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Title: Would cutting wages reduce unemployment?
Author: Anarcho
Date: April 30, 2008
Language: en
Topics: wage labor, unemployment, economics
Source: Retrieved on 28th January 2021 from https://anarchism.pageabode.com/?p=40

Anarcho

Would cutting wages reduce unemployment?

The “free market” capitalist argument is that unemployment is caused by

the real wage of labour being higher than the market clearing level.

The basic argument is that the market for labour is like any other

market and as the price of a commodity increases, the demand for it

falls. In terms of labour, high prices (wages) causes lower demand

(unemployment). Workers, it is claimed, are more interested in money

wages than real wages (which is the amount of goods they can buy with

their money wages). This leads them to resist wage cuts even when prices

are falling, leading to a rise in their real wages and so they price

themselves out of work without realising it. From this analysis comes

the argument that if workers were allowed to compete ‘freely’ among

themselves for jobs, real wages would decrease and so unemployment would

fall. State intervention (e.g. unemployment benefit, social welfare

programmes, legal rights to organise, minimum wage laws, etc.) and

labour union activity are, according to this theory, the cause of

unemployment, as such intervention and activity forces wages above their

market level and so force employers to “let people go.” The key to

ending unemployment is simple: cut wages.

So wages must be cut as profits provide the motive power for business

activity. Yet wage cutting is advocated despite workers not setting

interest rates nor making investment decisions. Thus working class

people must pay the price of the profit seeking activities of their

economic masters who not only profited in good times, but can expect

others to pay the price in bad ones. In the current economic climate, it

is useful to explain the flaws in the economics which rationalises this

position in order to better combat such arguments and present an

alternative to bolster our activity.

Are wages really too high?

First, we must question the underlying assumption. On the face of it,

arguing that unemployment in America today is caused by wages being too

high is hard to support. Its current economic expansion looks like being

the first ever in which median household income fails to recover its

previous peak. Job growth has been tepid for most of it and the

employment-to-population ratio has remained well below its previous

peak. This comes on top of three decades of wage stagnation during which

household income only grew because of longer working hours and having

both household heads work.

Only the late 1990 boom (based on the previous, dot.com, bubble) saw

marked improvements for workers. Yet the reality of the much praised

American labour market “flexibility” was shown when then head of the US

Federal Reserve Alan Greenspan explained in 1997 why unemployment

managed to fall below the standard NAIRU rate without inflation

increasing:

“Increases in hourly compensation ... have continued to fall far short

of what they would have been had historical relationships between

compensation gains and the degree of labour market tightness held ... As

I see it, heightened job insecurity explains a significant part of the

restraint on compensation and the consequent muted price inflation ...

The continued reluctance of workers to leave their jobs to seek other

employment as the labour market has tightened provides further evidence

of such concern, as does the tendency toward longer labour union

contracts ... The low level of work stoppages of recent years also

attests to concern about job security ... The continued decline in the

share of the private workforce in labour unions has likely made wages

more responsive to market forces ... Owing in part to the subdued

behaviour of wages, profits and rates of return on capital have risen to

high levels.”[1]

Under such circumstances, it is obvious why unemployment could drop and

inflation remain steady. Yet there is a massive contradiction in

Greenspan’s account. As well as showing how keen the Federal Reserve

investigates the state of the class struggle, ready to intervene when

the workers may be winning, it also suggests that flexibility works just

one way:

“Some of the features highlighted by Greenspan reflect precisely a lack

of flexibility in the labour market: a lack of response of compensation

to tight labour markets, a reluctance of workers to leave their jobs,

and the prevalence of long-term contracts that lock employment

arrangements for six or more years at a time. And so Greenspan’s

portrayal of the unique features of the US model suggests that something

more than flexibility is the key ingredient at work — or at least that

‘flexibility’ is being interpreted once again from an unbalanced and

one-sided perspective. It is, rather, a high degree of labour market

discipline that seems to be the operative force. US workers remain

insecure despite a relatively low unemployment rate, and hence

compensation gains ... were muted. This implies a consequent

redistribution of income from labour to capital ... Greenspan’s story is

more about fear than it is about flexibility — and hence this famous

testimony has come to be known as Greenspan’s ‘fear factor’ hypothesis,

in which he concisely described the importance of labour market

discipline for his conduct of monetary policy.”[2]

Flexploitation

So while this attack on the wages, working conditions and social welfare

is conducted under the pre-Keynesian notion of wages being “sticky”

downwards, the underlying desire is to impose a “flexibility” which

ensures that wages are “sticky” upwards. This suggests a certain

one-sidedness to the “flexibility” of modern labour markets: employers

enjoy the ability to practice flexpoilation but the flexibility of

workers to resist is reduced.

There is a unspoken paradox to this. If we look at the stated, public,

rationale behind “flexibility” we find a strange fact. While the labour

market is to be made more “flexible” and in line with ideal of “perfect

competition”, on the capitalist side no attempt is being made to bring

it into line with that model. Let us not forget that perfect competition

(the theoretical condition in which all resources, including labour,

will be efficiently utilised) states that there must be a large number

of buyers and sellers. This is the case on the sellers side of the

“flexible” labour market, but this is not the case on the buyers (where

oligopoly reigns). Most who favour labour market “flexibility” are also

those most against the breaking up of big business and oligopolistic

markets or are against attempts to stop mergers between dominant

companies in and across markets. Yet the model requires both sides to be

made up of numerous small firms without market influence or power. So

why expect making one side more “flexible” will have a positive effect

on the whole?

There is no logical reason for this to be the case — in an economy with

both unions and big business, removing the former while retaining the

latter will not bring it closer to the ideal of perfect competition.

With the resulting shift in power on the labour market things will get

worse as income is distributed from labour to capital. Which is, we must

stress, precisely what has happened since the 1980s and the much lauded

“reforms” of the labour market.

All this is unsurprising for anarchists as we recognise that

“flexibility” just means weakening the bargaining power of labour in

order to increase the power and profits of the rich (hence the

expression “flexploitation”!). A “flexible” labour market basically

means one in which workers are glad to have any job and face increased

insecurity at work (actually, “insecurity” would be a more honest word

to use to describe the ideal of a competitive labour market rather than

“flexibility” but such honesty would let the cat out of the bag).

Keynesianism versus Keynes

The chain of logic in this explanation for unemployment is rooted in

many of the key assumptions of neo-classical economics – a firm’s demand

for labour is the marginal physical product of labour multiplied by the

price of the output and so it is dependent on marginal productivity

theory. It is assumed that there are diminishing returns and marginal

productivity as only this produces a downward-sloping labour demand

curve. For labour, it is assumed that its supply curve is upwards

slopping. So marginal productivity theory lies at the core of

neo-classical theories of output and distribution and so the marginal

product of labour is interpreted as the labour demand curve. This

enforces the viewpoint that unemployment is caused by wages being too

high as firms adjust production to bring the marginal cost of their

products (the cost of producing one more item) into equality with the

product’s market-determined price. So a drop in labour costs

theoretically leads to an expansion in production, producing jobs for

the “temporarily” unemployed and moving the economy toward

full-employment.

Sadly for these arguments, the assumptions required to reach it are

absurd as the conclusions (namely, that there is no involuntary

unemployment as markets are fully efficient). More perniciously, when

confronted with the reality of unemployment, most supporters of this

view argue that it arises only because of government-imposed rigidities

and trade unions. In their “ideal” world without either, there would,

they claim, be no unemployment. Of course, it is much easier to demand

that nothing should be done to alleviate unemployment and that workers’

real wages be reduced when you are sitting in a tenured post in academia

save from the labour market forces you wish others to be subjected to

(in their own interests).

This perspective suffered during the Great Depression and the threat of

revolution produced by persistent mass unemployment meant that dissident

economists had space to question the orthodoxy. At the head of this

re-evaluation was Keynes who presented an alternative analysis and

solution to the problem of unemployment in his 1936 book The General

Theory of Employment, Interest and Money.[3]

Somewhat ironically, given the abuse he has suffered at the hands of the

right (and some of his self-proclaimed followers), Keynes took the

assumptions of neo-classical economics on the labour market as the

starting point of his analysis, namely that unemployment was caused by

wages being too high. However, he was at pains to stress that even with

ideally flexible labour markets cutting real wages would not reduce

unemployment.

Keynes argued that unemployment was not caused by labour resisting wage

cuts or by “sticky” wages. Indeed, any “Keynesian” economist who does

argue that “sticky” wages are responsible for unemployment shows that he

or she has not read Keynes — Chapter two of the General Theory critiques

precisely this argument. Taking neo-classical economists at its word,

Keynes analyses what would happen if the labour market were perfect and

so he assumes the same model as his neo-classical opponents, namely that

unemployment is caused by wages being too high and there is flexibility

in both commodity and labour markets. As he stressed, his “criticism of

the accepted [neo-]classical theory of economics has consisted not so

much in finding logical flaws in its analysis as in pointing out that

its tacit assumptions are seldom or never satisfied, with the result

that it cannot solve the economic problems of the actual world.”[4]

What Keynes did was to consider the overall effect of cutting wages on

the economy as a whole. Given that wages make up a significant part of

the costs of a commodity, “if money-wages change, one would have

expected the [neo-]classical school to argue that prices would change in

almost the same proportion, leaving the real wage and the level of

unemployment practically the same as before.” However, this was not the

case, causing Keynes to point out that they “do not seem to have

realised that ... their supply curve for labour will shift bodily with

every movement of prices.” This was because labour cannot determine its

own real wage as prices are controlled by bosses. Once this is

recognised, it becomes obvious that workers do not control the cost of

living (i.e., the real wage). Therefore trade unions “do not raise the

obstacle to any increase in aggregate employment which is attributed to

them by the [neo-]classical school.” So while workers could, in theory,

control their wages by asking for less pay (or, more realistically,

accepting any wage cuts imposed by their bosses as the alternative is

unemployment) they do not have any control over the prices of the goods

they produce. This means that they have no control over their real wages

and so cannot reduce unemployment by pricing themselves into work by

accepting lower wages. Given these obvious facts, Keynes concluded that

there was “no ground for the belief that a flexible wage policy is

capable of continuous full employment ... The economic system cannot be

made self-adjusting along these lines.”[5] As he summarised:

“the contention that the unemployment which characterises a depression

is due to a refusal by labour to accept a reduction of money-wages is

not clearly supported by the facts. It is not very plausible to assert

that unemployment in the United States in 1932 was due either to labour

obstinately refusing to accept a reduction of money-wages or to its

demanding a real wage beyond what the productivity of the economic

machine was capable of furnishing ... Labour is not more truculent in

the depression than in the boom — far from it. Nor is its physical

productivity less. These facts from experience are a prima facie ground

for questioning the adequacy of the [neo-]classical analysis.”[6]

This means that the standard neo-classical argument was flawed. While

cutting wages may make sense for one firm, it would not have this effect

throughout the economy as is required to reduce unemployment as a whole.

This is another example of the fallacy of composition. What may work

with an individual worker or firm will not have the same effect on the

economy as a whole for cutting wages for all workers would have a

massive effect on the aggregate demand for their firm’s products.

There were two possibilities if wages were cut. One possibility, which

Keynes considered the most likely, would be that a cut in money wages

across the whole economy would see a similar cut in prices. The net

effect of this would be to leave real wages unchanged. The other assumes

that as wages are cut, prices remain prices remained unchanged or only

fell by a small amount (i.e. if wealth was redistributed from workers to

their employers). This is the underlying assumption of “free market”

argument that cutting wages would end the slump. In this theory, cutting

real wages would increase profits and investment and this would make up

for any decline in working class consumption and so its supporters

reject the claim that cutting real wages would merely decrease the

demand for consumer goods without automatically increasing investment

sufficiently to compensate for this.

However, in order make this claim, the theory depends on three critical

assumptions, namely that firms can expand production, that they will

expand production, and that, if they do, they can sell their expanded

production. This theory and its assumptions can be questioned.

The first assumption states that it is always possible for a company to

take on new workers. Yet increasing production requires more than just

labour. Tools, raw materials and work space are all required in addition

to new workers. If production goods and facilities are not available,

employment will not be increased. Therefore the assumption that labour

can always be added to the existing stock to increase output is plainly

unrealistic, particularly if we assume with neo-classical economics that

all resources are fully utilised (for an economy operating at less than

full capacity, the assumption is somewhat less inappropriate).

Next, will firms expand production when labour costs decline? Hardly.

Increasing production will increase supply and eat into the excess

profits resulting from the fall in wages (assuming, of course, that

demand holds up in the face of falling wages). If unemployment did

result in a lowering of the general market wage, companies might use the

opportunity to replace their current workers or force them to take a pay

cut. If this happened, neither production nor employment would increase.

However, it could be argued that the excess profits would increase

capital investment in the economy (a key assumption of neo-liberalism).

The reply is obvious: perhaps, perhaps not. A slumping economy might

well induce financial caution and so capitalists could stall investment

until they are convinced of the sustained higher profitability will

last.

This feeds directly into the last assumption, namely that the produced

goods will be sold. Assuming that money wages are cut, but prices remain

the same then this would be a cut in real wages. But when wages decline,

so does worker purchasing power, and if this is not offset by an

increase in spending elsewhere, then total demand will decline. However,

it can be argued that not everyone’s real income would fall: incomes

from profits would increase. But redistributing income from workers to

capitalists, a group who tend to spend a smaller portion of their income

on consumption than do workers, could reduce effective demand and

increase unemployment. Moreover, business does not (cannot)

instantaneously make use of the enlarged funds resulting from the shift

of wages to profit for investment (either because of financial caution

or lack of existing facilities). In addition, which sane company would

increase investment in the face of falling demand for its products? So

when wages decline, so does workers’ purchasing power and this is

unlikely to be offset by an increase in spending elsewhere. This will

lead to a reduction in aggregate demand as profits are accumulated but

unused, so leading to stocks of unsold goods and renewed price

reductions. This means that the cut in real wages will be cancelled out

by price cuts to sell unsold stock and unemployment remains. In other

words, contrary to neo-classical economics, a fall in wages may result

in the same or even more unemployment as aggregate demand drops and

companies cannot find a market for their goods.

So, as is often the case, Keynes was simply including into mainstream

economics perspectives which had long been held by critics of capitalism

and dismissed by the orthodoxy. Keynes’ critique of Say’s Law

essentially repeated Marx’s while Proudhon pointed out in 1846 that “if

the producer earns less, he will buy less” and this will “engender ...

over-production and destitution.” This was because “though the workmen

cost [the capitalist] something, they are [his] customers: what will you

do with your products, when driven away by [him], they shall consume no

longer?” This means that cutting wages and employment would not work for

they are “not slow in dealing employers a counter-blow; for if

production excludes consumption, it is soon obliged to stop itself.”[7]

An unscientific science

So far our critique of the “free market” position has, like Keynes’s,

been within the assumptions of that theory itself. More has to be said,

though, as its assumptions are deeply flawed and unrealistic. It should

be stressed that while Keynes’s acceptance of much of the orthodoxy

ensured that at least some of his ideas become part of the mainstream,

Post-Keynesians like Joan Robinson would latter bemoan the fact that he

sought a compromise rather than clean break with the orthodoxy. This

lead to the rise of the post-war neo-classical synthesis, the so-called

“Keynesian” argument that unemployment was caused by wages being

“sticky” and the means by which the right could undermine social

Keynesianism and ensure a return to neo-classical orthodoxy.

First, there is the role of diminishing returns. The assumption that the

demand curve for labour is always downward sloping with respect to

aggregate employment is rooted in the notion that industry operates, at

least in the short run, under conditions of diminishing returns.

However, diminishing returns are not a feature of industries in the real

world. Thus the assumption that the downward slopping marginal product

of labour curve is identical to the aggregate demand curve for labour is

not true as it is inconsistent with empirical evidence. “In a system at

increasing returns,” noted one economist, “the direct relation between

real wages and employment tends to render the ordinary mechanism of wage

adjustment ineffective and unstable.”[8] In fact, without this

assumption mainstream economics cannot show that unemployment is, in

fact, caused by real wages being too high (along with many other

things).

Significantly, actual corporate price is utterly different from the

economic theory. This was discovered when researchers did what the

original theorists did not think was relevant: they actually asked firms

what they did and the researchers consistently found that, for the vast

majority of manufacturing firms their average costs of production

declined as output rose, their marginal costs were always well below

their average costs, and substantially smaller than ‘marginal revenue’,

and the concept of a ‘demand curve’ (and therefore its derivative

‘marginal revenue’) was simply irrelevant. Unsurprisingly, real firms

set their prices prior to sales, based on a mark-up on costs at a target

rate of output. In other words, they did not passively react to the

market. These prices are an essential feature of capitalism as prices

are set to maintain the long-term viability of the firm. This, and the

underlying reality that per-unit costs fell as output levels rose,

resulted in far more stable prices than were predicted by traditional

economic theory.

