Tuesday, May 03, 2011

Keynes - The General Theory - Chapter XIX

Section I: Keynes undertakes to examine the relationship between money wages and employment. The relationship between the two ought to be very obvious, but as is his wont, Keynes denies the validity of what he calls the Classical Theory: "The argument simply is that a reduction in money-wages will cet. par. stimulate demand by diminishing the price of the finished product, and will therefore increase output and employment..."

In other words, if unemployment is too high at present wage rates, wages must fall until the marginally unemployed become employable. This is economics 101: if the price of a good is too high to meet demand, the price must fall or the good will remain unsold. It matters not at all whether we are discussing labor or apples, the principle holds.

Naturally, Keynes denies this: "For, whilst no one would wish to deny the proposition that a reduction in money-wages accompanied by the same aggregate effective demand as before will be associated with an increase in employment, the precise question at issue is whether the reduction in money-wages will or will not be accompanied by the same aggregate effective demand as before measured in money, or, at any rate, by an aggregate effective demand which is not reduced in full proportion to the reduction in money-wages (i.e. which is somewhat greater measured in wage-units)."

But aggregate demand has nothing to do with whether or not a man can be employed. True, if the industry in which he is hired begins to slump, he may have to find alternative employment. This frictional employment, though not unimportant, is not germane to this discussion.

Section II: Keynes begins this next section by asking two questions:
(1) Does a reduction in money-wages have a direct tendency, cet. par., to increase employment, “cet. par.” being taken to mean that the propensity to consume, the schedule of the marginal efficiency of capital and the rate of interest are the same as before for the community as a whole? And (2) does a reduction in money-wages have a certain or probable tendency to affect employment in a particular direction through its certain or probable repercussions on these three factors?

It might appear at first glance that a reduction in wages will reduce the propensity to consume, thereby endangering the economy. But this analysis only makes sense if we also assume that the prices of things a man is trying to buy aren't falling at a similar rate. Yet it is exceedingly probable that the reason the man's wages were reduced was due to a decrease in the price of the goods he was making. A fall in the price of widgets necessitates a cut to the wages of the widget maker--not the other way around.

Keynes devotes some of this section to incorrect expectations of entrepreneurs. This has nothing to do with the systemic unemployment which transpires during a recession. Those employees of failed entrepreneurs can find work with successful bosses.

He goes on to list seven of the most important repercussions due to a reduction of money-wages, most of which he deems bad for employment. Most of his reasoning is specious, relying on some of his assumptions from earlier. Basically if wages fall, than consumption falls, which decimates the economy.

He continues: "We can, therefore, theoretically at least, produce precisely the same effects on the rate of interest by reducing wages, whilst leaving the quantity of money unchanged, that we can produce by increasing the quantity of money whilst leaving the level of wages unchanged."

Here the central planners smile. Finally, something is found for Paul Krugman to do.

Yet the attempt to solve unemployment through debasement of the currency is curious, for at least two reasons. First, inflation enriches those who have first access to the new money, that is, the bankers. My copy of The General Theory features a quote from Time calling the author a "workingman's revolutionary." Yet these policies would enrich the bankers at the expense of the workingman.

Second, unemployment is seldom evident across all industries. Our real estate bubble allocated too much labor into industries connected to real estate. This labor needed to be reallocated throughout the economy. But while inflation could conceivably prop up housing prices, thereby offsetting unemployment in that sector, we need recall that other sectors needed no such readjustment. Rather than allowing prices to fall so as to clear the supply--of workers and unsold houses--the solution is to inflate until those prices are realistic. And when the inflation causes another bubble in a different industry, we need only inflate once again.

Strikingly, Keynes recognizes this: "There is, therefore, no ground for the belief that a flexible wage policy is capable of maintaining a state of continuous full employment; — any more than for the belief than an open-market monetary policy is capable, unaided, of achieving this result. The economic system cannot be made self-adjusting along these lines."

The key word here is "unaided". But it's still a pretty telling admission by Keynes. Someone ought to tell Bernanke.

Still, on the whole, Keynes sides with the bankers: "Having regard to human nature and our institutions, it can only be a foolish person who would prefer a flexible wage policy to a flexible money policy, unless he can point to advantages from the former which are not obtainable from the latter. Moreover, other things being equal, a method which it is comparatively easy to apply should be deemed preferable to a method which is probably so difficult as to be impracticable."

Of course, allowing wages to fall is trivially easy. It takes no intervention from central planners and happens, by mutual consent, between the employer and the employee. The alternative, as we see clearly, is not an economic boost due to the benevolent bankers, but unemployment due to wage rigidity.

Again, Keynes puts things backwards, in assuming that wage flexibility creates debt, whereas increasing the money supply does not. On the contrary, an inflationary system punishes savers and rewards debtors, thereby encouraging the latter. Hence it is no surprise that the Western world, enthrall to inflationary policies, is drowning in a sea of debt.

Section III: We come across more nonsense: "The chief result of [a] policy [of flexible wage rates] would be to cause a great instability of prices, so violent perhaps as to make business calculations futile in an economic society functioning after the manner of that in which we live."

Here, as so often, Keynes paints a dark picture when, by simple recourse to economic history, he would see things in a better light. Wages were kept rigid during the Great Depression, yet unemployment persisted; prior to Hoover's intervention, wages were allowed to fall, and, instead of the violence Keynes postulates, we saw short recessions, followed by a return to normalcy.

And we have a bold-faced lie: "It is only in a highly authoritarian society, where sudden, substantial, all-round changes could be decreed that a flexible wage-policy could function with success." Again, recourse to economic history would have served Keynes well. The comparatively freer America of the post-Civil War years demonstrated wage flexibility. True, the changes were not "sudden, substantial, all-round", but only Keynes is silly enough to think they need to be.

"In the long period, on the other hand, we are still left with the choice between a policy of allowing prices to fall slowly with the progress of technique and equipment whilst keeping wages stable, or of allowing wages to rise slowly whilst keeping prices stable."

The first alternative sounds fine to me, but the choice is a false one as Keynes can only keep prices stable by becoming a dictator of a closed economy. In any event, it's telling that he thinks it would be terrible if one's cost of living is falling with respect to one's wages. This strikes me as sound economic policy.

No comments: