Debunking Economics, Part IV: The Many Ways to Debunk Labour Economics

Chapter 5 of Steve Keen’s Debunking Economics takes a look at labour market economics, an area where I feel there are almost too many different criticisms to know where to start. Keen spends a relatively short amount of time on this chapter, and though his expositions are sufficient to question many of the standard stories economists tell us about labour, I feel he misses some low hanging fruit.

Keen primarily builds on his earlier approach to demand-supply analysis. He first notes that the relatively uncontroversial backward bending labour supply curve, when aggregated, can mean a labour supply curve can have any shape at all – this aggregation issue is not fully explored on economics courses. He then applies his earlier analysis of demand curves, which implies the same for labour demand. The definitive PHD textbook , Mas-Collell, has also noted the latter, but assumes it away by supposing that:

…there is a benevolent central authority, perhaps, that redistributes wealth in order to maximise social welfare…

Naturally, this assumption isn’t true in reality, and since it’s a domain assumption – for which conclusions only follow as long as it applies (more on this in a later post) – we can safely ignore it. The result is that there may be any number of equilibrium points in a labour market.

On top of this, there are many more points that make the clear cut story of a single equilibrium highly questionable:

  • The intertwined nature of work and leisure – the latter relying on the former if, as Keen puts it, you want to do anything more than sleep.
  • The existence of nominal debt contracts.
  • Keynes’ argument at the beginning of TGT, which is that workers cannot control their real wages, as it is dependent on price, which are controlled by their employers. Keen weaves around this argument at the beginning of the chapter but never states it explicitly.
  • The fact that wages are an essential component of aggregate demand, and, similarly, that the labour market is so broadly defined that treating demand and supply as independent is not possible.
  • The fact that, since markets do not approximate perfect competition, even standard neoclassical analysis teaches that minimum wages and unionisation can be beneficial to combat market power.

Clearly, there are a multitude of reasons that ‘interfering’ with wages through demand management, legislation and unionisation is not obviously a bad thing.

This is actually fairly uncontroversial stuff, and most neoclassical economists would endorse some of it. Having said that, many still think real wages should fall, so clearly haven’t fully thought the implications through.

But maybe Keen should have been more controversial. For me his criticisms don’t go deep enough – he repeatedly refers to reasons that “workers will not be paid their marginal productivity”, without questioning the concept itself.

As I have noted before, labour only has productivity when combined with capital. Shops assistants need a shop, tills, hangers and bags; builders need tools, machinery and materials. Furthermore, some labourers only have productivity when combined with other labourers, too. Two people carrying a heavy box cannot be said to have a discernible individual productivity. The productivity of a McDonald’s relies on the cooks, the till operators and the supervisors combined – take away a cook and what’s the point in having an extra till operator when the cooks can’t keep up with the orders?

The result is that productivity can only be said to be a result of combined, rather than individual, factors. The relative shares are then determined by bargaining power.

I consider this argument a strong one, and it also fits quite nicely with many of the Sraffian arguments throughout the book: that firms do not hold capital fixed and employ more labour – they need to employ both simultaneously; that much of neoclassical analysis cannot take place independent of income distribution, which is dependent on political power (more on this in a later chapter). For these reasons I’m guessing Keen is unaware of this particular criticism, rather than rejects it – it would significantly strengthen his critique, which, though sufficient to complicate the neoclassical story, does not completely ‘debunk’ it.

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  1. #1 by Ron Ronson on July 18, 2012 - 6:00 pm

    Thanks for easy-to-follow guide to Keen’s book.

    I’d like to challenge your statement “productivity can only be said to be a result of combined, rather than individual, factors. The relative shares are then determined by bargaining power.”

    I agree that productivity is the result of combined efforts but fail to see why this leads to the conclusion that the shares are arrived at by bargaining. Take your example of a MacDonald. Clearly unless you have a building, other equipment, cooks, till operators etc you get no burgers being sold. But MacDonlds doesn’t really bargain for any of these things. Rather it just rents/buys/hires them at the going market rate. This then allows them to make and sell burgers at a prices that will be in line with their expected rate of profit (in other words they may well have a costs + markup model like the one you described in recent posts).

    Going back a stage – where do the prices for the inputs come from ? Essentially from supply and demand. Cooks and till-operators are both needed but if the supply of cooks in limited by the fact that this requires a rarer set of skills then cooks will tend to get a higher wage. What the wage level will be will depend upon a number of factors including the demand for burgers. If this rises (more burgers could be sold at current prices) then if Macdonalds strives to achieve a certain level of return they will be able to expand production which will tend to increase the price of chefs ( and the other inputs). This may or may not lead to increased burger prices depending upon the economies of scale of increasing burger production. In any case they will end up with the same rate of profit as before. If they increased neither prices or production there would simply be longer queues at the restaurants and this would signal to entrepreneurs tempted to move into the burger business that there were profits to be made. This would cause the price of chefs (and the other inputs) to tend to rise and put pressure on MacDonald for not having themselves reacted to these market signals.

