2: The Postulates of the Classical Economics

Now the substantive stuff begins… All this is tentative, please jump in to correct if I’ve misinterpreted something! 

Here Keynes clearly defines what he means by ‘the classical economics’. To what extent this matches other definitions is beside the point – at least we know what Keynes is arguing with.

Still, I can’t resist one quibble, related to what I was saying yesterday about the alternative epistemic break between ‘classical’ and ‘neoclassical’. Keynes implies that the classical economists (his definition) were/are “primarily concerned with the distribution of a given volume of resources” and not so much with the question of “the volume of the available resources”. He states correctly that “Ricardo expressly repudiated any interest in the amount of the national dividend, as distinct from its distribution.” [p. 4]

But his successors, less clear-sighted, have used the classical theory in discussions concerning the causes of wealth. [p. 4]

He is vague about who these successors are. One of the characteristics of the pre-marginalist classicals (my definition) was that they tied the theory of distribution to the theory of growth via the concept of capital accumulation. That is, growth depended on the share of output going to capital, because this determined investment. This concept of accumulation was lost by the marginalists, who did indeed lose interest in questions of growth. The recovery of this classical concept of accumulation, the relationship between distribution and growth, was a major motivator for the classical revivalists centred around Keynes’ own economics department at Cambridge. Keynes glosses over this important break in the history of economic thought. Of course, Keynes himself is less concerned here with growth over the long term than with fluctuations in output and employment over shorter periods where the capital stock must be taken as given.

Anyway, it’s clear from his exposition of their ‘postulates’ that Keynes’ ‘classicals’ are our ‘neoclassicals’. The two parts of the classical theory of employment he describes – “The wage is equal to the marginal product of labour” and “The utility of the wage when a given volume of labour is employed is equal to the marginal disutility of that amount of employment” – describe a demand curve and a supply curve respectively. The demand curve slopes down in wage-employment space, while the supply curve slopes up, and where they meet determines the actual wage rate and employment. Except for frictional unemployment, any gap between actual employment and potential employment is voluntary, because if workers would accept employment at a lower wage, they would find more work. The four ways Keynes gives of increasing employment according to this theory can be represented graphically as follows:

(a) a decrease in frictional employment – both curves shift to the right (i.e., higher employment at any given wage);

(b) a decrease in the marginal disutility of labour – the supply curve shifts right (i.e. more labour is supplied at any given wage, so if the demand schedule for labour remains the same the wage falls and employment rises);

(c) and (d) the price of wage goods falls relative to non-wage goods so that any given level of workers’ utility can be satisfied with the product of a lower share of total employment – the demand curve shifts right (i.e. more labour is demanded at any given wage, so if the supply schedule for labour remains the same the wage and employment rises).

Clearly we are talking about real wages here (i.e. in stuff, or more accurately, in utility) rather than nominal wages (in money).

Keynes mocks this tidy logical system by appealing to the evidence that in reality many unemployed workers are willing to work at the going wage. For ‘the classicals’ this is the fault of worker combinations “open or tacit” not to work for less than the going rate. [p. 8] Keynes disputes this again by appeal to empirical evidence – introducing the distinction between real and nominal wages, he points out that while it is difficult to get workers to accept nominal wage cuts without industrial action, they accept real wage cuts through price rises all the time.

In other words, it may be the case that within a certain range the demand of labour is for a minimum money-wage and not for a minimum real wage. The classical school have tacitly assumed that this would involve no significant change in their theory. But this is not so. For if the supply of labour is not a function of real wages as its sole variable, their argument breaks down entirely and leaves the question of what the actual employment will be quite indeterminate. They do not seem to have realised that, unless the supply of labour is a function of real wages alone, their supply curve for labour will shift bodily with every movement of prices. Thus their method is tied up with their very special assumptions, and cannot be adapted to deal with the more general case. [pp. 8-9]

Interestingly, though, Keynes’ own argument here is based on historical/institutional specifics, in this case about how workers perceive the wage relation and how they are able to organise around it. (Think about how worker consciousness and activity around the wage changed in the face of persistent inflation in later decades – wage-indexation contracts, etc.)  I have no complaint about that – historical specificity is vital – but it leads me to doubt whether a ‘general case’ can actually be established. Let’s pay attention to where Keynes’ criticism appeals to institutional realities, and when he is making arguments about economic logic.

Here, he continues to appeal to empirical evidence about fluctuations in employment in the Depression in the United States: “Wide variations are experienced in the volume of employment without any apparent change either in the minimum real demands of labour or in its productivity.” [p. 9]

More generally, Keynes points out that the (neo)classical theory implies that wage bargains between employer and worker determine the real wage, leaving out any consideration of the effect of prices, which, according to the theory, tend to vary with wage costs. Then we have the institutional proposition that in collective action over wages, workers are more concerned to protect their incomes relative to other workers, rather than to defend a real wage as such. There is a lot of truth in this, as anyone who has looked at the history of the Australian arbitration system can verify. But it’s certainly not the only consideration. He is right, though, that real wages have a much more complex determination than via the wage bargain alone.

