Thursday, February 25, 2010

Pricing employment

I previously criticized the Glibertarian/Austrian insistence that unemployment is caused by employees keeping their price too high. I've encountered this elsewhere, such as when Hayek said 25% of Germans were unemployed during the Great Depression because German workers chose to consume leisure rather than to work. Apparently, the business cycle folks like Edward Prescott believe that we never had a Great Depression -- instead, we had a Great Vacation, where people voluntarily chose to not work. Says the Glibertarian, "Resources are not slack or idle *as such*, but idle *at some price.*" Thus if a worker is not working, he by god is choosing not to work, because if he really wanted to work he'd simply lower his price!

To say that this is ridiculous is an understatement. Most unemployed people want a job, any job, and aren't finding one regardless of price because price of labor is only half the equation. I now introduce the primary Keynesian critique of classical thought, which is that the classical economists know the price of everything, but the demand for nothing. They know the price of labor, but not the demand for labor. That is, there are two parts to the supply and demand curve: the supply side, and the demand side. If the demand side collapses due to people deciding that their money is better saved than spent (rather than because prices rise), that is, if the entire demand curve shifts downward because people voluntarily choose to save more rather than spend, then employment declines regardless of what prices do.

Keynesian thought requires accepting two things as true:

1) One man's wage is another man's price, and vice versa. That is, if all prices and wages in a system go down (or up), it has no effect upon demand and thus no effect upon employment, since businesses are in business to make a profit, not to serve as charities hiring people they don't need in order to meet demand.

2) Demand can go down (or up) even if neither prices nor wages have changed due to changes in people's propensity to spend -- i.e., changes in how people decide to distribute their wages between savings and consumption.

These propositions agree with actual observed reality over the past 80 years, where e.g. we've had high unemployment during periods of high inflation (see: late 70's, early 80's), and high unemployment during periods of low inflation (see: now) or during actual deflation (see: 1930's) -- wage and price levels on a systemic basis seem completely irrelevant to the question of employment. What matters is demand.

Thus the neo-Keynesian emphasis upon the importance of the demand curve and, specifically, propensity to spend, which moves the demand curve up and down. This appears to comport more closely to reality than Austrian or neoclassical thought, which appear to describe reality in a universe where unicorns are real and cotton candy grows on trees but not reality in our universe, where businesses are not charities and hire only those workers they need in order to meet demand, regardless of how cheap those workers are. If I have a sandwich shop and I need six workers to meet my demand, that's all I hire -- period -- regardless of how cheap the workers are. Any theory that refuses to admit the centrality of demand to the employment problem is a theory that is not worth taking seriously, at least insofar as it pretends to address the employment problem.

-- Badtux the Economics Penguin


  1. Yeah.

    Conservative are out of touch with the real world.

    Reality has a liberal bias. that's why it's always wrong.

    jXb the reality trombonsit

  2. "If I have a sandwich shop and I need six workers to meet my demand, that's all I hire -- period -- regardless of how cheap the workers are."

    Radtux, you seem to be ignoring the fact that there is no such thing as a simple "number of workers needed to meet demand." As wages change, different numbers of workers may make sense. At some wage x, I might hire someone to put flyers for my shop under doors to drive up demand, whereas at x + y I won't. At wage x I might work the last two hours of the night myself, whereas at x - y I will hire someone to work those hours. Wagerates affect how long it makes sense to stay open, when to buy machinery, and more.

    Your analysis would be stronger if you acknowledged these factors.

  3. Gene, by necessity I simplify the model for a non-technical audience. You are correct that there is a marginal utility number that applies at the edge where a lower wage might cause my employment to flicker between 6 and 7 depending upon wage. We are, after all, talking about a continuous function here, not a discrete function, and there can be some flickering in the edges as we attempt to assign discrete assets to a continuous function.

    However, in a perfectly competitive environment, I will need to keep my hours down to as low as my competitor across the street, or otherwise I will either a) accept less profit (and that isn't something that I, as a businessman, want to do, I'm in business to make a profit, not to be a charity!), or b) raise my prices above what my competitor across the street charges, in which case I lose business to my competitor. Over time, both my wage base and my competitor's wage base will approach the minimum needed to fulfill demand, otherwise I will be outcompeted by my competitor undercutting my prices.

    Now, you might argue that perfect competitive environments do not exist. And that is, of course, true, but for the purpose of this model irrelevant.

    - Badtux the Economics Penguin

  4. The Great Vacation, eh?

    I guess I need to go back and reread The Grapes of Wrath. And go back and re-listen to Woody Guthrie's Dustbowl Ballads. Clearly, I misunderstood EVERYthing. Matter of fact, it was by choice that my grandmother's family subsisted on hard-tack with lard smeared on it, before they left UT for CA. Holy shit. The delusions I was under all this time. Not to mention my grandmother, who was more afraid of starvation and of not being prepared for times of scarcity than the GOP is of taxes.

  5. There have been economists (probably Chicago, I've lost the detail) here in the USA who, in the last year, have seriously put forth the idea that the unemployed chose not to work, just like Hayek, back in the day.

    It's amazing, the bullshit these people will delude themselves with.

    JzB the reality trombonist

  6. Well, bullshit is definitely part of the circle of life. No shit and no compost = no flowers or veggies.


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