The Importance of Money

Essays in Domestic Macroeconomics, 1949-1999

H.W. Arndt

• Publisher: Routledge
• Year: 2017
• Topic: Social Sciences
• eBook ISBN:
  9781351762502
• Subtopic: Sociology
• Index: Social Sciences

This title was first published in 2001. A collection of essays written by H.W. Arndt, over a 50 year period, that cover a broad range of his work, from analytical issues in monetary and fiscal theory to political economy. The earlier essays should appeal to those interested in the history of economic thought whilst the more recent essays deal with issues such as economic globalization.

Part I
THEORY

1

Keynes’s Theory of Wages

This essay formed part of a review article on The New Economics: Keynes’s Influence on Theory and Public Policy, edited by Seymour E. Harris (Knopf 1947). The essay drew on six chapters of the book to sum up the prolonged discussion of the theory of wages implicit in Keynes’s General Theory.

Originally published as “Recent Discussion of Keynes’s Theory of Wages: A Review”, in the Economic Record, December 1949.

In a symposium on “Keynes’ Influence on Theory and Public Policy”¹ which was published in the United States in 1947 both to mark the occasion of the tenth anniversary of the General Theory and as a Memorial to Lord Keynes, one aspect of Keynesian theory receives, apparently by accident rather than design, an unexpectedly large amount of attention. Of the twenty-five or so new essays of substance contained in the volume, at least six deal wholly or in part with Keynes’s theory of wages.² These six essays do not in themselves form a well-arranged symposium. But if one takes the trouble to piece the arguments together, one finds in them a useful starting point for a summing-up of the prolonged discussion which this part of the General Theory provoked.

The task which Keynes set himself in his treatment of wage theory in the General Theory was to refute the implication of classical theory that general wage deflation was an appropriate remedy for general unemployment. His special problem was to perform this task while retaining one of the basic assumptions of classical theory, the assumption that employment is inversely related to the level of real wages (from which it follows that unemployment is involuntary only if labour is willing to accept work at a lower real wage). His solution was expressed in two propositions. First, wage deflation is difficult because labour resists cuts in money wages even though it would be prepared to accept an equivalent reduction in real wages through rising prices (and would, therefore, qualify as “involuntarily unemployed” in the classical sense). Secondly, even if labour were willing to accept reductions in money wages, this would not increase employment since prices would fall proportionately, leaving real wages (and therefore output and employment) unchanged.

Both propositions and particularly the more far-reaching second one, were qualified by Keynes himself in the General Theory and have been subject to criticism ever since. Much of the discussion in these essays summarises and elaborates these qualifications and criticisms.

Keynes’s own qualifications of the second proposition related to four main points. (a) The argument applies only in a closed economy. In an open economy, a reduction in money wages will improve the balance of trade and thus increase employment, although these effects may be nullified by similar wage reductions (or tariffs) abroad or by changes in exchange rates. (b) A general fall in money wages and prices, by releasing cash balances from the transaction sphere, may reduce the rate of interest and thus stimulate investment. But this effect, on which Keynes—one cannot help feeling, with his tongue in his cheek—placed chief emphasis, is likely to be nullified either by the “liquidity trap” (at low interest rates) or by the tendency for investment to be interest-inelastic. At best, “monetary management by the Trade Unions” would be a singularly clumsy solution. (c) A reduction in money wage rates may have a favourable effect on business confidence. But if the general thesis is correct, any additional investment stimulated by the favourable impression made by cost reductions is bound to lead to losses, even if the wage cut is expected to be once-for-all and permanent. If, as is more likely because of resistance of labour, it is merely one stage in the process of a “sagging wage level” the effect will certainly be unfavourable. (d) Lastly, Keynes considered possible effects on the propensity to consume, through redistribution of income from wage-earners to other prime factors or from entrepreneurs to rentiers. The second of these Keynes thought doubtful and unimportant, while the effects of the first would be unfavourable.

At least four of the six contributors to the “symposium” on Keynes’s wage theory seem prepared to follow Keynes up to this point. The chief exception is Professor Haberler who is his generally critical essay makes a root-and-branch attack on Keynes’s position.³ Professor Haberler is primarily concerned to demonstrate that Keynes’s theory of under-employment equilibrium depends on his postulate of (downward) rigidity of money wages. He has little difficulty in showing that a completely unstable Wicksellian system could hardly be said to be in underemployment equilibrium; though, as Professor Hansen points out, that is hardly relevant to Keynes’s main problem. Professor Haberler also advances two arguments against the thesis that employment is independent of the level of money wages. The first, to the effect that a continuous rise in the value of money would increase the real value of cash balances held in the form of gold and may thus raise the consumption function, is not taken very seriously by himself. The second would seem to be a mere reassertion of the classical position against Keynes. No Keynesian denies that “a reduction in the cost of certain consumption or investment goods may well stimulate demand for them”; but when Professor Haberler adds “and for consumption and investment as a whole” he surely begs the central question. The argument which he advances in support of this proposition is little more convincing. “Assume that the elasticity of demand for some of these things, and therefore incidentally for labour, is unity. Then the wage bill remains unchanged and there are no adverse effects through a fall of consumption demand of the workers. Then employment will clearly rise” (p. 172). This assumes that the additional output (investment) will generate equivalent additional income before cost reduction has any effect on consumption; it is merely one hopeful version of the argument that cost reduction will increase business confidence, the marginal efficiency of capital and investment. Professor Haberler’s further point that the additional output must be interpreted as due to a rise in the marginal efficiency of capital or the consumption function, according as to whether the newly produced goods are consumption or investment goods, is even more difficult to accept. Professor Haberler’s oblique claim, later in the essay (p. 175), to have shown that Keynes was unable to reconcile “a competitive system (flexible money wages) with the existence of unemployment” can hardly be substantiated.

