June 24, 2017

The role of labor and business in a well-organized society

Comment on Sandwichman on ‘Hoxie on “Fixed Group Demand Theory” (the “lump of labor”)’


“In order to tell the politicians and practitioners something about causes and best means, the economist needs the true theory or else he has not much more to offer than educated common sense or his personal opinion.” (Stigum)

Fact is that economists do NOT have the true theory. This holds in particular for employment theory, and the lump of labor theory is a case in point. The lethal methodological blunder of employment theory consists in the Fallacy of Composition, i.e. the illegitimate transfer of truths that hold for one firm/market onto the economy as a whole. What the representative micro-brained economist never understood is that what is true for the molehill is not true for the universe.

Methodological conclusion: the traditional microfoundations approach is as false as one can get and has to be fully replaced by the macrofoundations approach.

The correct macro employment equation#1 is reproduced on Wikimedia.#2 From this objective-structural-systemic relationship follows inter alia:
(i) An increase of the expenditure ratio rhoE leads to higher employment L (the Greek letter rho stands for ratio).
(ii) Increasing investment expenditures I exert a positive influence on employment.
(iii) An increase of the factor cost ratio rhoF=W/PR leads to higher employment.

The complete structural-systemic employment equation is a bit longer and contains in addition the public sector and the foreign trade sector.

Item (i) and (ii) cover the familiar arguments about how effective demand affects employment. Item (iii) embodies the macroeconomic price mechanism. It works such that overall employment L INCREASES if the average wage rate W INCREASES relative to average price P and productivity R and vice versa.

From this follows the proper macroeconomic role of the institution union. To be clear, with the institution union is not meant the different historical variants as they have developed in different countries but an abstract entity that represents all workers/employees. At the other side of the table sits the abstract entity business which represents all firms of the business sector. These two macro-entities are now given the task to establish full employment by setting the average wage rate W and the average price P.

In the present situation (with rhoE and I given), a theoretically enlightened and politically empowered perfectly symmetric macro-institution would set the parameters as follows: price increase zero and wage increase greater than productivity increase. This increases employment for a while. Afterwards: price increase zero and wage increase equal to productivity increase. This stabilizes the economy at full employment.

With the historically given institutional setting one gets this chain of events: insufficient wage increase - employment L down/price P down - asymmetric weakening of the labor side - insufficient wage increase - employment down/price down - and so on. Correct macrofounded economic theory tells us that an economy with crappy institutions gets eventually caught in a spiral of deflation and falling employment. And that is exactly what can be observed.

Obviously, it is mentally retarded economists who ― after 200+ years still stuck with the lump of labor theory ― bear the intellectual responsibility for the economic mess.

Egmont Kakarot-Handtke

#1 For details see ‘NAIRU, wage-led growth, and Samuelson’s Dyscalculia’  and ‘Keynes’ Employment Function and the Gratuitous Phillips Curve Disaster
#2 Wikimedia