No other science would think it appropriate to develop theory utterly

independently of phenomenon under analysis. No other science would wait

decades before testing a theory against reality. No other science would

then simply ignore the facts which utterly contradicted the theory and

continue to teach that theory as if it were a valid generalisation of

the facts. But, then, economics is not a science. However, it makes

sense once what happens when the assumption of increasing marginal costs

is abandoned. As Steve Keen puts it:

“Strange as it may seem ... this is a very big deal. If marginal returns

are constant rather than falling, then the neo-classical explanation of

everything collapses. Not only can economic theory no longer explain how

much a firm produces, it can explain nothing else.

“Take, for example, the economic theory of employment and wage

determination ... The theory asserts that the real wage is equivalent to

the marginal product of labour ... An employer will employ an additional

worker if the amount the worker adds to output — the worker’s marginal

product — exceeds the real wage ... [This] explains the economic

predilection for blaming everything on wages being too high —

neo-classical economics can be summed up, as [John Kenneth] Galbraith

once remarked, in the twin propositions that the poor don’t work hard

enough because they’re paid too much, and the rich don’t work hard

enough because they’re not paid enough ...

“If in fact the output to employment relationship is relatively

constant, then the neo-classical explanation for employment and output

determination collapses. With a flat production function, the marginal

product of labour will be constant, and it will never intersect the real

wage. The output of the form then can’t be explained by the cost of

employing labour... [This means that] neo-classical economics simply

cannot explain anything: neither the level of employment, nor output,

nor, ultimately, what determines the real wage ...the entire edifice of

economics collapses.”[9]

Not-so marginal problems

The argument that unemployment is caused by wages being too high is

related to the marginalist theory of distribution.[10] In that theory,

the marginal product of labour is interpreted as the labour demand curve

as the firm’s demand for labour is the marginal physical product of

labour multiplied by the price of the output and this produces the

viewpoint that unemployment is caused by wages being too high. The

assumption that adding more labour to capital is always possible flows

from the assumption of marginal productivity theory which treats

“capital” like an ectoplasm and can be moulded into whatever form is

required by the labour available. Take, for example, leading

neoclassical Dennis Robertson’s 1931 attempt to explain the marginal

productivity of labour when holding “capital” constant:

“If ten men are to be set out to dig a hole instead of nine, they will

be furnished with ten cheaper spades instead of nine more expensive

ones; or perhaps if there is no room for him to dig comfortably, the

tenth man will be furnished with a bucket and sent to fetch beer for the

other nine.”[11]

So to work out the marginal productivity of the factors involved, “ten

cheaper spades” somehow equals nine more expensive spades? How is this

keeping capital constant? And how does this reflect reality? Surely, any

real world example would involve sending the tenth digger to get another

spade? And how do nine expensive spades become ten cheaper ones? In the

real world, this is impossible but in neoclassical economics this is not

only possible but required for the theory to work. As Robinson argued,

in neo-classical theory the “concept of capital all the man-made factors

are boiled into one, which we may call leets ... [which], though all

made up of one physical substance, is endowed with the capacity to

embody various techniques of production ... and a change of technique

can be made simply by squeezing up or spreading out leets,

instantaneously and without cost.”[12] While this allows economics to

avoid the obvious aggregation problems with “capital” it also ensures

reality has to be ignored and so economic theory need not discuss any

practical questions:

“When equipment is made of leets, there is no distinction between long

and short-period problems ... Nine spades are lumps of leets; when the

tenth man turns up it is squeezed out to provide him with a share of

equipment nine-tenths of what each man had before ... There is no room

for imperfect competition. There is no possibility of disappointed

expectations ... There is no problem of unemployment ... Unemployed

workers would bid down wages and the pre-existing quantity of leets

would be spread out to accommodate them.”[13]

Of course, it is not meant to be taken literally, it is only a parable,

but without it the whole argument collapses. Once capital equipment is

admitted to being actual, specific objects that cannot be squeezed,

without cost, into new objects to accommodate more or less workers, such

comforting notions that profits equal the (marginal) contribution of

“capital” or that unemployment is caused by wages being too high have to

be discarded for the wishful thinking they most surely are.

Hence Joan Robinson’s dismissal of this assumption, for “with

‘malleable’ capital the demand for labour depends on the level of

wages.”[14] Moreover, “labour and capital are not often as smoothly

substitutable for each other as the [neo-classical] model requires ...

You can’t use one without the other. You can’t measure the marginal

productivity of one without the other.” Demand for capital and labour

is, sometimes, a joint demand and so it is often impossible to adjust

wages to a worker’s marginal productivity independent of the cost of

capital.[15]

Cutting wages and reality

Thus, if we accept reality, we must end up “denying the inevitability of

a negative relationship between real wages and employment.”

Post-Keynesian economists have not found any empirical links between the

growth of unemployment since the early in 1970s and changes in the

relationship between productivity and wages and so there is “no

theoretical reason to expect a negative relationship between employment

and the real wage, even at the level of the individual firm.” Even the

beloved marginal analysis cannot be used in the labour market, as

”[m]ost jobs are offered on a take-it-or-leave-it basis. Workers have

little or no scope to vary hours of work, thereby making marginal

trade-offs between income and leisure. There is thus no worker

sovereignty corresponding to the (very controversial) notion of consumer

sovereignty.” Over all, “if a relationship exists between aggregate

employment and the real wage, it is employment that determines wages.

