A Keynsian Critique of Monetarist Low Wage and Unemployment Policy

Keynes Book Cover

Michael Stewart’s book, Keynes And After, (London: Penguin 1987) 3rd edition, is a study of Keynes’ economic theory aimed at the popular market, rather than professional economists. It attempts to explain it clearly, examine the rival Monetarist theory, and then demonstrate that Keynsianism remains economically valid and a better model of the economy than Monetarism, while making suitable adjustments to it. Although published in 1987, the book and its arguments remain extremely valid.

The Coalition government has pursued a policy of strict wage restraint, which has led to wage freezes or increases below the rate of inflation. As a result, much of the population has seen a decrease in real, take-home pay. They have attempted to justify it as necessary to pay off the massive public debt. It’s also assumed that somehow such pay freezes will curb inflation, and so promote economic growth.

Other sections of the Tory party have also demanded this, along with longer working hours, such as the authors of Britannia Unchained, so that Britain can remain competitive alongside workers in the Developing World, such as India and China, in the global market place. This is basically a Neo-Liberal restatement of the classic Monetarist arguments used by Thatcher that unemployment was the result of British wages being too high.

The Coalition is also determined to destroy the welfare state and cut unemployment benefit on the grounds that its present level makes it more attractive for some workers to go on the dole, thus pricing themselves out the labour market. As the Angry Yorkshireman over at Another Angry Voice has shown, Monetarism itself demanded that there should be a constant unemployment rate of about 6 per cent in order to keep the price of labour down. This partly invalidates any claim that Monetarism can combat unemployment. Stewart also refutes the Monetarist argument that lowering wages will some how reduce unemployment in the section ‘Reducing the Real Wage’, where he states

We saw in Chapter 8 that an important strand in monetarist thinking is that unemployment is the consequence of workers refusing to work for the real wage rate established in the market. If workers reduced their supply price – i.e. offered to work for lower real wages – they would find employment. For a fall in the price of labour will increase the demand for labour just as a fall in the price of apples will increase the demand for apples. In short, for unemployment to fall, all that is needed is for workers to accept a cut in the real wage. So the argument runs.

Although the argument may have a certain intuitive plausibility, the truth is not so straightforward. The issue of the relationship between real wages and unemployment is surrounded by controversy. One reason for this is that the matter arouses strong passions. The price of labour is not quite the same thing as the price of apples; it represents, viewed from another angle, the money on which a worker and his family have to live. Since it is the lower-paid workers who suffer most from unemployment those who lack skills, or who possess skills no longer in demand – talking of reducing real wages in order to bring down unemployment is to talk of reducing even further the living standards of people in the poorest 10 or 20 per cent of the population. Moreover, the devices which monetarist-inclined governments may adopt in order to persuade people to work for lower real wages can also be highly contentious. Reducing income tax or employees’ social security contributions, so that employers can pay lower wages to unskilled workers, without these workers’ take-home pay being affected, is one thing. It is quite another thing to adopt a series of measures, as the Thatcher government did, to reduce the real value of the social security benefits received by the unemployed. To monetarists who think that they unemployed are making a cool calculation about the advantages of being out of work rather than in work, this may seem reasonable. To those who do not believe that most unemployment is voluntary, it represents an inexcusable attack on the living standards of people who are already poor through no fault of their own.

Whatever the emotions aroused by this issue, it is at an intellectual level that it must be resolved. And it is clear that the idea that unemployment is caused by excessive real wages, and that real wages must be reduced if unemployment is to fall, is open to a challenge along a number of different lines. It is a measure of the extent to which monetarism represents a resurrection of the fallacies of classical economics that some of the lines of argument amount to little more than a restatement of some of the points made by Keynes in the General Theory, and discussed in Part One. But there are other arguments as well.

First of all, as was pointed out above, wages, although a cost to the employer, represent income to the employee. A cut in real wages is therefore likely to reduce workers’ consumption and, via the Multiplier mechanism discussed in Part One, the incomes and consumption of other workers. Thus there will be a fall in the output of the economy and a rise, not a fall, in unemployment. (To put it slightly more technically, the downward shift in the supply curve of labour represented by the cut in real wages may be offset, or more than offset, by a downward shift in the demand curve for labour, leaving the level of employment unchanged, or even lower than it was before.) With Keynesian techniques of demand management this adverse effect on incomes and employment could of course be counteracted by tax cuts or increases in public expenditure. But, as we have seen, monetarists reject the need for demand management, and argue that wage cuts will in themselves lead to a rise in employment. The reason why this should be so is very difficult to discern.
(pp. 183-5).

Now it is true that the Coalition is using some of the techniques of Keynesian demand management, like removing social security contributions for some workers, and a cut in taxation. It is claimed that these are reducing unemployment, though this is extremely dubious. Following Thatcher herself, all the administrations have altered the statistics to show that unemployment was falling when in fact it was much higher. The Coalition is no different, and Mike over at Vox Political has suggested that the true level of unemployment may be as high as 9 million. Similarly the tax cuts are designed only to benefit the rich, and so most people are now poorer due to the Coalition’s economic policy. As the above has shown, when workers’ wages are reduced, other workers suffer as people naturally spend less buying their products. So I very much doubt that the government’s cuts have led to increased domestic consumption and stimulation of the economy.

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One Response to “A Keynsian Critique of Monetarist Low Wage and Unemployment Policy”

  1. A Keynsian Critique of Monetarist Low Wage and ... Says:

    […] … than professional economists.It attempts to explain it clearly, examine the rival Monetarist theory, and then demonstrate that Keynsianism remains economically valid and a better model of the economy than Monetarism,……  […]

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