Home > Uncategorized > Cutting wages is not the solution

Cutting wages is not the solution

from Lars Syll

axA couple of years ago yours truly had a discussion with the chairman of the Swedish Royal Academy of Sciences (yes, the one that yearly presents the winners of The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel). What started the discussion was the allegation that the level of employment in the long run is a result of people’s own rational intertemporal choices and that how much people work basically is a question of incentives.

Somehow the argument sounded familiar.

When being awarded the ‘Nobel prize’ for 2011, Thomas Sargent declared that workers ought to be prepared for having low unemployment compensations in order to get the right incentives to search for jobs. The Swedish right-wing finance minister at the time appreciated Sargent’s statement and declared it to be a “healthy warning” for those who wanted to increase compensation levels.

The view is symptomatic. As in the 1930s, more and more right-wing politicians – and some economists – now suggest that lowering wages is the right medicine to strengthen the competitiveness of their faltering economies, get the economy going, increase employment and create growth that will get rid of towering debts and create balance in the state budgets. 

But, intimating that one could solve economic problems by wage cuts and impairing unemployment compensations, in these dire times, should really be taken more as a sign of how low the confidence in our economic system has sunk. Wage cuts and lower unemployment compensation levels do not save neither competitiveness, nor jobs.

What is needed more than anything else in these times is stimulus and economic policies that increase effective demand.

On a societal level wage cuts only increase the risk of more people getting unemployed. To think that that one can solve economic crisis in this way is a turning back to those faulty economic theories and policies that John Maynard Keynes conlusively showed to be wrong already in the 1930s. It was theories and policies that made millions of people all over the world unemployed.

It’s an atomistic fallacy to think that a policy of general wage cuts would strengthen the economy. On the contrary. The aggregate effects of wage cuts would, as shown by Keynes, be catastrophical. They would start a cumulative spiral of lower prices that would make the real debts of individuals and firms increase since the nominal debts wouldn’t be affected by the general price and wage decrease. In an economy that more and more has come to rest on increased debt and borrowing this would be the entrance-gate to a debt deflation crises with decreasing investments and higher unemployment. In short, it would make depression knock on the door.

The impending danger for today’s economies is that they won’t get consumption and investments going. Confidence and effective demand have to be reestablished. The problem of our economies is not on the supply side. Overwhelming evidence shows that the problem today is on the demand side. Demand is – to put it bluntly – simply not sufficient to keep the wheels of the economies turning. To suggest that the solution is lower wages and unemployment compensations is just to write out a prescription for even worse catastrophes.

  1. antireifier
    February 22, 2017 at 10:29 pm

    But the solution is not to artificially increase demand without paying attention to sustainability. Our planet is an environmental mess — climate change, plastics killing life in the oceans and the air, life-shortening smog in various cities (China), etc. We need a paradigm shift in political/economic/cultural thinking but that is not on the horizon from what I can tell. We create debt money to manufacture crappy products that are thrown away and see that as productive capacity. It is NOT. What about creating debt money for me to stay at home and write. Actually, I am retired so I do that anyway. But you likely get my point.

    • February 23, 2017 at 12:39 am

      “But the solution is not to artificially increase demand without paying attention to sustainability. Our planet is an environmental mess… ”

      We know how to make a market-based system work better. Do we know how to make a non-market-based system work? I personally don’t.

      • Grayce
        February 23, 2017 at 2:45 pm

        Who knows? But a start is to examine value: tangible value is easy since it is observable, weighable and so forth; intangible values such as quality of life in a village or “loss to society” are not natural to the American economist. This has a non-market aroma. The wholesale distaste for “government interference in private lives” may well be a misnomer for “government regulation of free markets.”
        It is time to also redefine the proper and value-laden powers of various forms of government. Not simply trying to eradicate the idea of commonwealth, but mining the historic purposes of government and weaving a new system that acknowledges the donation (tax) to the common good.

