about today, certainly not in the United States and other advanced economies where agriculture employs a tiny fraction of the work force (and much of agriculture is organized on capitalist lines). But a suitably modified labor-surplus model might be a better starting point than the efficiency-wage model for making sense of what is going on in the world today.

What I have in mind is redefining the subsistence wage as the federally mandated minimum wage, which regulates compensation to workers in the so-called service sector (especially retail and food-services). That low wage-rate serves a couple of different functions: it’s a condition of profitability in the service sector while keeping service-sector prices low, thereby cheapening both the value of labor power (for all workers who rely on the consumption of those goods and services) and making it possible for those at the top of the distribution of income to engage in conspicuous consumption (in the restaurants where they dine as well as in their homes). In turn, the higher average wage-rate of nonsupervisory workers is regulated in part by the minimum wage and in part by the Reserve Army of unemployed and underemployed workers. The threat to currently employed workers is that they might find themselves unemployed, underemployed, or working at a minimum-wage job.

In addition, the profits captured from both groups of workers are distributed to a wide variety of other activities, not just capital accumulation as presumed by Lewis. These include high CEO salaries, stock buybacks, idle cash, and financial-sector profits. And, if the remaining portion that does flow into capital accumulation takes the form of labor-saving investments, we can have an economic recovery based on private investment and production with high unemployment, stagnant wages, and rising corporate profits.

Now, I can’t say the labor-surplus model is the only way to model some of the stylized facts of the Second Great Depression. But, to my mind, it’s certainly a better starting-point than the efficiency-wage model.

  1. Paul Davidson
    January 8, 2014 at 6:29 pm

    If one understands Post Keynesian economics it is not to difficult to explain why corporate profits are continuing to rise while wages are declining and income inequality growing.

    For manufacturing goods and even many services (e.g., computer programming and other tech services, and even some medical services, etc) offshoring is the big explanation. Corporation can lower their wage bill by offshoring and producing products that even after shipping costs are added to total production costs are sufficiently low to yield a high profit margin. The competition of foreign cheap labor not only costs jobs here (and in the euro zone) but als okeeps the wages of American workers who still have jobs in check and labor is not able to share in higher productivity and profit margins that are going to multinational corporations

  2. BFWR
    January 8, 2014 at 8:22 pm

    The whole prob­lem is that econ­o­mists are too busy defend­ing an impos­si­bly wrong the­ory or plod­dingly try­ing to craft another when all you really need to do is social­ize the money/financial sys­tems for indi­vid­u­als a la Social Credit/Citizen’s Div­i­dend which frees the indi­vid­ual, resolves the indi­vid­ual demand/debt prob­lem in per­pe­tu­ity and fits seam­lessly into a profit mak­ing eco­nomic sys­tem that now approx­i­mates an equi­lib­rium. Then all you have to do is tweak it with a peri­odic gen­eral dis­count on prices and reg­u­late obvi­ous eco­nomic excesses and we all actu­ally progress toward a future freed up to inno­vate and pro­vide for us all. Then we can get on with help­ing the small per­cent­age of peo­ple who will inevitably make Life mis­takes or have bad atti­tudes despite a gra­cious money sys­tem and an abun­dant economy.…to wake up and die right. Life and Free­dom. It still has to be per­son­ally nav­i­gated by the indi­vid­ual, but it beats hell out of hav­ing to nav­i­gate it under the duress of an unsta­ble and rigged system.

  3. collinconstantine
    January 8, 2014 at 10:04 pm

    Reblogged this on and commented:
    An exciting piece…

  4. Ryan
    January 9, 2014 at 8:15 am

    Labor surplus model could apply if you take information technology and technical jobs as the new “industrial wage” industry.

  5. Nell
    January 10, 2014 at 2:52 pm

    The critique of the efficiency-wage model makes sense to me, but I really don’t get the last paragraph where its argued that economic recovery is possible with private investment, high unemployment, stagnant wages and rising corporate profits. If there is such a recovery surely it is unstable? Who will be able to afford the products produced by labour-saving investment? Are you assuming they all get exported? If so, since the world seems to be operating a global system of low wages and high profits – the question still stands. Who are buying the products? Or perhaps you are assuming populations in decreasing real incomes will purchase on credit?

  6. January 18, 2014 at 4:12 am

    Reblogged this on As the Adjunctiverse Turns.

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