Employment and unemployment are product market variables, not labour

market variables. Thus attempts to restore full employment by cutting

wages are fundamentally misguided.”[16] In addition:

“Neo-classical theorists themselves have conceded that a negative

relationship between the real wage and the level of employment can be

established only in a one-commodity model; in a multi-commodity

framework no such generalisation is possible. This confines

neo-classical theory to an economy without money and makes it

inapplicable to a capitalist or entrepreneurial economy.”[17]

All this means that “neither the demand for labour nor the supply of

labour depends on the real wage. It follows from this that the labour

market is not a true market, for the price associated with it, the wage

rate, is incapable of performing any market-clearing function, and thus

variations in the wage rate cannot eliminate unemployment.”[18]

Supply curve issues

As such, the “conventional economic analysis of markets ... is unlikely

to apply” to the labour market and as a result “wages are highly

unlikely to reflect workers’ contributions to production.” This is

because economists treat labour as no different from other commodities

yet “economic theory supports no such conclusion.” At its most basic,

labour is not produced for profit and the “supply curve for labour can

‘slope backward’ — so that a fall in wages can cause an increase in the

supply of workers.” In fact, the idea of a backward sloping supply curve

for labour is just as easy to derive from the assumptions used by

economists to derive their standard one. This is because workers may

prefer to work less as the wage rate rises as they will be better off

even if they do not work more. Conversely, very low wage rates are

likely to produce a very high supply of labour as workers need to work

more to meet their basic needs.[19]

This means that the market supply curve “could have any shape at all”

and so economic theory “fails to prove that employment is determined by

supply and demand, and reinforces the real world observation that

involuntary unemployment can exist” as reducing the wage need not bring

the demand and supply of labour into alignment. While the possibility of

backward-bending labour supply curves is sometimes pointed out in

textbooks, the assumption of an upward sloping supply curve is taken as

the normal situation but “there is no theoretical — or empirical —

justification for this.” Sadly for the world, this assumption is used to

draw very strong conclusions by economists. The standard arguments

against minimum wage legislation, trade unions and demand management by

government are all based on it. Yet, as Keen notes, such important

policy positions “should be based upon robust intellectual or empirical

foundations, rather than the flimsy substrate of mere fancy. Economists

are quite prone to dismiss alternative perspectives on labour market

policy on this very basis — that they lack any theoretical or empirical

foundations. Yet their own policy positions are based as much on wishful

thinking as on wisdom.”[20]

The backward-bending supply curve of labour suggests that cutting real

wages will have the opposite effect on the supply of labour than its

supporters claim. It is commonly found that as real wages fall, hours at

work become longer and the number of workers in a family increases. This

is because the labour supply curve is negatively slopped as families

need to work more (i.e., provide more labour) to make ends meet. This

means that a fall in real wages may increase the supply of labour as

workers are forced to work longer hours or take second jobs simply to

survive. The net effect of increasing supply would be to decrease real

wages even more and so, potentially, start a vicious circle and make the

recession deeper.

Strong evidence that this model of the labour market can be found from

the history of capitalism. Continually we see capitalists turn to the

state to ensure low wages in order to ensure a steady supply of labour

(this was a key aim of state intervention during the rise of capitalism,

incidentally). For example, in central and southern Africa mining

companies tried to get locals to labour. They had little need for money,

so they worked a day or two then disappeared for the rest of the week.

To avoid simply introducing slavery, some colonial administrators

introduced and enforced a poll-tax. To earn enough to pay it, workers

had to work a full week. Much the same was imposed on British workers at

the dawn of capitalism. As Stephen Marglin points out, the “indiscipline

of the labouring classes, or more bluntly, their laziness, was widely

noted by eighteenth century observers.” By laziness or indiscipline,

these members of the ruling class meant the situation where “as wages

rose, workers chose to work less.” In economic terms, “a backward

bending labour supply curve is a most natural phenomenon as long as the

individual worker controls the supply of labour.” However, “the fact

that higher wages led workers to choose more leisure ... was disastrous”

for the capitalists. Unsurprisingly, the bosses did not meekly accept

the workings of the invisible hand. Their “first recourse was to the

law” and they “utilised the legislative, police and judicial powers of

the state” to ensure that working class people had to supply as many

hours as the bosses demanded.[21]

Looking at the US, we find evidence that supports this analysis. As the

wages for the bottom 80% of the population fell in real terms under

Reagan and Bush in the 1980s, the number of people with multiple jobs

increased as did the number of mothers who entered the labour market. In

fact, “the only reason that family income was maintained is the massive

increase in labour force participation of married women ... Put simply,

jobs paying family wages have been disappearing, and sustaining a family

now requires that both adults work ... The result has been a squeeze on

the amount of time that people have for themselves ... there is a loss

of life quality associated with the decline in time for family ... they

have also been forced to work longer ... Americans are working longer

just to maintain their current position, and the quality of family life

is likely declining. A time squeeze has therefore accompanied the wage

squeeze.”[22] That is, the supply of labour increased as its price fell

(Reagan’s turn to military Keynesianism and incomplete nature of the

“reforms” ensured that a deep spiral was avoided).

To understand why this is the case, it is necessary to think about how

the impact of eliminating the minimum wage and trade unions would

actually have. First, of course, there would be a drop in the wages of

the poorest workers as the assertion is that these increase unemployment

by forcing wages up. The assertion is that the bosses would then employ

more workers as a result. However, this assumes that extra workers could

easily be added to the existing capital stock which may not be the case.

Assuming this is the case (and it is a big assumption), what happens to

the workers who have had their pay cut? Obviously, they still need to

pay their bills which means they either cut back on consumption and/or

seek more work (assuming that prices have not fallen, as this would

leave the real wage unchanged). If the former happens, then firms may

find that they face reduced demand for their products and, consequently,

have no need for the extra employees predicted by the theory. If the

latter happens, then the ranks of those seeking work will increase as

people look for extra jobs or people outside the labour market (like

mothers and children) are forced into the job market. As the supply of

workers increase, wages must drop according to the logic of the “free

market” position. This does not mean that a recovery is impossible, just

that in the short and medium terms cutting wages will make a recession

worse and be unlikely to reduce unemployment for some time.