Finally Keynes gives his own definition of involuntary unemployment:

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. [p. 15]

This is clear but odd. I’m not sure why the “…in the event of…” clause can’t be removed. Is that supposed to make it more useful for an empirical test? Because I’m not sure that it does.

Keynes then makes clear his acceptance of the first classical postulate: “The wage is equal to the marginal product of labour.” He is not conceding this for the sake of argument but stresses his agreement. I don’t find it convincing, but let’s leave that for now and accept it for the sake of understanding what he is trying to do. Keynes intends to leave neoclassical microeconomics intact, along with this doctrine that legitimises (more than it explains) factor incomes to labour and capital. (Note that earlier Keynes defends the rationality of the worker focus on income relative to other workers, rather than the real wage, because he accepts this neoclassical argument that real wages are inversely related to employment: “…it is fortunate that workers, though unconsciously, are instinctively more reasonable economists than the classical school…” [p. 14].) 

Big jump now – from the theory of employment to Say’s Law, “that supply creates its own demand”, which Keynes interprets as: “…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.” [p. 18] Or, a little later: “… that the aggregate demand price is equal to the aggregate supply price for all levels of output and employment.” [p. 22] The corollary is “that any individual act of abstaining from consumption necessarily leads to, and amounts to the same thing as, causing the labour and commodities thus released from supply consumption to be invested in the production of capital wealth.” [p. 19] He quotes a particularly silly version of the statement from the early Marshall.

There are hints here that Keynes objects to this based on the fact that purchasing power can remain stored in the form of money. But he doesn’t state his reasons here outright; he leaves it hanging. The destruction of Say’s Law, he argues, means the destruction of much of ‘classical theory’, and he claims that it stands and falls along with the (neo)classical theory of employment, though it is not clear yet how they are linked.

Finally, just to flag one side issue I want to keep an eye on throughout the book: considerations of the international dimension. My preconception is that Keynes excludes it from consideration. In this chapter he writes that the conclusions of the classical theory of employment are “supposed to be equally applicable to a closed system as to an open system, and are not dependent on the characteristics of an open system or on the effects of a reduction of money-wages in a single country on its foreign trade, which lie, of course, entirely outside the field of discussion.” [p. 11] So Keynes is excluding the international, but is clear about doing it.

Whew. I’m not going to be able to keep up this level of detail in later chapters, it took too long. Let’s see how we go.

Published in: on 5 October, 2007 at 10:19 am  Comments (5)  

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  1. […] Beggs has begun blogging over at Scandalum Magnatum. Mike currently has posts up on the first two chapters, with more (much more!!) planned: Where are the lefty economics blogs? I find myself haunting the […]

  2. Actually, Ackerloff published an article which said that although people are very conscious of large swings in prices, in small ones, they are not so much interested, thus you can get a positively sloped Phillips Curve.

    I think the same can be said here of Keynes workers, who do not, ‘on every occasion’, withdraw their work with a given rise in prices. Yes, if prices rise a great deal, and if they are part of a union, yes. But private unionization rates in the US are in the lower single digits.

    So, the supply of labor is not simply a function of the real wage, but also the relative wage, some menu pricing costs, and the fact that the price level depends on aggregate relationships not private ones.

    So ‘Aggregate Supply’ and ‘Aggregate Demand’ are not in P and Y space as they are in our texts (and what a Walrasian might write), but rather PQ and E space – that is, they are real. In fact these Aggregates look a lot like the Aggregate Supply and Demand for Labor. What puzzles me is why Say or any classical economist should say these curves are not downwardly and upwardly sloping. If there is an increase in the demand for labor, and labor is up warding sloping, then you get a rise in output (PQ) and employment (E). What is the deal here? Can we ignore the digression into Say’s law? It is odd that no books really sort of look at what Keynes actually wrote but rather look at Hicks model (or Leonavfud (spelling apologies) and Clower)

  3. I think the reaction to inflation is always institutionally-dependent. Not only on expectations but on the balance of power in industrial bargaining, though obviously if the capitalists expect inflation they will be more willing to allow wages to rise. The original Phillips curve article (i.e. Philips, 1958 or whenever) was aware of this, and I guess it is behind the move from the ‘natural rate of unemployment’ to the present ‘time-varying NAIRU’ doctrine.

    It’s interesting to see these ideas played out obliquely in Australia at the moment in press debate about the effects of industrial relations reform – according to the government it’s not just about ‘jobs’ but about ‘jobs consistent with controlling inflation’.

  4. I just came across Joan Robinson’s rejoinder to Keynes’ convoluted definition of full employment: “the point at which every impediment on the side of labour to a rise in money wages finally gives way.” [Essays in the Theory of Employment, 1937: p. 9]

  5. hanbit2014.com

    2: The Postulates of the Classical Economics | Scandalum Magnatum

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