The market for oranges, er, labor

Posted: 17 July 2013 in Uncategorized
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In neoclassical economics, everything comes down to flexible markets. And in neoclassical macroeconomics, everything comes down to the labor market, which should follow the rules of any other market, like the market for oranges.* Hence, the neoclassical lamentation that wages are downwardly rigid.**

As neoclassical economists understand it, if only nominal wages would decline in the face of significant unemployment, an equilibrium between the quantity supplied of and the quantity demanded of labor would be achieved and unemployment itself would cease to exist (because the number of people looking for work would exactly equal the number of jobs being offered by employers). In such a neoclassical world, there aren’t any financial bubbles and crashes, no problems of aggregate demand, no decisions by employers not to hire additional workers even with hoards of cash on hand. It’s all about the inflexibility of the labor market.***

The latest report from the Federal Reserve Bank of San Francisco tells exactly this story. For reasons the authors can’t seem to fathom, employers were hesitant to reduce wages and workers reluctant to accept wage cuts in the midst of growing unemployment. (What an idea! Employers don’t want to risk losing the workers they have while the only alternative for workers who have managed to keep their jobs is to do what they can to resist wage cuts.) Not only did that wage rigidity cause high levels of unemployment; in their view, it created “a significant buildup of pent-up wage cuts” that “will probably continue to slow wage growth long after the unemployment rate has returned to more normal levels.”

What they obtain, then, is their second-best option: although nominal wages didn’t in the end fall, the slow growth in nominal wages along with creeping inflation has meant that real wages for different groups of workers have either stagnated or declined. Their hope, then, is that “slower wage growth also means businesses are able to hire more workers, which stimulates the demand for labor and pushes the unemployment rate down further.”

That’s how the neoclassical model is supposed to work: squeezing workers in order to induce employers to hire more labor and thus to reduce unemployment—just like the market for oranges. The presumption, of course, is that private employers will in fact create more jobs and hire more workers and not use their increased profits for some other purpose, such as hoarding cash, buying back stock, rewarding CEOs, investing in new labor-saving technologies, or participating in the financial casino.

Alternatively, we might consider keeping the market for oranges and abolishing the market for labor entirely.


*The analogy to the market for oranges comes from Rajiv Sethi:

What I cannot understand is why people of considerable intelligence persist in conducting a partial equilibrium Walrasian analysis of the labor market, as if we were dealing with the market for oranges. Please stop it.

**And, truth be told, it’s not just neoclassical economists. I once had a dean and a department chair who actually wanted to decrease the salaries of some faculty members who, in their view, were not productive enough. They, too, lamented that faculty salaries were downwardly rigid. They opted, instead, to increase salaries at less than the rate of inflation, which of course resulted in a decrease in real salaries. That achieved the punishment they wanted, only more slowly than they desired.

***Keynesian economists, of course, have a different view. Their argument is that wage flexibility would actually make matters worse, because a fall in nominal wages would lead to deflation and a resulting downward spiral of prices and aggregate demand (based on declining consumption and investment).

  1. […] known for a long time (as I’ve written about before, e.g., here, here, and here) that neoclassical economists blame workers and their downwardly rigid wages for creating and […]

  2. […] Ah, if only the labor market were like the market for oranges! […]

  3. […] Ah, if only the labor market were like the market for oranges! […]

  4. […] inherent in the capitalist commodification of labor. Unlike other commodities, such as oranges, labor is both treated as a homogeneous quantity (as labor power, the ability to work) that is […]

  5. […] of supply and demand—at both the micro and macro levels: supply and demand in the market for oranges or labor (which determine the equilibrium price and quantity), as well as aggregate supply and demand for […]

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