Wages and Unemployment. 1. Pre-Keynesian economics. Equilibrium in all markets, FE of labor in labor market equilibrium. 2. Keynes' revolution

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1 Wages and Unemploymen 1. Pre-Keynesian economics Equilibrium in all markes, FE of labor in labor marke equilibrium 2. Keynes' revoluion 3. Inflaion His ideas developed in he hisorical conex of pos-wwi devasaion in Europe, persisen unemploymen and povery in 1920s Already recommending defici financed spending in 1920s long before GT in 1936 Key argumens in GT o Sysem is subjec o urbulen flucuaions due o dependence of invesmen on expeced ne rae of profi (r e - i) o Unemploymen does no lead o a fall in real wages or a leas no fas enough o make an effecive move o FE o Ineres rae does no fall in he face of unemploymen, so his canno serve o raise ne rae of profi and hence invesmen (which flucuaes anyway) o Hence in periods of persisen unemploymen, governmen deficis are appropriae o pump up oupu and employmen In NC heory he sysem is normally a effecive FE, so an increase in aggregae demand fueled by an increase in money supply will lead only o an increase in prices. In Keynesian heory he sysem is normally below effecive FE, so an increase in aggregae demand will firs increase in oupu and employmen up o he poin of effecive FE, and hen increase prices aferward In boh heories, "effecive FE" implies a cerain amoun of "fricional unemploymen": o always a cerain number of people who are on he way from one job o anoher. 4. Phillips money-wage curve Phillips (1958) showed ha a empirical level from he cyclically-adjused rae of change of money wages in he UK rose when unemploymen was below a cerain level, and fell when unemploymen was higher han his criical level. o Noe ha his was a proposiion abou he rends, i.e. cyclically adjused levels o I implies a curve of he shape below 1

2 The Phillips Curve w w u L * u L 5. The Keynesian price Phillips curve Keynesian policies in force from he 1950s onward did no have a concree way o express he relaion beween inflaion and unemploymen A ransformed version of he Phillips curve seemed o provide he perfec ool for Keynesian policy o By assuming ha prices were formed as markups on money wages, one could ransform he original Phillips curve in erms of he rae of change in money wages ino one of he rae of change of prices, i.e. inflaion versus unemploymen. o This mean ha policy makers could hink of reducing employmen below he criical level in reurn for acceping some olerably higher rae of inflaion. 2

3 The Inflaion Tradeoff Phillips Curve p p u L * u L 6. Poswar Phillips curves Phillips' original daa covered in he UK Early poswar daa in oher counries seemed o confirm Phillips' "law", e.g. US 3

4 Bu hen soon he Phillips curve fell apar Worse ye, unemploymen rose, ye inflaion also rose insead of falling, which direcly conradiced he Phillips curve and Keynesian heory 4

5 7. Revenge of he Empire: The Neoclassical "Soluion" Keynesian heoriss were rapped by he conradicion beween heir heory and he facs o According o heir heory, inflaion should fall when unemploymen rises o According o he facs, inflaion rose when unemploymen rose Friedman and Phelps sepped ino he breach by proposing wo hings: o Firs, ha he rue Phillips curve was in erms of he rae of change of real wages, no he rae of change of nominal wages o Second, ha in he long run any observed unemploymen is volunary or induced by workers hemselves: i is a "naural" rae of unemploymen Wha appears like involunary unemploymen is really volunary in wo differen senses Some workers choose no o work a he going wage because hey prefer he opions of unemploymen benefis, welfare paymens, ec. Oher workers use unions and he sae o raise heir real wages above he marke rae, which means ha he real wage is above he labor marke clearing rae so ha labor demand is below labor supply: he volunary raising of he wages of some employed workers leads o involunary unemploymen of oher workers. o Dynamics of adapive adjusmen Since he real wage = nominal wage/price level, he rae of change nominal wages = he rae of change of real wages + inflaion (rae of change of prices) From his poin of view, he Phillips curve shifs when inflaion is higher Friedman/Phelps proposed ha in he case of a "surprise" increase in aggregae demand we will ge a surprise increase in inflaion and oupu would iniially rise and real wages would no adjus adequaely because i akes ime for workers and firms o cach on o a new unexpeced rise in inflaion. So when firms see ha heir own price has risen hey expand oupu and employmen because hey fail o realize ha heir coss will soon rise. Hence unemploymen falls. This induces workers o demand a higher rae of change of money wages in correspondence o he new lower unemploymen rae, bu since hey have no ye realized ha prices have also risen, his nominal new wage demand is oo low. As firms cach on ha heir coss have also risen, i.e. ha heir real profis are acually no any differen, hey drif back o he original level of oupu and rae of unemploymen. A he same ime, as workers cach on o he fac ha prices have risen, heir rae of change of money wages caches up o he new inflaion rae. 5

