Wednesday, September 22, 2010

Keynes - The General Theory - Chapter II - Sections I and II

Section I: Keynes starts the second chapter thus: "Most treatises on the theory of value and production are primarily concerned with the distribution of a given volume of employed resources between different uses and with the conditions which, assuming the employment of this quantity of resources, determine their relative rewards and the relative values of their products."

I'm not terribly familiar with the literature, but there are reasons to believe that this statement is not true. Whatever Keynes's ability as an economist, he often speaks as if he has a deep familiarity with divergent economic thought even when it is not the case. The problem is a real one, which is why Keynes was not the first to address it.

Continuing, Keynes gives two postulates upon which is based the "classical theory of employment." To wit:

1) The wage is equal to the marginal product of labour

My research tells me that this first postulate is an accurate summary of the classical position. However, this is not consistent with Austrian teaching, under which the wage is that which is agreed upon by the employer and the employee. There is no real equality; instead, the employee works for a wage which he prefers--both to other wage offers as well as the prospect of remaining idle--while the employer pays this wage because he prefers dispensing with this money in exchange for which he expects certain work from his employee.

The explanation offered by Keynes serves only to muddy the waters.

Onto the second postulate:

2) The utility of the wage when a given volume of labour is employed is equal to the marginal disutility of that amount of employment

I'm honestly not sure what this means or why Keynes thought it was necessary. If you've defined your equality above, I'm not sure what this second postulate gives you. I may be missing something here.

Keynes uses a trichotomy to classify unemployment: frictional, voluntary, and involuntary. Yet frictional unemployment can be either, so I don't think it's a very helpful distinction. Nonetheless, Keynes proposes to look into involuntary employment and how it may come about.

He uses some more unhelpful terminology in this section by dividing goods into wage-goods and non-wage-goods. I can't think of any non-wage-goods. Further research suggests that by wage-goods, Keynes means consumer goods. I'm not sure why he felt need to introduce strange terminology--though in fairness these terms come from Pigou.

Section II: Keynes postulates: "that within a certain range the demand of labour is for a minimum money-wage and not for a minimum real wage." This is interesting, but not surprising. I'm certain a fair number of employees would accept a pay cut if they could find no other work; this number would be more substantial without generous unemployment benefits. When this wage reduction occurs clandestinely through inflation--for this is the primary cause of a reduction in real wages--it makes sense that people would tolerate this as well. There is a point at which people will seek employment elsewhere or cease working entirely; but it is not one penny less per hour as Keynes seems to think classical economists thought.

Keynes tells us: "It is not very plausible to assert that unemployment in the United States in 1932 was due either to labour obstinately refusing to accept a reduction of money-wages or to its obstinately demanding a real wage beyond what the productivity of the economic machine was capable of furnishing." Unfortunately, he does not tell us why it is implausible. Murray Rothbard makes a good case in his book, America's Great Depression, that the refusal of the partnership of big business and government to let wages fall exacerbated the depression. It would certainly seem reasonable to argue that allowing wages to fall would have created more employment.

He also writes: "It would be interesting to see the results of a statistical enquiry into the actual relationship between changes in money-wages and changes in real wages." His argument is empirical, so it would behoove him to take the time to accumulate some data, so as to see if his theory is reasonable. Keynes fails to do the necessary research here.

Continuing: "The traditional theory maintains, in short, that the wage bargains between the entrepreneurs and the workers determine the real wage ; so that, assuming free competition amongst employers and no restrictive combination amongst workers, the latter can, if they wish, bring their real wages into conformity with the marginal disutility of the amount of employment offered by the employers at that wage." Note the italics. Barring interference from the State--as for instance, raising the minimum wage would disallow laborers from working for less than the minimum--this is sound.

Then Keynes starts to get muddled by looking at the forest and forgetting that it is comprised of trees: "The classical conclusions are intended, it must be remembered, to apply to the whole body of labour and do not mean merely that a single individual can get employment by accepting a cut in money-wages which his fellows refuse." There is no such law which applies to the body of labor. All action occurs with individuals, and, to be more specific, at the margins. Employers do not say, "we shall raise employment by some quantity today" but rather ask, "shall we hire this person?" It is foolish to speak otherwise.

More: "To sum up: there are two objections to the second postulate of the classical theory." We have explained the problems with the first, so we'll move to the second: "There may exist no expedient by which labour as a whole can reduce its real wage to a given figure by making revised money bargains with the entrepreneurs. This will be our contention." Again, labor does not act as a whole. Individual laborers may seek alternative employment should a change in conditions prove undesirable to them. I don't see how this can be disputed.


Jeff said...

I will withhold comments on the preface and Chapter 1, mainly because you summed up his points well, but also because he offers nothing of real value.

Section I: In regards to the first postulate, “1) The wage is equal to the marginal product of labour,” there is some value to what is said. The wage that an employer will be willing to offer a prospective employee will not exceed what he deems the employee’s discounted marginal value product to be. It may in certain cases end up being equal, but this is not the rule. It is important to note that any attempt to use this equality to derive a mathematical equation, is not only invalid but of no consequence to economic analysis. Lastly, there is no reason to differentiate between the marginal product of labor and the marginal product of capital. Both are viewed as commodities by the employer, so both simply have a marginal value product. Occam’s razor applies to economics.

I believe that the second postulate, “2) The utility of the wage when a given volume of labour is employed is equal to the marginal disutility of that amount of employment,” is essentially saying that people will only work if the utility gained from the wage equals the disutility of giving up leisure time or another job opportunity. As Mises writes in Human Action, “For acting man his own labor is not merely a factor of production but also the source of disutility, he values it not only with regard to the mediate gratification expected but also with regard to the disutility it causes.”

Keynes goes on to claim regarding the postulates that, “the first gives us the demand schedule for employment and the second gives us the supply schedule.” I agree that the first postulate relates to the wage the employer will offer, and the second to the wage an employee will be willing to accept. The problem is that he goes on to state, “the amount of employment is fixed at the point where the utility of the marginal product balances the disutility of marginal employment.” This statement reveals precisely how Keynes views employment; as an aggregate rather than individual issue. As you stated, employment comes about when the employer and employee agree on a certain wage. Considering Keynes begins his analysis of employment from the wrong perspective, it should be no surprise when his conclusions are found to be erroneous.

Thoughts on section II to follow.

A Wiser Man Than I said...

It may in certain cases end up being equal, but this is not the rule.

Absolutely correct. If Keynes realizes this, he doesn't run into mistakes later. If the equality always holds true, employees would see their wages fluctuate rapidly. Since we don't see this, Keyens thinks there is a problem, but it's only with one of his postulates.

I believe that the second postulate... is essentially saying that people will only work if the utility gained from the wage equals the disutility of giving up leisure time or another job opportunity.

That's what I think, too. I'm just not sure how this helps Keynes. Certainly it's of no use in providing us with some sort of equality.

Taya said...

I think the definition of wage-goods is reasonably clear from the text. A wage good is a good on which the utility of your money-wage depends. The utility of what I earn is not affected by the price of private jets. Private jets are non-wage-goods (for most of us!) But the utility of my wage *does* depend on the price of some goods, such as food, rent, transport, etc. These are wage-goods as far as I understand them...

Anonymous said...

Did you guys ever take a introductory or intermediate microeconomics theory course? Or a labor economics course? The first and second postulates are exactly what is taught in those courses. Keynes is only trying to sum up those theories, not expand on them in the normative sense. He is simply saying he believes there is another reason why people are unemployed, because the classical models didn't include it.

In the years The General Theory was written, an employee and an employer didn't sit down and agree on a wage. Employees didn't have any rights unless they were part of a union.