    So in terms of pricing no (or very little) bargaining is needed. MacDonalds still needs to calculate the optimal mix of inputs (how many chefs per till operators, how square feet of building per restaurant etc etc). The optimum would partially depend upon price. But I’m pretty sure MacDonald has a whole department that deals with this kind of thing.

    All of this may break if the shape of the supply and demand for burgers and their inputs were totally indeterminate in the way that Keen seems to imply – but I would place money on the fact that is not the case in this industry.

    • #2 by Unlearningecon on July 19, 2012 - 4:10 pm

      I clarified exactly why it might be arrived at by bargaining in the post to which I linked – if each factor of production relies on the other in order to produce at all, the position of each will be determined by which one can more easily replace the other. Now, this might sound like a way of saying demand and supply, and it sort of is. Bargaining power and supply and demand are almost two ways of saying the same things. The difference is that one ignores income distribution while the other doesn’t.

      Your comment is very vulnerable to the Cambridge Capital Controversy criticisms, which are coming up in the next post. The basic point is a sort of chicken and egg problem – it’s not possible to examine prices of factor inputs and their profitability, such as the ones you describe, independent of each other. I’m quite busy at the moment so I hope you don’t mind saving the disagreements until then!

      In the mean time here are some links:

      You may/may not be aware of this already.

      • #3 by Ron Ronson on July 19, 2012 - 10:23 pm

        I should have looked at the link before replying. The key part there seems to be:

        “Each wants as much as possible, but each requires the others in order to gain any produce at all. So the share for one factor of production is determined by its relative ability to replace the other factors of production. Or, to put it another way, the produce is distributed by bargaining power. ”

        However again I don’t see how you end up with the conclusion that it is all down to bargaining power. Its the buyer who decides what mix of inputs to use based on looking at buying price and physical output of all the combinations and choosing the one that generate the best margins. Where does the bargaining come into it ?

        On “each will be determined by which one can more easily replace the other” – I’m still not getting this point. I can see that if 2 workers whose market wage is $10/hr can do the same as 1 worker whose wage is $30/hr then a firm will choose the first option, But I don’t see why this necessitates bargaining .

        On the Cambridge Capital Stuff: Looks like a fascinating subject and I want to study it some more. . Perhaps I’m over-simplifying but it looks like what is being said is that the optimum mix of inputs to produce a given good will vary depending upon the rate of profit. However as I was assuming a fixed rate of profit Its not clear how this is relevant. Perhaps this would mean that at different rates of profit the relative rewards to the different inputs would vary and this could be seen as random and unfair? In any case this conclusion seems to rest on the assumption that the rate of profit is itself the result of bargaining between business-owners and workers rather than (as in my model) itself the result of market forces.

      • #4 by Unlearningecon on July 23, 2012 - 7:17 pm

        However again I don’t see how you end up with the conclusion that it is all down to bargaining power. Its the buyer who decides what mix of inputs to use based on looking at buying price and physical output of all the combinations and choosing the one that generate the best margins. Where does the bargaining come into it ?

        This is a very economisty sentence. The buyer is a price taker. He is optimising. He is making marginal decisions. There are so many implicit assumptions that it is hard to unpick.

        You say he “looks at buying price and physical output of all the combinations.” Right. What I’m saying is that there can only be output when the factors are combined, not individually. Since output isn’t separable into factor inputs there’s no reason to believe labour has a marginal productivity that will be equal to or close to its wage. So what will it be paid? Under neoclassical assumptions, the buyer wants the lowest price possible; the seller the highest. The easier it is for the labourer to get another job, the higher the wage he will be able to demand; the easier it is for the firm to hire another labourer, the lower. This is why I say it is determined by bargaining power.

        On the CCC: the basic problem is that the measured rate of profit and the price of capital are interconencted. You cannot assume one to be separated from the other. I will post on this soon.

      • #5 by john77 on July 23, 2012 - 9:10 pm

        Two criticisms (one of which supports you, if you can stand the shock); firstly when I was a teenage computer programmer my employer had a “cut-off” return on capital for potential investment projects – this was naturally related to borrowing costs as well as risk so “nakedkeynesian” is talking through his hat: if borrowing costs went up £multi-million investment projects got cancelled and thousands of jobs disappeared. Secondly, MacDonalds (more usually their franchisees) do bargain – if the landlord owns adjacent retail property it can push up rents to reflect the additional passing trade drawn by MacDonalds. It is well known (except to left-wing economists) that any developer wishing to set up a retail park or an urban shopping centre looks for an “anchor tenant” such as M&S or Waitrose (Carrefour on the continent) which pays a much lower rental per sq ft than other tenants. So MacDonalds does *not* have to take the “going rate” unless it is moving into a single vacancy in an established shopping area where the landlord owns no other property in the vicinity. MacDonalds has additional bargaining power thanks to the intangible brand, which is a form of capital.

