Home > unemployment > The ‘bad luck’ theory of unemployment

The ‘bad luck’ theory of unemployment

from Lars Syll

As is well-known, New Classical economists have never accepted Keynes’s distinction between voluntary and involuntary unemployment. According to New Classical übereconomist Robert Lucas, an unemployed worker can always instantaneously find some job. No matter how miserable the work options are, “one can always choose to accept them,” according to Lucas.

unemployedThis is, of course, only what you would expect of New Classical economists.

But sadly enough this extraterrestrial view of unemployment is actually shared by ‘New Keynesians,’ whose microfounded dynamic stochastic general equilibrium models cannot even incorporate such a basic fact of reality as involuntary unemployment!

Of course, working with microfunded representative agent models, this should come as no surprise. If one representative agent is employed, all representative agents are. The kind of unemployment that occurs is voluntary, since it is only adjustments of the hours of work that these optimizing agents make to maximize their utility. 

In the basic DSGE models used by most ‘New Keynesians’, the labour market is always cleared – responding to a changing interest rate, expected life time incomes, or real wages, the representative agent maximizes the utility function by varying her labour supply, money holding and consumption over time. Most importantly – if the real wage somehow deviates from its “equilibrium value,” the representative agent adjust her labour supply, so that when the real wage is higher than its “equilibrium value,” labour supply is increased, and when the real wage is below its “equilibrium value,” labour supply is decreased.

In this model world, unemployment is always an optimal choice to changes in the labour market conditions. Hence, unemployment is totally voluntary. To be unemployed is something one optimally chooses to be.

If substantive questions about the real world are being posed, it is the formalistic-mathematical representations utilized to analyze them that have to match reality, not the other way around.

To Keynes this was self-evident. But obviously not so to New Classical and ‘New Keynesian’ economists.

Austerity-CoverThe notion that unemployment is voluntary is, in the context of the current self-inflicted wound in Europe, downright offensive. Real workers must pay bills and feed families from jobs that have fixed hours and fixed wage rates. The idea that workers ‘trade off’ labor against leisure by figuring out the real wage rate and then slacking off or going on an indefinite unpaid leave is the type of thinking that leads us to see the Great Depression as a giant, unexpected, and astonishingly long unpaid vacation for millions of people: original, yes; helpful, no.

  1. March 7, 2015 at 2:30 pm

    The more I hear about DSGE, the more utterly confounded I get about how it could have possibly gained a monopoly in macroeconomic modeling. What is wrong with the field?

    • Macrocompassion
      March 8, 2015 at 11:26 am

      The problem with DSGE as I see it is not that it is a bad method, but that in using it not one expert has managed to correctly model the actual macroeconomics situation of our social system.

      Without exception the significance of land as distinct from durable capital goods has been avoided. Land is not something you can create and most of its value depends on the number of people living and working close by. Much of the investment in the infrastructure from taxation contributes to the land value. On the other hand, durable capital goods, like buildings, transports, machinery, raw materials in progress, animals and plants etc., are the result of our labor using the 3 factors of production of Adam Smith, including the land. A suitable model for this was provided by the author and is on Wikimedia as: DiagFuncMacroSyst.pdf

      I look forward to DSGE models which incorporate this representation of our social system.

  2. Paul Schächterle
    March 7, 2015 at 3:29 pm

    As sad as the topic is, it is actually really valuable that Lars regularly points out the severe flaws of neoclassical theory.

    And the neoclassical theory of the labour market is the most ridiculous and outrageous “theory” neoclassical economists have invented so far.

    They do not even have a proper definition of labour. So their assumption is that any worker can increase the demand for his/her labour by reducing the wage rate demanded. That assumption is false but for the sake of argument let’s accept it for now.

    So let us ask then, why does the worker supply labour? Well, it is a necessary evil for the sake of receiving an income. So the goal is not to have work but to have an income.

    What then happens to the labourer’s income if the wage rate falls? Can the labourer always increase his/her income by reducing the wage rate?

    But even worse the assumption is that workers weigh between leisure and income and that they will want to work less if the wage rate goes down.

    Think about it. Would you work less if your wage rate gets cut? It obviously depends on what your alternative sources of income are. Because if you need a certain income out of labour you can’t work less but on the contrary you must work more to earn that income!

    B.t.w. neoclassical economists tend to be very sloppy when it comes to graphing their supply and demand functions. Normally they don’t even label the axes properly and they don’t graph extrema. But we can extrapolate from their concepts. Where does the labour supply curve go if the wage rate approaches zero? It goes to zero as well. So in fact neoclassical economists assume that workers prefer to starve in their spare time if the wage rate goes low enough.

