Home > Uncategorized > Some problems of the neoclassical concepts of employment and unemployment

Some problems of the neoclassical concepts of employment and unemployment

real-wagesAre neoclassical macro models post-truth? It might very well be. The ‘workhorse’ neoclassical macro  ‘DSGE’ models used by for instance central banks state that lower real wages will solve unemployment, largely because these lower wages will entice ‘marginal’ workers, like the elderly and women to leave the labor force (read this, by Lawrence Christiano, Mathias Trabandt and Karl Walentin (2011). Less workers, unemployment solved! But does this also happen? Ehhmmm…no (graph2).

participation4

After 2008, real wages fell in the UK and increased in the USA. But contrary to the ideas embedded in the Cristiano e.a. model, the participation rates of, for instance, elderly women in the USA decreased. While the opposite happened in the UK…  (the same held for the entire labor force, though in different degrees, but it seemed worthwhile to take a closer look at those ‘marginal’ workers). When one looks at a larger set of countries, using  the OECD real wages data and the Eurostat participation data it shows that even in Greece, which knew a 20% decline of real wages, the participation rate (especially of women) still increased… Just like in Iceland, which witnessed a 15% increase of real wages.

The economists writing down these models (or at least the European ones) have of course noticed such developments. How do they try to explain these, using models which predict the opposite?  To explain this, I have to say a little about these models. According to neoclassical macro, people do not like to work. Hence, they have to be paid to work. Lower pay will lead to a decline of the ‘participation rate’ or the percentage of people wanting a job (or the total amount of hours or the average amount of hours supplied by ‘the representative household’, the models do not entirely agree about the metric of choice). Consumption of these lazy dropouts won’t decrease, as the entire nation is one big happy household which takes loving care of its members, employed, unemployed and non-participating members alike. In this world, foreclosure does not exist!

Real life unemployment basically means that wages are too high (i.e: they did not decline enough) and too many people want a job (look here for a Banca d’Italia study by Fransesco Nucci and Mariana Riggi which tries to explain the difference between the EU and the USA. Look here for a 2016 working paper by Miguel Casares Miguel and Jesús Vázquez (2016), ‘Why are labor markets in Spain and Germany so different?’). Though there is what’s called ‘habit persistence’, too, or  the idea that the unemployed, somewhat irrationally, are loath to diminish consumption when real wages go down (this is not entirely consistent with the idea that everybody is 100% consumption-insured, but whatever). In your and mine language: the rent (or your mortgage interest bill) has to be paid. This irrationality makes (members of ) households want to stay in the labor force… And there are of course ‘shocks’, like the doubling of the participation rate of women, everywhere (also in Turkey, albeit fourty years after the USA and thirty years after the EU). The answer of these economists to cope with such schocks: lower wages. As that will restrict the inflow of people into the labor market. And when people can’t pay their mortgage interest bill? Let them get lost. Let them drop out. And let them discover the truth:  in the real world, foreclosure does exist. Just like involuntary unemployment. Might this all sound as a somewhat extreme, not to say juvenile rant? Look here for comparable ideas by Roger Farmer and here for comparable ideas from the Worhtwhile Canadian Initiative blog. Aside: TALA ( There Are Loads of Alternatives ): much less dogmatic, more comprehensive, subtle and more interesting (and non-neoclassical) study is: Casado, Jose Maria, Cristina Fernandez and Juan F. Jimeno (2015). ‘Worker flows in the European Union during the Great Recession’ ECB Working Paper Series 1862

  1. December 18, 2016 at 5:25 pm

    Somewhat irrationally, the consumer in economics does not have to live, eat, et cetera, and can therefore ‘drop out’ of needing to do so daily and acting providently to do so. Since human beings must act providently to meet their needs (and wants beyond their needs) if they are to be deemed rational by human beings, then the consumer in economics cannot be rational, having neither needs nor wants. Consumers exist in economics solely if they have an ability to pay; and they cease to exist if they do not have that ability.

    This nonsense clearly prevails at the macro level of economics.

  2. David Chester
    December 19, 2016 at 8:48 am

    At the level of macroeconomics there is a big difference between what Larry has written and the way the aggregate quantities work. The apparent lack of logic when applied to situations at the microeconomics level should not concern us when examining the trends of the functional parts of the Big Picture. So it is not nonsense at all, simply a different subject being confused about!

    • merijntknibbe
      December 19, 2016 at 9:03 am

      My critique (and not just mine!) of neoclassical macro is that (untested!) micro relations are supposed to be transposable to the macro level, compare the ‘representatieve household’, i.e. the idea that all households together act as one small Household while assuming fallacies of composition away.

      • David Chester
        December 20, 2016 at 5:27 pm

        The subject of complexity and of how the aggregate properties represent the individuals in a collective way is poorly understood by economists.

        Try to think like a physicist and consider the Gas Laws for the relationship between gas density, pressure and temperature, when a particular mass of gas is confined in a specific volume. These Gas Laws (expressed by a simple algebraic formula, which I will avoid here) can be derived from the molecular theory of gasses too, where each molecule is moving at a different speed and collides with others and the wall of its container. But the two theories are completely different when compared. The macro theory can be tested for gasses and also some of the aggregate nature of macro- can be used to simulate the whole shebang! I have done this and certain aspects do agree, so please don’t think that testing at the macro- scale is impossible

        In microeconomics, this analogy applies to separate families within a country and the way its population behaves IN AGGREGATE. Once you have reached the macro level, to better understand our science, there is no point in going back to the family sized (Micro-) one.

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