Sticky Wages and Unemployment

Sticky wages are the reason for unemployment. The standard academic explanation of this can be found here:

Unemployment is just a labor surplus; since wages are the price of labor, the fundamental cause of unemployment has to be excessive wages.

The fact that wages are an essential component of AD is completely ignored here. Suppose we cut wages across the economy. Following this, there are two possibilities:

(1) Prices fall. Real wages remain unchanged and all that happens is that real private debt increases and the money stock increases, the former being negative and the latter achievable with expansionary monetary policy.

(2) Prices do not fall. Profits and rents are increased by reducing wages, but that effectively means redistributing to the rich, who have a lower MPC. It would not be right to assert that consumption will always fall by reducing nominal wages, but it is fair to expect a drop. And in the face of this falling consumption, are businesses really going to invest their profits?

Number (2) rests on a lot of introspection and supposition. But the fact is that there are no examples in the real world of wage cuts leading to falling employment, quite simply because wages drive demand, which is what drives employment. Nominal cuts didn’t work in the Great Depression, and the period with sustained real wage increases (1945-1973) coincided with very low unemployment, whilst the period of stagnant median wages (1980-present) has generally coincided with higher unemployment.

And, of course, no, Keynes did not argue that sticky wages explained demand side recessions. He argued the exact opposite – that they actually help to nullify them. Sometimes I wonder if anybody has even read TGT.


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  1. #1 by Liquidationist on December 26, 2011 - 9:46 pm

    Are you saying that in case 1 the demand for labor curve is vertical and in case 2 the demand for labor curve slopes upwards ?

    If so, no wonder this site is called “unlearning economics”. You are however correct that this was indeed Keynes’ view.

    • #2 by Unlearningecon on December 26, 2011 - 10:09 pm

      No, I completely reject the idea of coherent demand or supply curves as a useful modelling technique.

      Your post doesn’t engage my argument – it’s just from personal incredulity, coupled with an ad hom and a generic internet attack on Keynes.

  2. #3 by Liquidationist on December 26, 2011 - 10:26 pm

    Despite my snarky comment on your blogs title (which was meant as a joke) my post was in fact a genuine question about your views on the demand for labor curve, and an observation that I thought you were accurately reflecting Keynes’ views. on sticky wages.

    I am interested in why you “reject the idea of coherent demand or supply curves”. Can you point me to a post that explains this idea in more detail?

    • #4 by Unlearningecon on December 26, 2011 - 10:45 pm

      Basically the problem with a demand curve for labour is that paying employees more or less violates ceteris paribus to such an extent that the model cannot be useful. As the wage share of the economy changes it creates ripple effects that change the firms costs/revenue, which in turn affects their profits/employment, and so forth.

      I also reject the idea of ‘marginal productivity’ used to derive labour demand curves. It basically assumes that, if 9 workers are using 9 spades to dig a hole and a 10th is employed, the spades dissolve into 10 slightly smaller ones. In reality, of course, a 10th spade is bought and the worker alone does not have a discernible ‘marginal productivity’. More on this here and here.

      I can point you in the direction of Steve Keen, who goes more in depth wrt demand-supply in general.

  3. #5 by Sean Fernyhough (@Sean_Fernyhough) on December 26, 2011 - 10:56 pm

    But economic theory doesn’t need to assume sticky wages to provide a viable business cycle theory. That’s economic theory that doesn’t compare itself with the real world and when discrepancies occur conclude that the real world is wrong.

    And that’s before we realise that markets have emergent characteristics that cannot be simply understood by aggregating individual behaviour.