Wednesday, March 04, 2009

Paul Lewis On Unproven Justifications For Flexible Labor Markets

Many who do not understand economics, such as many mainstream economists working at the OECD, the IMF, the World Bank, and other powerful institutions, think less unemployment would result from more "flexible" labor markets. Flexibility is a code-word for eliminating unions, lowering the real value of minimum wages, and otherwise decreasing standards in labor markets. I have pointed out some reasons why this push for labor market flexibility is theoretically and empirically unjustified.

There is more to Paul Lewis' recent paper than this echo of my favorite argument:
"One rationalisation of F[lexible] L[abour] M[arkets] rests upon neoclassical economic theory, in particular M[arginal] P[roductivity] T[heory]. A key feature is optimisation of the quantity of each factor employed so that its price equals its marginal productivity. To fit with the trade and technology hypotheses this neoclassical model must contain a minimum of two homogeneous categories of labour - low and high skilled - and two types of 'capital' - advanced high-skill complementary and low-skill complementary equipment.1...

...What results from these labour market conditions at a macro level is the natural rate of unemployment, or N[on]-A[ccelerating] I[nflation] R[ate] of U[nemployment] as it has come to be known. This is a long-run equilibrium, a consequence of supply and demand in the labour market, in this case largely constituted by the market for the low-skilled. It is consistent with firms having zero net profit,3 which corresponds with a 'warranted wage' for labour (Blanchard, 2006, p. 13).

1 I consider the arguments for F[lexible] L[abour] M[arkets] rest upon the following neoclassical assumptions. (i) Capital refers to the physical means of production, which has to be homogeneous in its inherent productive features, (ii) it is quantifiable independently of its price, which allows it to be optimised in production. This characterisation of capital was shown to be nothing more than a 'neoclassical parable' as Samuelson put it, with no grounding in reality (see Blaug, 1997; Hodgson, 1997; Hunt, 2002). However, this shortcoming has not prevented its continued use as a foundation of mainstream microeconomics.

3 A condition of perfect competition in the product markets. The outcome of zero profits in equilibrium is a further example of the inability of M[arginal] P[roductivity] T[heory] to model common features of real economies." -- Paul Lewis, "(How) Do Flexible Labour Markets Really Work? The Role of Profitability in Influencing Unemployment, Cambridge Journal of Economics, V. 33 (2009): pp. 51-77


Anonymous said...

"However, this shortcoming has not prevented its continued use as a foundation of mainstream microeconomics."

I have to admit to thinking this understatement is quite funny, and describes so much of mainstream economics...

What gets me is that it is almost like Keynes never existed. I know people like Marx and Galbraith can be safely ignored, but Keynes?

His arguments on how flexible wages and prices increase uncertainty, so making investment and other economic decisions extremely difficult, are in the The General Theory, as are his arguments on the negative aggregate impact of wage flexibility.

The former gets ignored, the latter transformed into unemployment is caused by "sticky" wages (which Keynes explicitly denied).

I suppose the former gets ignored thanks to equilibrium analysis, the notion that the economy jumps from one state of equilibrium to another (in that case, the impact of wage and prices changes can be safely ignored).

Is it likely that equilibrium economics along with other neo-classical orthodoxies will go down with the crisis? Will this economic crisis produce a crisis in economics? There seems to be some movement in that direction...

Oh, btw, thanks for linking to my work. Although, I should point out that the link is wrong. My articles can be found here while my blog is here. I generally post a blog entry when I post articles.

An Anarchist FAQ

YouNotSneaky! said...

"flexible wages and prices increase uncertainty, so making investment and other economic decisions extremely difficult"

Take flexible wage US and a less flexible wage Sweden. Over the past forty, fifty years. Or hell, last thirty years (Republicans + the neoliberal Clinton). Get their income per capita. Detrend those suckers and calculate % dev from trend (it goes with out saying that US has higher trend). Look at those calculations, and just to convince yourself calculate the st. dev. Guess who's got the more volatile economy?
(To the extent that matters. All developed countries, whatever their labor market and other institutions look fairly similar)

If that is Keynes, then he was wrong. But I prefer the Hicks Keynes who was more right and who's alive and well (things said by weirdos like Prescott not withstanding).

YouNotSneaky! said...

The obvious theoretical riposte to the above is that with fixed prices and wages and in the face of external changes to the environment a lot of these non-difficult economic decisions that had been end up looking pretty wrong.