Within a capitalist economy the opposite assumption to that taken by

economics is far more likely, namely that there is a backward sloping

labour supply curve. This is because the decision to work is not one

based on the choice between wages and leisure made by the individual

worker. Most workers do not choose whether they work or not, and the

hours spent working, by comparing their (given) preferences and the

level of real wages. They do not practice voluntary leisure waiting for

the real wage to exceed their so-called “reservation” wage (i.e. the

wage which will tempt them to forsake a life of leisure for the

disutility of work). Rather, most workers have to take a job because

they do not have a choice as the alternative is poverty (at best) or

starvation and homelessness (at worse). The real wage influences the

decision on how much labour to supply rather than the decision to work

or not. This is because as workers and their families have a certain

basic living standard to maintain and essential bills which need to be

paid. As earnings increase, basic costs are covered and so people are

more able to work less and so the supply of labour tends to fall.

Conversely, if real earnings fall because the real wage is less then the

supply of labour may increase as people work more hours and/or more

family members start working to make enough to cover the bills (this is

because, once in work, most people are obliged to accept the hours set

by their bosses). This is the opposite of what happens in “normal”

markets, where lower prices are meant to produce a decrease in the

amount of the commodity supplied. In other words, the labour market is

not a market, i.e. it reacts in different ways than other markets.[23]

Unemployment and high wages

Even ignoring the theoretical problems, the facts are that high wages

are generally associated with booms rather than slumps and this has been

known to mainstream economics since at least 1939 when in March of that

year The Economic Journal printed an article by Keynes about the

movement of real wages during a boom in which he evaluated the empirical

analysis of two labour economists.

These studies showed that “when money wages are rising, real wages have

usually risen too; whilst, when money wages are falling, real wages are

no more likely to rise than to fall.” Keynes admitted that in The

General Theory he was “accepting, without taking care to check the

facts”, a “widely held” belief. He discussed where this belief came

from, namely leading 19^(th) century British economist Alfred Marshall

who had produced a “generalisation” from a six year period between

1880–86 which was not true for the subsequent business cycles of 1886 to

1914. He also quotes another leading economist, Arthur Pigou, from 1927

on how “the upper halves of trade cycles have, on the whole, been

associated with higher rates of real wages than the lower halves” and

indicates that he provided evidence on this from 1850 to 1910 (although

this did not stop Pigou reverting to the “Marshallian tradition” during

the Great Depression and blaming high unemployment on high wages).[24]

Keynes conceded the point, arguing that he had tried to minimise

differences between his analysis and the standard perspective. He

stressed that while he assumed countercyclical real wages his argument

did not depend on it and given the empirical evidence provided by labour

economists he accepted that real wages were pro-cyclical in nature.

The reason why this is the case is obvious. Labour does not control

prices and so cannot control its own real wage. Looking at the Great

Depression, it seems difficult to blame it on workers refusing to take

pay cuts. The notion of all powerful unions or workers’ resistance to

wage cuts causing high unemployment hardly fits these facts. Since then,

economists have generally confirmed that real wage are procyclical. In

fact, “a great deal of empirical research has been conducted in this

area — research which mostly contradicts the neo-classical assumption of

an inverse relation between real wages and employment.”[25] As Hugh

Stretton summarises in his excellent introductory text on economics:

“In defiance of market theory, the demand for labour tends strongly to

vary with its price, not inversely to it. Wages are high when there is

full employment. Wages — especially for the least-skilled and lowest

paid — are lowest when there is least employment. The causes chiefly run

from the employment to the wages, rather than the other way.

Unemployment weakens the bargaining power, worsens the job security and

working conditions, and lowers the pay of those still in jobs.

“The lower wages do not induce employers to create more jobs ... most

business firms have no reason to take on more hands if wages decline.

Only empty warehouses, or the prospect of more sales can get them to do

that, and these conditions rarely coincide with falling employment and

wages. The causes tend to work the other way: unemployment lowers wages,

and the lower wages do not restore the lost employment.”[26]

Will Hutton, the British neo-Keynesian economist, summarises research by

two other economists that suggests high wages do not cause unemployment:

“the British economists David Blanchflower and Andrew Oswald [examined]

... the data in twelve countries about the actual relation between wages

and unemployment — and what they have discovered is another major

challenge to the free market account of the labour market. Free market

theory would predict that low wages would be correlated with low local

unemployment; and high wages with high local unemployment.

“Blanchflower and Oswald have found precisely the opposite relationship.

The higher the wages, the lower the local unemployment — and the lower

the wages, the higher the local unemployment. As they say, this is not a

conclusion that can be squared with free market text-book theories of

how a competitive labour market should work.”[27]

Unemployment was highest where real wages were lowest and nowhere had

falling wages being followed by rising employment or falling

unemployment. Blanchflower and Oswald stated that their conclusion is

that employees “who work in areas of high unemployment earn less, other

things constant, than those who are surrounded by low unemployment.”[28]

This relationship, the exact opposite of that predicted by “free market”

capitalist economics, was found in many different countries and time

periods, with the curve being similar for different countries. Thus, the

evidence suggests that high unemployment is associated with low

earnings, not high, and vice versa.

While this evidence may come as a shock to those who subscribe to the

arguments put forward by those who think capitalist economics reflect

the reality of that system, it fits well with the anarchist analysis.

For anarchists, unemployment is a means of disciplining labour and

maintaining a suitable rate of profit (i.e. unemployment is a key means

of ensuring that workers are exploited). As full employment is

approached, labour’s power increases, so reducing the rate of

exploitation and so increasing labour’s share of the value it produces

(and so higher wages). Thus, the fact that wages are higher in areas of

low unemployment is not a surprise, nor is the phenomenon of

pro-cyclical real wages. After all, the ratio between wages and profits

are, to a large degree, a product of bargaining power and so we would

expect real wages to grow in the upswing of the business cycle, fall in

the slump and be high in areas of low unemployment.