      • #6 by Unlearningecon on July 24, 2012 - 7:25 pm

        I don’t think it’s so much that individual firms employ capital reswitching – it’s that taken as a whole, entire industries will change their output procedures. Individual firms may go bust or scale down.

        It’s also worth noting that reswitching isn’t necessarily an empirical matter: it was simply designed to refute neoclassical economics on its own terms.

        It is well known (except to left-wing economists) that any developer wishing to set up a retail park or an urban shopping centre looks for an “anchor tenant” such as M&S or Waitrose (Carrefour on the continent) which pays a much lower rental per sq ft than other tenants.

        Actually what you call ‘left wing’ economists are far more likely to take this kind of stuff into account than right wing economists, who would insist that it’s not microfounded and tend to cling to the core RBC or New Classical DSGE framework.

  2. #7 by Blue Aurora on July 19, 2012 - 8:20 am

    Regarding Keynes and the General Theory…doesn’t Keynes say in the beginning Chapters that he does agree with the classical school on certain points? The point of the General Theory was to demonstrate the limitations of the classical school as describing that of a full employment equilibrium. Keynes doesn’t explicitly say it in his magnum opus, but if you read between the lines, he is arguing for the existence of multiple equilibria in the goods market (only one is that of full employment, the rest are all unemployment equilibria).

    • #8 by Jon Finegold on July 19, 2012 - 9:01 am

      Yes, which is something Keen doesn’t mention. Keynes’ and Keen’s criticisms are two different things. The latter is interested in attacking the theory that wages are set by the marginal productivity of labor (Keynes’ first postulate). The former, Keynes, accepted this theory and, instead, attacked the theory that anybody unwilling to work for a given real wage must face a disutility higher than the real wage (the second postulate). The first postulate was attacked, though, by post Keynesians, including G.L.S. Shackle.

    • #9 by Unlearningecon on July 19, 2012 - 3:48 pm

      Keynes’ work has two major recurrences:

      (a) His ongoing struggle to escape the neoclassical doctrine.
      (b) His political savvy.

      (a) is uncontroversial, but (b) is worth noting. He knew TGT would face strong opposition and may have edited it to make it more palatable. For example, an earlier draft included marx’s criticism of Say’s Law (which was actually far better and clearer than what Keynes ended up putting in there), but he presumably edited it out to distance himself from marxism.

      His reaction to Abba Lerner on simply printing money to fund expenditure was along the lines of “let’s not go too crazy, the establishment can only take so much.” His letter to FDR and his compromises with BW also demonstrated a similar careful eye for what would appeal to policymakers.

      • #10 by Blue Aurora on July 20, 2012 - 5:01 am

        Well, how well Keynes escaped from the classical/neoclassical doctrine is another matter. I’m not sure about that “Alternative Rates of Interest” as proof that Keynes supposedly abandoned his marginal efficiency of capital concept, for example. And I liked Keynes’s moderation though I wish he lived longer – it’s better not to go too extreme.

  3. #11 by john77 on July 20, 2012 - 12:39 am

    Since capital is the net result of accumulated production less consumption, there must have been labour productivity before capital existed.

    • #12 by Unlearningecon on July 20, 2012 - 5:22 pm

      Whether or not this is true, it is certainly true that in a modern capitalist economy, labour is combined with capital to produce – the clue is in the name, after all.

  4. #13 by Roman P. on July 20, 2012 - 7:25 pm

    I believe, considering Keen’s lectures and addendums to his book, that he is actually well aware of the criticism you propose. He did analyze Sraffa’s ‘Production of Commodities’ after all…
    I think that he did not use this argument because his methodology for writing ‘Debunking Economics’ was to take as many assumptions neoclassical economics uses as possible and still see it fail. After all, he rules out comparative statics after chapter about demand, but assumes it is reliable anywhere else, just to find what else is broken. After all, it is very easy to reject neoclassical economics just for its underlying axioms and methodology, and it had been done (like Hutchison 1938). But this course of action is not very convincing to those who take neoclassical economics seriously.
    By the way, have you read aforementioned Hutchison’s ‘The Significance and Basic Postulates of Economic Theory’? I believe this is a great and fundamental critique of the neoclassical school, but sadly very underappreciated.

    • #14 by Unlearningecon on July 21, 2012 - 1:23 pm

      Yes I see your point and I realise that was his aim. I’m still undecided on whether I approve of that approach or not.

      I have not read that but it does look excellent, thanks.


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