The Sticky Money Wage Keynes
Liquidity, Default, Risk

The "The Labor Market Is Not a Partial-Equilibrium Market" Keynes

From John Maynard Keynes's General Theory. One of the Keyneses. The Keynes who argues that the main thing wrong with classical economics is that it analyzes the labor market as though it can be analyzed in partial equilibrium:

The Postulates of the Classical Economics: [T]he other, more fundamental, objection... flows from our disputing the assumption that the general level of real wages is directly determined by the character of the wage bargain.... There may exist no expedient by which labour as a whole can reduce its real wage to a given figure by making revised money bargains with the entrepreneurs.... Though the struggle over money-wages between individuals and groups is often believed to determine the general level of real-wages, it is, in fact, concerned with a different object... the struggle about money-wages primarily affects the distribution of the aggregate real wage between different labour-groups, and not its average amount per unit of employment, which depends, as we shall see, on a different set of forces. The effect of combination on the part of a group of workers is to protect their relative real wage. The general level of real wages depends on the other forces of the economic system.

Thus it is fortunate that the workers, though unconsciously, are instinctively more reasonable economists than the classical school, inasmuch as they resist reductions of money-wages, which are seldom or never of an all-round character, even though the existing real equivalent of these wages exceeds the marginal disutility of the existing employment; whereas they do not resist reductions of real wages, which are associated with increases in aggregate employment and leave relative money-wages unchanged, unless the reduction proceeds so far as to threaten a reduction of the real wage below the marginal disutility of the existing volume of employment....

We must now define the third category of unemployment, namely "involuntary" unemployment in the strict sense, the possibility of which the classical theory does not admit.... [I]t will be convenient to exclude "frictional" unemployment from our definition of "involuntary" unemployment. My definition is, therefore, as follows: Men are involuntarily unemployed if, in the event of a small rise in the price of wage-goods relatively to the money-wage, both the aggregate supply of labour willing to work for the current money-wage and the aggregate demand for it at that wage would be greater than the existing volume of employment.... So long as the classical postulates hold good, unemployment, which is in the above sense involuntary, cannot occur. Apparent unemployment must, therefore, be the result either of temporary loss of work of the "between jobs" type or of intermittent demand for highly specialised resources or of the effect of a trade union "closed shop" on the employment of free labour....

From the time of Say and Ricardo the classical economists have taught that supply creates its own demand;¾meaning by this in some significant, but not clearly defined, sense that the whole of the costs of production must necessarily be spent in the aggregate, directly or indirectly, on purchasing the product.... The doctrine is never stated to-day in this crude form. Nevertheless it still underlies the whole classical theory, which would collapse without it. Contemporary economists, who might hesitate to agree with Mill, do not hesitate to accept conclusions which require Mill's doctrine as their premiss. The conviction, which runs, for example, through almost all Professor Pigou's work, that money makes no real difference except frictionally and that the theory of production and employment can be worked out (like Mill's) as being based on "real" exchanges with money introduced perfunctorily in a later chapter, is the modern version of the classical tradition....

At different points in this chapter we have made the classical theory to depend in succession on the assumptions: (1)  that the real wage is equal to the marginal disutility of the existing employment; (2)  that there is no such thing as involuntary unemployment in the strict sense; (3)  that supply creates its own demand in the sense [p.22] that the aggregate demand price is equal to the aggregate supply price for all levels of output and employment. These three assumptions, however, all amount to the same thing in the sense that they all stand and fall together, any one of them logically involving the other two.