    Neoclassical theory is just so pathetic.

  3. March 7, 2015 at 5:33 pm

    “The idea that workers ‘trade off’ labor against leisure by figuring out the real wage rate and then slacking off or going on an indefinite unpaid leave…”

    This only captures the visible part of the absurdity. What is not visible are the unacknowledged assumptions embedded in the labor/leisure trade-off model at conception. Who knows that a prime ‘simplifying’ assumption stated by J.R. Hicks in the original formulation of the model was the existence of trade unions strong enough to enforce hours of work that are optimal for output? The reason for this simplification was the accepted theoretical finding of market failure in optimizing hours for output. In a competitive model, hours would tend to be excessively long. Whoops!

    How to get around this theoretical result? Trade unions! Collective bargaining as the corrective to market failure. Then, once we have set aside the result of the competitive model, we can also set aside the trade unions since they have accomplished their model-simplifying task!

  4. March 8, 2015 at 3:34 am

    Excerpt from Krugman: How Did Economists Get it So Wrong? — about how current RBC theories turn the Great Depression into the Great Vacation:

    See also John Quiggin: The Big Issues in Macroeconomics: Unenmployment

    But don’t recessions look like periods in which there just isn’t enough demand to employ everyone willing to work? Appearances can be deceiving, say the freshwater theorists. Sound economics, in their view, says that overall failures of demand can’t happen — and that means that they don’t. Keynesian economics has been “proved false,” Cochrane, of the University of Chicago, says.

    Yet recessions do happen. Why? In the 1970s the leading freshwater macroeconomist, the Nobel laureate Robert Lucas, argued that recessions were caused by temporary confusion: workers and companies had trouble distinguishing overall changes in the level of prices because of inflation or deflation from changes in their own particular business situation. And Lucas warned that any attempt to fight the business cycle would be counterproductive: activist policies, he argued, would just add to the confusion.

    By the 1980s, however, even this severely limited acceptance of the idea that recessions are bad things had been rejected by many freshwater economists. Instead, the new leaders of the movement, especially Edward Prescott, who was then at the University of Minnesota (you can see where the freshwater moniker comes from), argued that price fluctuations and changes in demand actually had nothing to do with the business cycle. Rather, the business cycle reflects fluctuations in the rate of technological progress, which are amplified by the rational response of workers, who voluntarily work more when the environment is favorable and less when it’s unfavorable. Unemployment is a deliberate decision by workers to take time off.

    Put baldly like that, this theory sounds foolish — was the Great Depression really the Great Vacation? And to be honest, I think it really is silly. But the basic premise of Prescott’s “real business cycle” theory was embedded in ingeniously constructed mathematical models, which were mapped onto real data using sophisticated statistical techniques, and the theory came to dominate the teaching of macroeconomics in many university departments. In 2004, reflecting the theory’s influence, Prescott shared a Nobel with Finn Kydland of Carnegie Mellon University.

  5. blocke
    March 8, 2015 at 10:52 am

    “In short, World War II reduced unemployment and raised GNP. Thus, in a sense, World War II was good for the U.S. economy though in many other senses war is bad (obviously).” (Quiggin)

    Moreover, Congress stepped in to make huge investment in human capital through the
    GI bill for WWII and Korean Veterans. When I left the service (1952), I didn’t joined the ranks of the unemployed, but the ranks of students studying under government programs. The Federal Government kept me going for 4 years, the State of California paid for a year of graduate education, which was followed by four years of teaching assistantships and fellowship during my years of PhD studies out of funds provided by the University of California. I was not in the ranks of the unemployed for 8 years after military service. And I was no exception.

  6. Herb Wiseman
    March 8, 2015 at 4:14 pm

    Voluntary unemployment? What a crock. I could write papers about this topic from my 47 year perspective as a social worker in Canada. But let me just note that many people living with disabilities are not able to find work because there is discrimination against those living with disabilities. How are they voluntarily unemployed? Rare is the employer who chooses to hire a Downs Syndrome youth, or person in a wheel chair, or someone with disfigurement, etc.

    My workplace is not accessible except during business hours and then not if you need mechanical help to open the door. And our Liberal provincial government has decided not to enforce the law requiring buildings to be accessible.

    Of course we all know that transportation is accessible right? Toronto’s subway system is only partly accessible so it is necessary for persons living with mobility disabilities to exit where the elevator is (if it is working) and then find their way to their destination on the surface which in the winter is impossible sometimes when snow has piled up.

    The root of the problem seems to be the economic notions of productivity and efficiency added to the discrimination factor.

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