In The Labor Market Puzzle, I sketched a one-sector model in which marginal productivity was falling as average productivity was rising. This would account for a drop in employment along with higher average productivity.
Paul Kasriel has a more extended description of this model. It includes basic diagrams.
What do you suppose has been happening to the growth in real wages in recent years? They have been soaring. As shown in Chart 2, on a 3-year moving average basis, annual growth in real wages hit a postwar high of 4.3% in 2000. Subsequently, growth slowed to 3.1% in 2002. But even at this slower rate, real wage growth was high relative to most of the postwar era. This recent strong growth in real wage rates is consistent with Case 3. Namely, Corporate America has been laying off folks because it is just unprofitable to keep them on the payrolls.
For Discussion. Kasriel argues that if real wages are too high relative to the marginal product of labor, then expansionary monetary policy will increase inflation. But would that also expand employment in his sticky-nominal-wage model?