It is difficult for workers to resist wage cuts and speeds-up when faced

with the fear of mass unemployment. As such, higher rates of

unemployment “reduce labour’s bargaining power vis-a-vis business, and

this helps explain why wages have declined and workers have not received

their share of productivity growth” (between 1970 and 1993, only the top

20% of the US population increased its share of national income)[29].

Strangely, though, this obvious fact seems lost on most economists. In

fact, if you took their arguments seriously then you would have to

conclude that depressions and recessions are the periods during which

working class people do the best!

This is on two levels. First, in neo-classical economics work is

considered a disutility and workers decide not to work at the

market-clearing real wage because they prefer leisure to working.

Leisure is assumed to be intrinsically good and the wage the means by

which workers are encouraged to sacrifice it. Thus high unemployment

must be a good thing as it gives many more people leisure time. Second,

for those in work their real wages are higher than before, so their

income has risen. Alfred Marshall, for example, argued that in

depressions money wages fell but not as fast as prices. A “powerful

friction” stopped this, which “establish[ed] a higher standard of living

among the working classes” and a “diminish[ing of] the inequalities of

wealth.” When asked whether during a period of depression the employed

working classes got more than they did before, he replied ”[m]ore than

they did before, on the average.”[30]

Thus, apparently, working class people do worse in booms than in slumps

and, moreover, they can resist wage cuts more in the face of mass

unemployment than in periods approaching full employment. That the

theory which produced these conclusions could be taken remotely

seriously shows the dangers of deducing an economic ideology from a few

simple axioms rather than trusting in empirical evidence and common

sense derived from experience. Nor should it come as too great a

surprise, as “free market” capitalist economics tends to ignore (or

dismiss) the importance of economic power and the social context within

which individuals make their choices.

So, in summary, the available evidence suggests that high wages are

associated with low levels of unemployment. While this should be the

expected result from any realistic analysis of the economic power which

marks capitalist economies, it does not provide much support for claims

that only by cutting real wages can unemployment be reduced. The “free

market” capitalist position and one based on reality have radically

different conclusions as well as political implications. Ultimately,

most laissez-faire economic analysis is unpersuasive both in terms of

the facts and their logic. While economics may be marked by axiomatic

reasoning which renders everything the markets does as optimal, the

problem is precisely that it is pure axiomatic reasoning with little or

no regard for the real world. Moreover, by some strange coincidence,

they usually involve policy implications which generally make the rich

richer by weakening the working class. Unsurprisingly, decades of

empirical evidence have not shifted the faith of those who think that

the simple axioms of economics take precedence over the real world nor

has this faith lost its utility to the economically powerful.

Economics in more than one lesson

So, as radical economists have correctly observe, such considerations

undercut the “free market” capitalist contention that labour unions and

state intervention are responsible for unemployment (or that depressions

will easily or naturally end by the workings of the market). To the

contrary, insofar as labour unions and various welfare provisions

prevent demand from falling as low as it might otherwise go during a

slump, they apply a brake to the downward spiral. Far from being

responsible for unemployment, they actually mitigate it. For example,

unions, by putting purchasing power in the hands of workers, stimulates

demand and keeps employment higher than the level it would have been.

Moreover, wages are generally spent immediately and completely whilst

profits are not. A shift from profits to wages may stimulate the economy

since more money is spent but there will be a delayed cut in consumption

out of profits. All this should be obvious, as wages (and benefits) may

be costs for some firms but they are revenue for even more. Moreover,

labour is not like other commodities and reacts in changes in price in

different ways.

Given the dynamics of the labour “market” (if such a term makes much

sense given its atypical nature), any policies based on applying

“economics 101” to it will be doomed to failure. As such, any book

entitled Economics in One Lesson must be viewed with suspicion unless it

admits that what it expounds has little or no bearing to reality and

urges the reader to take at least the second lesson. Of course, it is

irrelevant that it is much easier to demand that workers’ real wages be

reduced when you are sitting in a tenured post in academia. True to

their ideals and “science”, it is refreshing to see how many of these

“free market” economists renounce tenure so that their wages can adjust

automatically as the market demand for their ideologically charged

comments changes.

So when economic theories extol suffering for future benefits, it is

always worth asking who suffers, and who benefits. The notion of wage

cutting emerges from theoretical claims that price flexibility can

restore full employment, and it rests dubious logic, absurd assumptions

and on a false analogy comparing the labour market with the market for

peanuts. Which, ironically, is appropriate as the logic of the model is

that workers will end up working for peanuts!

What now?

To conclude, a cut in wages may deepen any slump, making it deeper and

longer than it otherwise would be. Rather than being the solution to

unemployment, cutting wages will make it worse. The capitalist solution

to crisis is based on working class people paying for capitalism’s

contradictions. For, according to the mainstream theory, when the

production capacity of a good exceeds any reasonable demand for it, the

workers must be laid off and/or have their wages cut to make the company

profitable again. Meanwhile the company executives — the people

responsible for the bad decisions to build lots of factories — continue

to collect their fat salaries, bonuses and pensions, and get to stay on

to help manage the company through its problems. For, after all, who

better, to return a company to profitability than those who in their

wisdom ran it into bankruptcy? Strange, though, no matter how high their

salaries and bonuses get, managers and executives never price themselves

out of work.

This suggests that the task of anarchists, in the short run, is to

encourage attempts to organise unions and resist wage cuts in the

workplace as well as taking over closing workplaces and placing them

under self-management (if sensible). While “free market” economics

protrays unions as a form of market failure, an interference with the

natural workings of the market system and recommend that the state

should eliminate them or ensure that they are basically powerless to

act, this simply does not reflect the real world. Any real economy is

marked by the economic power of big business. Unless workers organise

then they are in a weak position and will be even more exploited by

their economic masters. Left-wing economist Thomas I. Palley presents

the correct analysis of working class organisation when he wrote:

“The reality is that unions are a correction of market failure, namely

the massive imbalance of power that exists between individual workers

and corporate capital. The importance of labour market bargaining power

for the distribution of income, means that unions are a fundamental prop

for widespread prosperity. Weakening unions does not create a ‘natural’

market: it just creates a market in which business has the power to

dominate labour.

