Relationship between wages and employment


  Paul Krugman looks again at the relationship between deficit reduction, wages and employment in the USA.

Yglesais says that a decline in deficit could lead to further employment expansion if it led to lower general wages (through a more flexible wage system) .

Krugman argues that this misses a key point: when you cut the price of something, it normally get cheaper relative to other things and this allows a redistribution of spending towards the cheaper good. But “when you cut the price of everything -which is more or less what happens when wages fall across the board – there is nothing to substitute away from”.

So, Krugman contends, the argument is not just morally wrong (because it inflicts further pain on people who are not responsible for what happened to the financial system) but it also technically wrong. It won’t have any positive effect on employment and could well prove negative.

This issue does not arise in Australia because (a) Australia has a much higher relative minimum wage than in the USA (b) we have a much stronger Fair Work Act and (c) Australian levels of unemployment are much lower than in the USA.

This entry was posted in Uncategorized. Bookmark the permalink.

7 Responses to Relationship between wages and employment

  1. observa says:

    “Yes, but that’s because when you cut the price of something, it normally gets cheaper relative to other things, leading people to redistribute their spending toward the cheaper good.

    But when you cut the price of everything — which is more or less what happens when wages fall across the board — there’s nothing else to substitute away from.”

    Who said anything about cutting wages across the board? The cuts were to come specifically from PS wages or jobs, because they are not presently being paid for in real terms now, due to deficit spending which is being financed by printing money. If Krugman’s logic is correct why then hasn’t record low interest rates and money printing produced Keynesian nirvana? Just print more money to pay more public servants and/or more benefits and presto, increased aggregate demand and no more unemployed. Or does it simply pay to be first cab off the rank with all that funny money Paul? Public servants and Morgan Sachs folk strolling arm in arm together humming ‘Too big to fail’?

  2. Paul Bamford says:

    America is just too big to adjust primarily through the currency channel. So one possible route is nominal deflation. You cut nominal public sector salaries, lay off public sector workers, and reduce nominal transfer payments (Security Security, SNAP, etc.). This ought to drive down wages in the private sector, too, and eventually everyone is making sufficiently little money that it makes sense to start hiring more people. But there are major problems with this beyond the messaging challenge associated with “our agenda is to make you take a pay cut.” []Source

    And that’s from the guy whose logic Krugman is criticising. It’s this simple – if you push down wages across the board then you don’t get any improvement in employment – because the only substitute for labour is (ceteris paribus) someone else’s labour. It’s like trying to relieve a potato famine by pushing down the price of potatoes…

  3. Fred Argy says:

    Everyone agrees that action against public sector workers (in the USA) would create more competition for the new open jobs in the private sector and thus drive low and medium wages down for everybody.

    Like Krugman, I personally doubt that such policy action would do anything to reduce overall unemployment. So it would not be a morally correct policy change, as it would mean more unequal treatment of all citizens (lead only to lower wage levels for medium and low workers relative to profits and the elite).

  4. Judith Sloan says:

    This is complete drivel. Keynesians have always accepted that real wage rigidity leads to unemployment and it is why real economists such as Tobin, Modigliani and Samuelson had no time for Krugman. Even these economists point to the pernicious impact of minimum wages.

    The idea that nothing happens with an across-the-board wage reduction (which wouldn’t happen by the way) is similar tosh as labour is but one input into the production process and the labour intensity varies greatly. Therefore the effect of the wage reduction on labour intensive goods could be substantial but slight for less labour intensive goods. The argument also seems to be assuming a closed economy which is also unrealistic. An across-the-board reduction in real wages is the equivalent of a currency depreciation and would add to employment.

    As to public sector employees, is it really unfair to target them when so many of them have egregiously generous pensions, health insurance plans and conditions generally (work only part of the year)? The reality is that there is a lot of resentment on the part of private sector workers and the unemployed to public sector workers, hence the activities of a number of State Governors to pare back public sector employment entitlements.

  5. Patrick says:

    Judith is quite right that there is an entire moral case for attacking public sector entrenched privilege (wasn’t that the definition of progressive, once, attacking entrenched privilege?) that doesn’t even mention unemployment.

  6. Fred Argy says:

    Judith Sloan. Krugman’s argument has nothing to say about curbing minimum wages or sectional wage reductions (in some sub-set of the work force) as a form of unemployment boost. I agree that this proposition has some merit (I believe with appropriate compensation such as in the Australian Wage Accord). There many economists (not all) who favour this idea.

    Krugman’s argument addresses instead a general decline in medium and low wages (assuming that would result from an attack on public sector wages and indirectly on private wages) – and what the subsequent redistribution from poorer to rich people would do to overall unemployment. I can quote many, many other economists (like Krugman) who are opposed to this concept in terms of employment.

    You accept that there would be some redistribution from wages to wider incomes and that, in an open economy, this could cause an eventual devaluation of the currency (affecting both wages and purchasing power of workers). This assumes other nations do not respond to devaluations in kind.

    What Krugman is arguing is that the initial reduction in purchasing power of wage earners has to be weighed against the reduction in wage costs and any exchange rate effects. He says the impact on unemployment is, at best, inconclusive and I agree with him.

    There are many other ways, much more equitable, of achieving lower deficits in US. And that is where the moral argument rests.

  7. Victor Trumper says:

    Judith has reading skills problems if this drivel is any indication as both budget papers and the RBA Bulletin is well beyond her.

Leave a Reply

Your email address will not be published. Required fields are marked *

Notify me of followup comments via e-mail. You can also subscribe without commenting.