Monday, June 11, 2012

General Theory Study Guide: Book 1, Chapter 2, Sections I and II

To start off Chapter 2 of "The General Theory of Employment, Interest, and Money", Keynes makes a keen observation of the economics profession.  That there is a tendency to talk more about how an economy distributes its wealth, and not how to produce more wealth as well as what determines the employment of the available resources.  He attributes this to be because classic political economists believe that the answer is so simple and obvious it is barely worth mentioning.   However, since Keynes is planning on refuting much of it, he'll prove that he understands the "classical" position by restating it.  In Section 1,  Keynes restates the classical position on several economic items, including: What determines wages, the "types" of unemployment, and how to reduce unemployment.  In section II, Keynes starts to refute some of these by implying that there is the possibility that there is another type of unemployment.

Section 1 is just a restatement of the "classical" view of wages and unemployment. Keynes uses Professor Pigou's writings as representative of the mainstream understanding of economics.  The reason is that Pigou was, at the time, the head of the world renown school of economics at University of Cambridge.  He studied under Alfred Marshall.  I would probably compare Pigou to Larry Summers or Greg Mankiw.  A well-known, influential economist who mostly adheres to conventional wisdom.

The classical view of wages is the typical supply vs. demand curve, like the one below, that we're all used to seeing.  The value of the worker to the company sets the demand line.  The willingness of workers to give up their time sets the supply line.

Simple Supply and Demand Curve of Labor
The classic postulate allows for only two types of unemployment.  The first is "frictional" That's a fancy way of saying someone is literally "between" jobs for various reasons.  For instance, was just laid-off and is looking for another job.  The other type is 'voluntary' unemployment.  And I purposely use quotes around voluntary.  This is unemployment where a person or persons either doesn't want a job, or is holding out for more pay.

From this, Keynes lists the 4 logical ways to increase employment according to the Classic economists:(I'm paraphrasing)

A)  Better policies to make "frictional" unemployment end quicker.

B)  Make workers more willing to give up their time(to eliminate so-called "voluntary" unemployment)

C) Make workers more productive so that companies are willing to hire more at the current wage

D) All Labor becomes cheaper as compared to everything else a company(or "firm") needs to make its products

Before going to Section two let's look at the two categories of unemployment the classic economists recognize vs. those that we recognize today.  Today, economists recognize "frictional" unemployment, just like pre-Keynes's classic economists.  Today, we also recognize "structural" unemployment.  Since structural unemployment just means workers don't have the skills or knowledge to do the jobs that are available, we could categorize that as long-term frictional unemployment that the classics recognize.  That means the only point of contention between classics and today is Voluntary and "Cyclical".    "Voluntary" unemployment isn't even considered a "type" of unemployment these days.  The other category we have today, "cyclical" is what Keynes is introducing to the world.  It is appropriate that these are the types that the others don't recognize.  Because, in section II, Keynes will introduce what people will one day call "cyclical" unemployment.  However, what we call cyclical unemployment today, classical economists would call "voluntary".

Section II
In this section, Keynes is calling "Bullshit!" on the classical theory as he describes in section I.  the mainstream view of the time was that if unemployed workers would just quit being so obstinate and agree to a decrease in wages, then they could get a job and end mass unemployment.  Therefore, mainstream economists believed that massive "cyclical" unemployment was really just a type of 'voluntary unemployment'.  Keynes takes 2 issues with this.  The first issue is covered in this section and is only a minor issue.  The second issue is the "fundamental" issue and will be described in this book.

To start off explaining his first issue, Keynes again demonstrates his understanding of classic economics.  In classic economics, economists always assume that the money(or dollar) wages workers agree to are always the same as the REAL wage(i.e. adjusted for inflation) that they would work for.  Logically, if a worker would quit if an employer cut his salary by 10%, then a worker would also quit if prices of products rose 10%.  This seems logical because in both scenario's workers are getting 10% less stuff in the end.  Classical economists agree with this logic.

Keynes points out that this doesn't happen in the real world.  Workers will not resist short term REAL wage cuts that come in the form of rising prices, but do resist short term dollar cuts in wages.  As Keynes puts it, "whether logical or illogical, experience shows that this is how labor in fact behaves."  Keynes claims that the  Classical economists actually acknowledge that a short term drop in REAL wages won't lead to workers quitting - but they assume that. since it's a short term thing, it isn't a significant departure from their theory. Keynes disagrees. If dollar-wages aren't solely dependent on REAL wages then the whole classical theory of employment falls apart.

The second issue is the more fundamental issue to Keynes. Wage workers have no way to lower their own REAL wages as a group, they have only the ability to redistribute REAL wages.  Here is what I think Keynes is getting at:  An individual can always agree to lower his or her own wages to get a job.  However, that act alone will not increase employment, instead what will happen is that someone else becomes unemployed.  If labor as a group lowers it's REAL wages as a group, the number of workers won't increase, instead, the income will only be redistributed to non-labor input.  He doesn't say what that input is, but I assume he means capital and land.  Explaining how and why this all happens is the purpose of this book.
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