Saturday, January 29, 2011

Keynes, Wages, Inflation

In Ch. 2 of The General Theory, Keynes makes a distinction between money-wages and real wages. The money-wage is the amount of money a worker is making at his job per hour, week, or month. A reduction in one's wages from $10/hr to $9/hr. would be a money-wage reduction. It is not surprising that people resist such reductions in wages, as they see that as a reduction in purchasing power -- which is not true of prices are going down, of course. Which brings us to real wages. If prices go down, our real wages go up; if prices go up, our real wages go down. Keynes argues that workers resist reductions in money-wages, but are less resistant to real wage reductions. Workers, he argues

resist reductions of money-wages, which are seldom or never of an all-round character, even though the existing real equivalent of these wages exceeds the marginal disutility of the existing employment; whereas they do not resist reductions of real wages, which are associated with increases in aggregate employment and leave relative money-wages unchanged, unless the reduction proceeds so far as to threaten a rduction of the real wage below the marginal disutility of the existing volume of employment. Every trade union will put up some resistance to a cut in money-wages, however small. But since no trade union would dream of striking on every occasion of a rise in the cost of living, they do not raise the obstacle to any increase in aggregate employment which is attributed to them by the classical school. (14-15)
It should be clear where he is going with this. Under conditions of falling prices, workers resist falling wages. For some reason this is a problem, though it has yet to be explained. Now, he hasn't made it clear why prices are falling, which is bound to make a difference.

If wages are high because the workers were participating in a bubble economy, and the bubble bursts, causing prices to drop precipitously, then such money-wage resistance is a problem for those participating in the bubble economy. The only way to maintain the number of workers employed in the bubble economy is for wages to drop. Because there is money-wage resistance, the solution is to lay off workers. This is of course backed up by the fact that, once the bubble bursts, you aren't making nearly as many units of produced goods as you were, and don't need as many workers. Keyne's argument seems to point to somehow increasing prices to overcome money-wage stickiness, thus reducing real wages. Of course, the only "somehow" possible would be to have a central bank print more money, resulting in monetary inflation which drives up prices relative to wages, thus driving down the real wage. This of course only addresses wage stickiness and not the fact that when a bubble bursts, you still don't need as many workers as before. The consequence of that should be clear: unemployment with inflation. We saw this consequence in the 1970's; if we did not see it before, it was only because the market recovered and workers were hired in other jobs before the inflation came online. Money does not enter the economy in all sectors equally, after all, and neither does it enter it right away.

Another way prices can fall is for the economy to grow. If the economy is growing faster than the population is growing, meaning more products are being made relative to the number of people available to buy said products, you could also have price deflation. Another way is to improve efficiency, thus making it cheaper to make more goods. We see the latter quite clearly in computer technology, where prices for a particular computer or similar device drops very quickly after its initial release. If prices are dropping because there are more goods available relative to population growth, then it is difficult to see why money-wages should go down. These prices are after all going down with the prevailing wages. Nevertheless, monetarists, who are apparently persuaded by Keynes' observations above, argue that the money supply ought to grow at more or less the same rate as the economy. If there is a 3% growth in GDP, then the money should grow 3%. This prevents whatever problems they imagine will occur because of money-wage resistance. But as just noted, it seems quite unlikely that under this scenario anyone would want to decrease wages (any more than a business owner would like to reduce wages to increase profits, of course -- an entirely irrelevant point, since obviously the business owners figured out what wages they had to pay to get the workers the needed in the first place).

Keynes (and the monetarists to a lesser degree) are concerned, then, with the fact that wages don't go down when they think they should. The way to reduce real wages, then, is through inflation. Inflation hits prices first, and then wages follow. If inflation drives up prices, it makes sense to borrow now to purchase now, and wait for wages to rise in response to inflation, thus making your past purchase cheaper (since your loan payments do not increase with inflation). The goal for each is, of course, full employment. Both seem to imply that without inflation, unemployment would slowly rise and rise. This seems a strange claim. It would mean that unemployed people would refuse to work except at the money-wages they used to make. This ignores the fact that over time people become more and more willing to work for less and less. And if there is a firm that has unionized workers who are resistant to a decrease in wages, then you can expect a nonunion company to emerge and hire those laid-off skilled people to work for them at the lower wage they are now willing to work at.

The only thing, then, that an inflationist policy seems designed to do is protect union workers from competition against nonunion companies and workers. Indeed, the so-called Keynesian period of U.S. political economy, between the end of WWII and the election of Ronald Reagan in 1980, was a period of strong unions. When the switch was made to supply-side economics, the unions collapsed. Is it any surprise, then, that President Obama, who has (and whose Federal Reserve has) been pursuing more or less Keynesian policies, is also pro-union?

One has to distinguish between the Keynesian and monetarist policies, though, because Keynes did at least seem to have enough sense (from what I have read about his ideas -- I haven't gotten that far yet myself in The General Theory) to argue that inflationist policies like deficit spending and printing money should only occur during recessions; the monetarists argue for printing money at the same rate every year, with the result of a continual downward pressure on real wages. Reagan, of course, added to this with high deficit spending during a non-recessionary economy. As observed above, the Keynesian policy, though, seems to protect unions, while the monetarist-Reaganomics approach proved to not protect unions in the least. The reasons for this difference would make for an interesting economics paper (assuming, of course, I'm right about everything I just said above).
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