6 In he end, he sysem reurns o he original "naural" rae of employmen wih a higher rae of increase of money wages equal o he higher inflaion rae i.e. o he same real wage as before. Lucas acceped he naural rae of unemploymen hesis, bu rejeced he Friedman/Phelps slow (adapive) adjusmen of inflaion expecaions in favor of "raional expecaions". o Then afer brief period due o he iniial surprise, firms and workers jump o he correc expecaions of he new objecive rae of inflaion. In all approaches, he sysem reurns o a naural rae of unemploymen afer any aemp o pump i up, so he only effec will be a higher rae of inflaion 8. The classical approach o he relaion beween wages and unemploymen Marx's heory of he reproducion and mainenance of a persisen rae of unemploymen depends crucially on he negaive feedback beween wages and unemploymen o RAL sory Goodwin's formalizaion o Real wage Phillips curve o Consan rae of produciviy growh and labor supply growh Alernae formalizaion: wage sruggle and corresponding wage curve o A he individual level, workers and firms sruggle over he division of value added o This leads o a paricular relaion beween he average real wage rae and produciviy 1) w y where is a measure of he relaive srengh of labor o Bu relaive labor srengh iself depends on he unemploymen rae 2) f u L o Equaion 1 can be expressed in raes of growh, w y w y so if we define he wage share as wy hen equaion 2 implies ha he rae of change of he wage share is a negaive funcion of he unemploymen rae. 3) f u L o This Classical Curve appears as one of he wo dynamic relaions in Goodwin's elegan formalizaion of Marx's Reserve Army argumen (1967, p. 55) 6

7 9. Phillips' quesion vs. Phillips's answer: a ale of hree Phillips' curves Phillips' original quesion has o be disinguished from his answer Phillips' quesion: wha is he effec of unemploymen on wage raes? Phillips answer is a Keynesian one posed in erms he rae of change of money wages Bu as Friedman and Phelps poin ou, workers sruggle for a sandard of living, i.e. for a real wage, no a money wage. o Hence from heir poin of view, he correc "Phillips-ype" relaion should be in erms of he rae of change of real wages However, in he classical radiion i has always been recognized ha he real wage iself is relaed o he general level of developmen of sociey, i.e. o he level of produciviy o Thus from he classical poin of view, he correc "Phillips-ype" relaion curve would be in erms of he rae of change of real wages relaive o produciviy, i.e. in erms of he rae of change of he wage share. So we end up wih hree answers o Phillips's quesion o Phillips' Keynesian answer in erms of he rae of change of money wages o Friedman/Phelps/Lucas' answer in erms of he rae of change of real wages o The classical answer in erms of he rae of change of he wage share Noe ha any classical version of a Phillips-ype curve will shif down and may also change shape when relaive labor srengh is reduced, since a real wages will change a a lower rae relaive o produciviy when labor is weaker. 10. Empirical evidence (SEE POWERPOINT ANIMATION) Verical axis = rae of change of he wage share Horizonal axis = (unemploymen rae) x (unemploymen duraion index o ) 7

8 Following Phillips' original procedure, all daa is cyclically adjused, in he presen case by using HP-filered values of he variables 1.2% 1.0% Classical Curve: Wage share % change vs. unemploymen inensiy US (HP filered values) % 0.6% % 0.2% % % -0.4% % % 0% 5% 10% 15% 20% 25% 30% Anwar Shaikh, 2/13 Unemploymen Inensiy Noe he long duraion of a sable poswar classical curve from , corresponding o a sable (albei deerioraing) balance of power beween labor and capial. Noe he reverse movemen along his sable curve from during he Vienam War boom. Noe ha he curve coninues o hold during he infamous Sagflaion Crisis of he 1970s and early 1980s Noe he subsequen clear downward shif in he curve from afer labor is dramaically weakened during he Reagan-Bush era, ino an region of falling wage shares. Noe he reverse movemen along he new lower curve during he Do.com credi bubble from