Even those, however, who broadly accept Keynes’s argument so far, and Dr Tobin and Dr Smithies in particular, insist that it is acceptable only on the special assumptions on which the whole model of the General Theory was worked out, especially the short-period assumption of constant techniques and equipment, the assumption that consumption is entirely a function of real income, the assumption of perfect competition, the neglect of variable factors other than labour, of changes in relative prices and wages, and of the role of Government, and finally, the predominantly static character of the model. Their further elaboration of the argument proceeds primarily by an analysis of the consequences of relaxing these assumptions.

Dr Tobin is led by his analysis to add two further qualifications to Keynes’s thesis. First, Keynes’s neglect of prime factors other than labour led him to ignore the possibility of substitution of labour for other factors in the event of a reduction in money wages. Substitution will take place, and thus increase employment, unless the other prime factors are totally immune to the “money illusion” which, according to Keynes, is a characteristic of labour. Dr Tobin’s subtly developed argument is unexceptionable. One may yet doubt whether the technical obstacles to substitution in the short period in most modern industries do not deprive this qualification of any very serious significance.

Secondly, Keynes’s definition of the consumption function in real terms led him to ignore the possible effects of falling money incomes (with stable real incomes) on the propensity to consume. Dr Tobin argues that these effects may be expected to be favourable to employment (a) because, if wage-earners in their capacity as consumers are subject to the same money illusion as afflicts them in their capacity as sellers of labour, a decline in their money incomes should make them feel worse off and thus tend to raise their propensity to consume; (b) because, if consumers’ price expectations are inelastic, a rise in the value of money will lead them to anticipate purchases; while, if they are not, the increase in the real value of past savings will tend to depress wage-earners’ propensity to save. Here again, the net effect is probably (though not so obviously)⁴ in the direction which Dr Tobin indicates; but it is hard to believe that this effect would be of practical importance.

As against these two favourable effects of wage deflation, Dr Tobin points out that, once the assumption of pure competition (or at least a constant degree of monopoly) is abandoned, price rigidity may lead to a redistribution of income in favour of (monopoly) profits which would have an unfavourable effect on the consumption function and employment.

Dr Smithies, incidentally to his main argument, adds two further points. First, if the role of Government is taken into account, a general fall in money incomes will automatically reduce the yield of progressive income tax and, since some parts of Government expenditure are fixed in money terms, is likely to bring about a budget deficit with favourable effects on effective demand. Dr Smithies, however, would probably agree that this effect is likely to be more significant in the reverse case of wage inflation (which is the context in which he raises the point) than in the case of wage deflation with which we are here concerned. Secondly, changes in relative wages between different industries which Keynes’s aggregate analysis ignored may have important effects on the propensity to consume though, in the nature of the case, their direction cannot be determined in advance.⁵

It is doubtful whether analysis of this often analysed question can fruitfully be carried further than it has been in these essays. What then are we to conclude? On the one hand, there is no question that the bold thesis of Keynes’ formal system that real income and employment are independent of the level of money wages is untenable even in a closed economy. There is a large number of ways in which changes in money wages can, and are likely to, bring with them consequential changes in real wages, real income and employment. What cannot be said to have been shown by Keynes’s critics is that these effects will necessarily yield a negative correlation between money wages and employment, or, if they do, that they will be sufficiently certain and significant to justify a policy of wage reduction in a depression. As a theoretical foundation for the “presumption against wage-cutting” Keynes’s simplification would seem to emerge remarkably unscathed from the ordeal.

What of the other part of Keynes’s wage theory, the proposition that “labour stipulates (within limits) for a money-wage rather than a real wage”?⁶ This is a question of fact, not of economic analysis; a matter for empirical verification rather than for theoretical reasoning. The contributors to the symposium seem, on the whole, agreed that Keynes’s hunch was sound.⁷ As Dr Tobin puts it, “his denial of the ‘homogeneity postulate’ for the labour supply function constitutes a belated theoretical recognition of the facts of economic life” (p. 581). Here, too, however, the symposium clarifies a number of issues. It also stimulates one or two doubts about the soundness of the traditional formulation of the...

Table of contents

• Cover
• Half title
• Dedication
• Title Page
• Copyright Page
• Table of Contents
• Preface
• Part I Theory
• Part II Policy
• Part III National Accounts and External Relations
• Part IV Political Economy
• Index of Names