“The notion of perfect natural markets is built on the assumption that

market participants have no power. In reality, the process of labour

exchange is characterised not only by the presence of power, but also by

gross inequality of power. An individual worker is at a great

disadvantage in dealing with large corporations that have access to

massive pools of capital and can organise in a fashion that renders

every individual dispensible ... Unions help rectify the imbalance of

power in labour markets, and they therefore correct market failure

rather than causing it.”[31]

Given this, it is understandable why bosses hate unions and any state

aid which undermines their economic power. This must be supplemented by

community organising to support workplace struggle as well as to resist

wage increases in commodities (bosses will try to maintain profits by

increasing prices) as well as rent and basic utilities. This is not to

suggest that economic struggles are the only focus of struggle, simply

that it is difficult to fight against all forms of hierarchy when you

are worried about whether you will have enough to eat or a roof over

your head. This must be placed in the context of social change, the

ending of capitalism and its state and the creation of a free society.

The “hallmark” of the neo-liberal age “is an economic environment that

pits citizen against citizen for the benefit of those who own and

manage” a country.[32] Our task is to build a movement rooted in

solidarity. So we have two options — accept a deeper depression in order

to start the boom-bust cycle again or get rid of capitalism and with it

the contradictory nature of capitalist production which produces the

business cycle in the first place (not to mention other blights such as

hierarchy and inequality). In the end, the only solution to crisis is to

get rid of the system which created it by workers seizing their means of

production and abolishing the state. When this happens, then production

for the profit of the few will be ended and so, too, the contradictions

this generates.

Bibliography

Blanchflower, David and Oswald, Andrew, The Wage Curve, MIT Press,

Cambridge, Mass., 1994.

Howell, David R. (ed.), Fighting Unemployment: The Limits of Free Market

Orthodoxy, Oxford University Press, New York, 2005.

Hutton, Will, The State We’re In, Vintage, London, 1996.

Keen, Steve, Debunking Economics: The Naked Emperor of the social

sciences, Pluto Press Australia, Annandale, 2001.

Keynes, John Maynard, The General Theory of Employment, Interest and

Money, MacMillan Press, London, 1974.

Palley, Thomas I., Plenty of Nothing: The Downsizing of the American

Dream and the case for Structural Keynesian, Princeton University Press,

Princeton, 1998.

Richard P. F. Holt and Steven Pressman (eds.), A New Guide to Post

Keynesian Economics, Routledge, London, 2001.

Robertson, Dennis, “Wage-grumbles”, Economic Fragments, pp. 42–57, in W.

Fellner and B. Haley (eds.), Readings in the theory of income

distribution, The Blakiston, Philadephia, 1951.

Robinson, Joan, Contributions to Modern Economics, Basil Blackwell,

Oxford, 1978.

Stretton, Hugh, Economics: A New Introduction, Pluto Press, London,

2000.

Targetti, Ferdinando, Nicholas Kaldor: The Economics and Politics of

Capitalism as a Dynamic System, Clarendon Press, Oxford, 1992.

[1] quoted by Jim Stanford, “Testing the Flexibility Paradigm: Canadian

Labor Market Performance in International Context,” pp. 119–155,

Fighting Unemployment, David R. Howell (ed.), pp. 139–40

[2] Jim Stanford, Op. Cit., p. 140

[3] It should be noted that the Polish socialist economist Michal

Kalecki independently developed a similar theory a few years before

Keynes but without the neo-classical baggage Keynes brought into his

work.

[4] Keynes, The General Theory, p. 378

[5]

p. 12, pp. 8–9, p. 15 and p. 267

[6]

p. 9

[7] System of Economical Contradictions, p. 204 and p. 190

[8] Ferdinando Targetti, Nicholas Kaldor, p. 344

[9] Debunking Economics, pp. 76–7

[10] Significantly, Joan Robinson and Piero Sraffa had successfully

debunked this theory in the 1950s. “Yet for psychological and political

reasons,” notes James K. Galbraith, “rather than for logical and

mathematical ones, the capital critique has not penetrated mainstream

economics. It likely never will. Today only a handful of economists seem

aware of it.”( “The distribution of income”, pp. 32–41, Richard P. F.

Holt and Steven Pressman (eds.), A New Guide to Post Keynesian

Economics, p. 34)

[11] “Wage-grumbles”, Economic Fragments, p. 226

[12] Contributions to Modern Economics, p. 106

[13]

p. 107

[14]

p. 6

[15] Hugh Stretton, Economics: A New Introduction, p. 401

[16] John E. King, “Labor and Unemployment,” pp. 65–78, Holt and

Pressman (eds.), Op. Cit., p. 68, pp. 67–8, p. 72, p. 68 and p. 72

[17] King, p. 71

[18] King, p. 65

[19] Steve Keen, Debunking Economics, pp. 111–2 and pp. 119–23

[20] Keen, pp. 121–2 and p. 123

[21] “What do Bosses do?”, pp. 60–112, Review of Radical Political

Economy, Vol. 6, No. 2, pp. 91–4

[22] Thomas I. Palley, Plenty of Nothing, pp. 63–4

[23] Stretton provides a good summary of this argument (Economics: A New

Introduction, pp. 403–4 and p. 491)

[24] Keynes, p. 394, p. 398 and p. 399

[25] Targetti, p. 50

[26] Stetton, pp. 401–2

[27] The State We’re In, p. 102

[28] The Wage Curve, p. 360

[29] Palley, p. 55 and p. 58

[30] quoted by Keynes, p. 396

[31] Palley, pp. 36–7

[32] Palley, p. 203