Arnold Kling  

Productivity and Unemployment

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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?


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COMMENTS (8 to date)
Tom Dougherty writes:

"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?"

That assumes that people are fooled by a monetary illusion. Anticipated inflation due to expansionary monetary policy would be taken in consideration in contract negotiations. Unions, for example, are sophisticated enough to know that it is rising real wages that matter not merely rising nominal wages.

If the Fed engaged in "jerky" monetary policy in order to generate unanticipated inflation, then it might have some short term impact on real wages, but there would have to be a permanent monetary illusion to have lasting effect. Also, the damaging effects of "jerky" monetary policy on the economy would probably offset any positive employment benefits from unanticipated inflation.

In addition, money inflation in the form of increased credits to business in excess of actual savings would cause distortions in the intertemporal allocation of resources including labor resources. Later readjustments in the economy to previous distortions would a source of unemployment.

Expansionary monetary policy, in my opinion, is a bad policy option to cure unemployment.

Lawrance George Lux writes:

Kasriel has a sound argument, but expansionary monetary policy will not expand employment; until such time as Real Wages decrease. Marginal Productivity must increase to justify Real Wage increase, nominal Wage increases will not induce employment. Industry will not hire until there is a shift in their Real Production Costs downward.
lgl

Mcwop writes:

Seems to me Kasriel has not addressed supply of goods that wages are spent on. There is a glut of products and services (excluding energy) competing for wage dollars. So long as that supply remains big, then I can't see inflation being a factor.

Matt Young writes:

Neglected is the short term effects of the tax cut in an economic contraction. Wages that yield higher take home pay are worth more and the tendency is to drop workers in place of more output from existing workers at higher salary. There is the entitlement tax cost to figure, when an existing worker produces more without the large additional payroll tax that an additional worker would bring.

I think that what we are seeing is the effect of government expansion raising the overhead of addition work force. To stay afloat when a company is in effective competition with an expanding government, the only solution is increased productivity. Least productive industry should be dropping out and moving overseas.

David Thomson writes:

I also suspect that employers think twice about hiring new workers because of the possible legal ramifications. There are just too many ways of getting sued. This is especially true regarding “minorities.” I personally know of a number of instances when employers walked on egg shells when it came to justifiably firing a minority worker. The mere hint of a law suit often scares the hell out of them.

Are there are any empirical data to support my theory? I wonder if I’m merely offering questionable anecdotal evidence---or is the problem far worse than many would like to admit.

Lawrance George Lux writes:

David and Matt's arguments are both valid, and must enter into the equation with some effective weight. David brings up the implication that Employers use Downsizing to get rid of less productive employees, without having to meet criterea for normal firing; especially in the case of Minorities. The glut of Supply, though, is a question of real Production Costs, where more intensive (most expensive) marketing is required to maintain Sales. lgl

Kevin writes:

The legal environment especially with regard to liability gets very little play as a factor holding back the expansion of employment.

It's easy to overlook as it is hard to quantify, unlike taxes whose affects on any given transaction are measurable.

I think the legal environment is often overlooked as a method to induce emplyment growth.

David Thomson writes:

Most businesses are modest successes. Even one lawsuit, however frivolous, is sometimes enough to serious damage a company. You do not need to be found guilty in a court of law! The cost of litigation alone is enough to scare you. What about the larger companies? They are often afraid of the “bad publicity.”

The trial lawyers threaten our nation’s economic vitality. Regrettably, the liberal media essentially ignore these scoundrels. We cannot allow this nonsense to get any worse.

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