August 12, 2015

Australian upside-down economics

Comment on Bill Mitchell on ‘Australia wages growth drops to a new record low’


You write: “Depending on how we measure inflation, the annual wages growth translates into a small real wage rise or fall. Either way, real wages are growing well below trend productivity growth and Real Unit Labour Costs continue to fall. This means that the gap between real wages growth and productivity growth continues to widen as the wage share in national income falls (and the profit share rises).” (See intro)

This statement contains at least three errors/mistakes. They relate to employment -, distribution -, and profit theory. Intuition tells us that these phenomena are interconnected. The question is how to make this intuition explicit? This can be done only on the basis of a comprehensive macroeconomic theory. Here the problems start because economists have no such theory. This, unfortunately, includes you.

To recall, Keynes's main issue was employment theory and he was quite clear that orthodox employment theory was defective. However, Keynes's succeeded only partly, his employment theory is not general either and misses a crucial point (2012).

The most elementary version of the correct Employment Law is given on Wikimedia AXEC62:
From this equation follows inter alia:
(i) An increase in the expenditure ratio ρE leads to higher employment. An expenditure ratio ρE>1 indicates credit expansion, a ratio ρE<1 indicates credit contraction/debt repayment.
(ii) Increasing investment expenditures I exert a positive influence on employment, a slowdown of growth does the opposite.
(iii) An increase in the factor cost ratio ρF≡W/PR leads to higher employment. This implies that a higher average wage rate W leads to higher employment. This is, of course, contrary to conventional economic wisdom. It is, though, easy to prove that conventional wisdom is a mere Fallacy of Composition (2015). The factor cost ratio formally represents the price mechanism.
(iv) The complete Employment Law is a bit longer and contains in addition profit distribution, public deficit spending, and the trade balance with the rest of the world. As a matter of principle, the structural Employment Law contains only measurable variables and is testable. Hence, matters can be settled once and for all.

Point (i) and (ii) is old Keynesian stuff. Let us focus here alone on the factor cost ratio ρF as defined in (iii). This variable embodies the price mechanism which, however, does not work as Orthodoxy imagines it works. As a matter of fact, overall employment increases if the average wage rate W increases relative to average price P and productivity R. This gives us the lever to improve the employment situation without the drawbacks of the familiar Keynesian measures.

The correct employment theory states that the average wage rate must rise in order to prevent unemployment and deflation. For the relationship between real wage, productivity, profit, and real shares see (2015, Sec. 10)

The core of the employment problem is that the price mechanism does not work as orthodox economics says and this has nothing to do with wage or price stickiness but only with the traditional scientific incompetence of economists.

That much is certain: with a falling average wage rate, Australia is heading for rising unemployment and deflation.

Egmont Kakarot-Handtke

Kakarot-Handtke, E. (2012). Keynes’s Employment Function and the Gratuitous Phillips Curve Disaster. SSRN Working Paper Series, 2130421: 1–19. URL
Kakarot-Handtke, E. (2015). Major Defects of the Market Economy. SSRN Working Paper Series, 2624350: 1–40. URL

For details of the big picture see cross-references Employment.