March 8, 2016

The labor market and the consistent failure of 101-economics

Comment on ‘What’s Up with Wage Growth?’

Blog-Reference and Blog-Reference and Blog-Reference on Mar 9

Even if it were true that a falling wage rate increases employment in a sub-sector of the labor market, it would be a blatant fallacy of composition to generalize this inverse relationship for the economy as a whole.

To cut a meticulous formal derivation short, the most elementary version of the correct employment equation for the economy as whole is given here.

From this equation follows:
(i) An increase of the expenditure ratio rhoE leads to higher employment (the letter rho stands for ratio). An expenditure ratio rhoE>1 indicates credit expansion, a ratio rhoE<1 indicates credit contraction/debt repayment of private households.
(ii) Increasing investment expenditures I exert a positive influence on employment, a slowdown of growth does the opposite.
(iii) An increase of the factor cost ratio rhoF=W/PR leads to higher employment.

The complete employment equation is a bit longer and contains in addition profit distribution, public deficit spending, and import/export. The equation contains only measurable variables and is testable.

Item (i) and (ii) is familiar since Keynes. What is missing in the Keynesian employment multiplier, though, is the ratio rhoF as defined in (iii). This variable embodies the price mechanism. It works such that overall employment INCREASES if the AVERAGE wage rate W increases relative to average price P and productivity R.

The employment equation says that an increase of investment expenditure or deficit spending increases employment. The multiplier, though, is different from Keynes’s flawed multiplier (2012). The crucial difference consists in rhoF.

The fact of the matter is, that an increase of productivity counteracts the expansive effect of investment or household deficit spending. The same holds for price increases.

To increase overall employment requires an increase of rhoF and this means that the expansion must be wage driven, i.e., the increase of the wage rate must be such that it OVERCOMPENSATES the retrograde employment effects of productivity and price increases.

All this is clearly beyond the horizon and the intuition of Econ 101 economists (2014).

Egmont Kakarot-Handtke

Kakarot-Handtke, E. (2012). Keynes’s Employment Function and the Gratuitous Phillips Curve Desaster. SSRN Working Paper Series, 2130421: 1–19. URL
Kakarot-Handtke, E. (2014). Towards Full Employment Through Applied Algebra and Counter-Intuitive Behavior. SSRN Working Paper Series, 2456184: 1–25. URL

Related 'Have data, lack theory' and 'Austerity and the utter scientific ignorance of economists'.
For details of the big picture see cross-references Employment.


COMMENT on jonny bakho on Mar 9 and NOTE on 'On the Economy' blog

For the correct/testable Phillips Curve see Sec. 7 of ‘Keynes' Employment Function and the Gratuitous Phillips Curve Disaster’.


REPLY to mulp on Mar 10

W sub i denotes the average wage rate in the investment good sector and W sub c denotes the average wage rate in the consumption good sector. Both are NOT equal but have here been set equal in order to simplify the formula and to focus the argument.

For more details see Sec. 4 of ‘Essentials of Constructive Heterodoxy: Employment’.