  2. February 23, 2017 at 12:11 am

    There are two major intertwined problems here. One is sustainability, the other is growing income and wealth inequality. Moreover, we need look no further than the revelation that 50% of Americans now live at or below the poverty level to understand why Donald Trump defeated Hillary Clinton. Donald will most likely not succeed in what he has promised to do, but that’s another issue. Incidentally, Bernie Sanders did very well in the primaries against Hillary for precisely the same reason, and if the DNC had not stabbed him in the back then he would probably now be president.

  3. February 23, 2017 at 2:21 am

    “What is needed more than anything else in these times is stimulus and economic policies that increase effective demand.”

    That depends. For an economy with relatively low private debt levels and with an industry relying primarily on export markets, the slight lowering or freezing of wages could stimulate foreign demand and therefore boost the economy and improve the foreign trade position (reduce foreign debt). But it is a risky path, as it can lead both to reduced local consumption, as you point out, as well as to ‘brain drain’ in favour of competing, but better paying economies. I tend to agree that monetary incentives work better than starving people into submission, but ‘too much’ incentives can lead to reduction in work hours, as part time work may generate enough income….

    • Hepion
      February 25, 2017 at 6:00 am

      But in the currency markets balances balance. If capital account is in balance, imports pay for exports, so when you lower wages and lower imports you also lower exports. Japan has been lowering nominal wages for years with no improvement in competitiveness.

      It is sad all this is so complicated policy makers don’t understand

  4. February 25, 2017 at 9:54 am

    The assertions that begin this post are in my view correct. But in a much different form I think than intended by the authors of those statements Yes, the level of employment in the long run is a result of people’s intertemporal choices. But these choices cannot be labeled rational since there are dozens of often conflicting interpretations of rational currently in use. Which of those should be applied and how do we assess if the actions in question fit the interpretation we choose? Also, these choices are not individual. Partly because of a similar lack of clarity about which actions are and are not individual. And partly because humans only exist in relationships with other humans and the other things in the world. No human is ever alone so individuals don’t exist. It’s also correct that incentives play some part in these choices. Incentives of many sorts Biological and evolutionary incentives around health, life, and survival. Serving the needs of family. Satisfying work and work that makes society better. Making life more pleasant and interesting. And improving understanding of ourselves and the universe. Powerful incentives. Finally, keep in mind in reading all this that none of it existed 100 years ago. Such questions as why and how people are employed, how the economy fits or does not fit around work, and “the economy” simply did not exist. They only exist now because people invented them. Keep that in mind when economists speak in naturalistic terms about “the economy.”

  5. February 27, 2017 at 5:15 pm

    RE: WAGE DECREASES

    They would start a cumulative spiral of lower prices that would make the real debts of individuals and firms increase since the nominal debts wouldn’t be affected by the general price and wage decrease.

    I disagree that general wage decreases would “start a cumulative spiral of lower prices”.

    1. There is no reason to ASSUME that, among employers, the monies saved from general wage decreases would lead to a fall in produce prices, for such monies saved may simply enter short-term profit streams of employers and contribute to inequalities in incomes distribution.

    2. There would be a shift to lower priced goods with a fall in ‘demand’ for higher priced goods, but the shift may lead to rises in the prices of lower priced goods as more of these are being sought. Further, in terms of categories of expenditures, the shares of expenditures out of wages would rise for most-needed essential goods — food, shelter, a minimum of clothing, heating, transportation — while falling shares of expenditures out of wages would occur across less essential goods. [In the latter case, producer competition for shrinking markets could lead to lower prices and bankruptcies at such lower prices if ‘other’ markets cannot be found.

    3. The share of nominal wage income needed to discharge prior nominal indebtedness would rise. This would lead to further shifts in consumption patterns — towards lower priced goods — and yet further decreases in less ‘essential’ expenditures out of wages.

    4. These shifts in domestic demand will lead to lower price, poorer quality goods driving out more expensive ‘quality’ goods across the full range of consumption expenditures out of wages.

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