9 11. Implicaions of he classical approach for he Phillips curve debae Had Phillips posed his quesion in classical raher han Keynesian erms, here would no have been a heoreical crisis during he Sagflaion era of he 1970s and 1980s Hence here would no have been he same opening for he neoclassical heoreical aack on Keynesian policy This of course need no have changed he poliical aack, which was afer all o weaken labor and raise he rae of change of he profi share by reducing he rae of change of he wage share Since he sable relaion is beween he rae of change of he wage share and he unemploymen inensiy, we can explain he shifs of he original (Keynesian) Phillips curve in a simple way o A an empirical level 1) rae of change of he wage share = f(unemploymen inensiy) o Algebraically 2) wage share = (he money wage/he price level)/produciviy o Combining hese wo gives 3) rae of change of money wages = f(unemploymen inensiy) + inflaion + produciviy growh o The firs wo erms (in boldface) in equaion 3 represen he original Phillips curve, while he oher wo pars represen "shif" facors prediced by he classical approach. o From his poin of view, we can esimae he impac of he shif facors by regressing he excess of he rae of growh of money wages over fied funcions in unemploymen inensiy agains inflaion and produciviy growh 4) [rae of change of money wages - f(unemploymen inensiy) = c 1 + c 2 inflaion + c 3 produciviy growh o I is hen possible o esimae he responsiveness of he rae of change of money wages a any given level of unemploymen inensiy, i.e. he responsiveness of he original Phillips curve, by fiing funcional forms o he wo sable segmens of he classical curve in equaion 1for and using he fied funcions in a regression equaion 4 o esimae he parameers on inflaion and produciviy growh The fied funcions are of he form used by Phillips himself : c y a bx The fied curves are displayed below The corresponding regressions resuls are summarized in he corresponding able. All hree variables are highly significan. 9

10 1.5% Classical Curve: Wage share % change vs. unemploymen inensiy US (HP filered values) 1.0% 1949 Curves were fied o wo "eras" from and Phillips' orginal funcional form: y = a +b*x^c 0.5% 0.0% % % 0% 5% 10% 15% 20% 25% 30% Anwar Shaikh, 2/13 Unemploymen Inensiy [money wage growh - f(unemploymen inensiy)] = c 1 + c 2 inflaion + c 3 produciviy growh Consan Inflaion Produciviy Growh Wha is paricularly sriking is he coefficien on inflaion in he firs period which includes he period of Sagflaion is only slighly below one. This implies ha nominal wages were essenially able o keep up wih inflaion bu los ground wih respec o produciviy growh in he face of seadily rising unemploymen inensiy. Bu in he second era of a weakened labor force, nominal wages los ground relaive o boh inflaion and produciviy in he face of a long cumulaive rise in unemploymen inensiy. 10

11 Dependen Variable: GMWAGEHPXCESSA Mehod: Leas Squares Dae: 03/12/13 Time: 22:56 Sample (adjused): Included observaions: 34 afer adjusmens Variable Coefficien Sd. Error -Saisic Prob. C INFLRATEHP GPRODVTYHP R-squared Mean dependen var Adjused R-squared S.D. dependen var S.E. of regression Akaike info crierion Sum squared resid 2.63E-06 Schwarz crierion Log likelihood Hannan-Quinn crier F-saisic Durbin-Wason sa Prob(F-saisic) Dependen Variable: GMWAGEHPXCESSB Mehod: Leas Squares Dae: 03/12/13 Time: 22:58 Sample (adjused): Included observaions: 18 afer adjusmens Variable Coefficien Sd. Error -Saisic Prob. C INFLRATEHP GPRODVTYHP R-squared Mean dependen var Adjused R-squared S.D. dependen var S.E. of regression Akaike info crierion Sum squared resid 2.82E-06 Schwarz crierion Log likelihood Hannan-Quinn crier F-saisic Durbin-Wason sa Prob(F-saisic) References Goodwin, Richard M "A Growh Cycle," In Socialism, Capialism and Economic Growh, ed. C. H. Feinsein. London: Cambridge Universiy Press. Phillips, A. W "The Relaion beween Unemploymen and he Rae of Change of Money Wage Raes in he Unied Kingdom, " Economica, 25(100), pp