Wednesday, September 17, 2014

Economics 101: Wages

Employment and wages.

     G. Reisman in one of his blog posts purports to prove that lower wages will result in lower unemployment, but that the standard of living will not fall. See:

     The key claim is:
     A drop in wage rates to the full employment point does not imply any drop in the average worker’s standard of living. That is, it does not imply any reduction in the goods and services he can actually buy — any reduction in his so called real wages — because the elimination of unemployment that the fall in wage rates brings about means more production and a fall in costs of production, both of which mean lower prices.

     Reisman’s theoretical argument is very nice: assuming his premises were true, the conclusion follows. His major assumption is that lower wages will increase employment. His minor assumption is that if wages fall, businesses will hire more workers. But his argument leaves out the human factor. His simplistic theory would work if people weren't people, and if the economic system weren't a human construct.
     What Reisman doesn’t take into account is that the employer will not pass on the lower costs of production any more than he absolutely has to. In other words, he will try to keep as much of the lower cost of production as profit as he possibly can. What’s more, if he can raise his prices because of the higher demand (which brought about his need for more workers in the first place), he will do so. The notion that increased supply lowers prices, and increased demand raises them, ignores the fact that someone has to decide to ask more (or less), and someone else has to decide to pay more (or less). These two decisions are not complementary. More precisely, they are not symmetrical. Marketing experts know this, and do their best to shift the asymmetry in the vendor’s favour.
     In any case, business people don't think in terms of the economic system or economic theories any more than workers do. Reisman assumes that a business will hire more workers just because wages are lower. Why would a business do that?  Businesses think in terms of the work they have available to produce the goods they wish to sell. If a business doesn't need additional workers, it won't hire, even at lower wages (or lower taxes, for that matter). The argument that lower wages result in more employment is I think founded on the same fallacy as "Save more if you buy two!" On the other hand, if the market demand for the goods is there, the business will hire, and may even pay a higher wage in order to get the workers it needs.
     The economic system is the net result of how people see their economic choices, plus the confusing factors of desire, fear, greed, generosity, fashion, obligations, and so on. Abstract economics can capture these factors if it begins with observations of how people actually behave, but it’s fiendishly difficult, because you can’t run experiments in which these factors are controlled. Statistical analysis can give a rough picture of how these factors affect economic choices, and marketing strategies rely on these rough guides. But as spectacular marketing failures and successes have shown, these statistics are more of a guide to placing bets than principles to guide planning.
     Worse, the human factors interfere with each other. Consider price (again). One of our desires is to fulfill our obligations to those people whom we love, or fear, or wish to influence in our favour, or merely to impress. But we also desire to get the most for the least. For each of us, for any given purpose there is a threshold price above which we won’t buy. But there may also be a price below which we won’t buy. That is, the threshold prices depend on why we desire the goods. Casual observation suggests that many people will pay more when they wish to impress someone than when they wish to express their affection. Conversely, people will often ask a lower price from people they wish to impress, or will even give the goods gratis. Why? Because a gift creates an obligation. Capitalist economics, which assumes that the purpose of trade is to amass wealth, doesn’t capture this aspect of pricing. In fact, it can’t capture it, because the Capitalist assumption is that the purpose of economic activity is to increase wealth. (It’s certainly Reisman’s assumption). That wealth beyond subsistence is almost always a tool for achieving other goals is something that Capitalist apologists don’t seem to understand. On top of that, traditional economics assumes that economic decisions are rational.
     Actual observation of business behaviour shows that lowering costs does not result in increased employment unless corresponding lowered prices increase the demand, ie, if the price of goods falls below the threshold price of an additional group of potential buyers. In that case, the producer may well need more workers. However, technology is the spoiler in this neat theoretical argument. Technology may make it possible to lower costs and employment simultaneously. Lower wages cannot compete against more efficient technologies. That lowering wages reduces the buying power of the workers, and so may reduce the market for the employer’s goods, is something that is, as far as I can tell, rarely a consideration. Technology can also obsolete the vendor’s goods, in which case there is no price low enough to prompt a decision to buy. To take the stereotypical example: motor cars made the buggy whip obsolete.
     However, abstract economics built to defend an ideology doesn’t capture these human factors, it is in fact incapable of doing so. If, as Ayn Rand’s Objectivism posits, wealth is the end-purpose of life, then any stance that sees wealth as something to be used for other purposes is meaningless. In a very real sense, using wealth as a means and not an end is unimaginable to adherents of Rand’s ideology. Significantly enough, Reisman states that his musings are in part based on her ideology. This may explain his preferences for diagrams and theorems that leave out merely human factors.

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