Persistent Unemployment: A Flaw In Capitalism

Defenders of capitalism, whether of a liberal reformist or of a more conservative variety, portray it as harmonious, in some sense. One aspect of this portrayal is that under ideal conditions, at least, markets tend to clear. This supposed tendency must apply especially to the labor market. Another aspect, put aside in this post, is the obsolete and explopoded marginal productivity theory of distribution.

Nicholas Wapshott was correct in putting this supposed tendency as a central point of contention between John Maynard Keynes and Friedrich Hayek:

"... the objections of Circus members ... suggested to Keynes what was to become a pivotal element of The General Theory, that overall output was not fixed and could be raised through increased investment to a point where everyone in an economy was employed. It was this first slender thread of thought that led to Keynes's wholesale contradiction of the claim of classical economists like Hayek that an economy, left to its own devices, in the long run inevitably came to rest at a state of equilibrium where there was full employment. Keynes was to argue in The General Theory that in the short and medium terms an economy could reach equilibrium with considerable unemployment and that the full employment equilibrium predicted by classical economists too often proved to be elusive. Keynes believed that the chronic unemployment endured in Britain and America in the 1920s and 1930s was evidence that the full employment equilibrium was a fallacy." -- Nicholas Wapshott. 2011. Keynes Hayek: The Clash That Defined Modern Economics. New York: W. W. Norton and Co.: p. 128.

I can think of three positions to take here:

• No such tendency for markets, including labor markets, to clear in any run.
• Such tendency would exist, but imperfections and rigidities prevent this tendency from manifesting itself.
• Although imperfects and such like exist, they are not empirically important enough to prevent this tendency for markets to clear, if we are patient enough.

Keynes and Piero Sraffa have convincingly argued for the first position, that no tendency exists for markets, including the labor market to clear. Keynes had many arguments. For example, workers and capitalists may have no way of negotiating about the real wage. Suppose unemployment is high. A system-wide drop in the money wage occurs. Prices might drop as a result, leaving the real wage unchanged. If the money supply is exogenous, the real money supply is increased in some sense. You might get money policy implemented by trade unions. But this effect is outside the usual partial equilibrium story about the labor 'market'. Furthermore, capitalists would be inclined not to open new factories in a period of declining wages and prices. They can anticipate that new factories opened tomorrow, instead of today, will have decreased costs and a decreased burden of debt. With declining prices of output, too, capitalists will put off investment.

Sraffa showed that prices, in a long run theory, do not have the properties needed to support just-so stories about supply and demand. Prices of production can support a long run theory in which labor markets do not necessarily clear. Say's law is false.

For the second position, I think of failures of competition, information asymmetries, search costs, incomplete contracts, principal agent problems, and so on. Many misleadingly characterize Keynes as holding this position. I guess those investigating these imperfections often advocate government interventions to remove or mitigate their effects. A radical position is that at least some of these imperfections cannot be removed. Government might then need to simulate how markets would work without these limitations. Is this the position of ordoliberalism?

Those with the third position would be for a more laissez faire approach.

But to return to the first position. Suppose no tendency exists for markets, including the labor market, to clear. Keynes recommended a "somewhat comprehensive socialisation of investment". But he was not clear on what that means.