Wednesday, December 21, 2011

Sumner and Caplan: Let the People Eat Wage Cuts

     Caplan argues that if the Keynesians knew what they really were about they would be demanding wage cuts. While Scott Sumner has long worried that the extravagant current minimum wage of $7.25 might endanger the recovery, some of Caplan's fellow Market Monetarists aren't so sure-Nick Rowe, Bill Woolsey.

     Woolsely gives this idea some rigorous analysis. He sees much virtue in this idea of a wage cut for America. Or at least Caplan's proposal has a sound macroeconomic foundation.

      "In my view, Caplan's macroeconomic understanding is sound. He is assuming that wages are sticky and prices are flexible. If nominal expenditure on output falls a given amount and then stays constant, prices of output fall immediately. But wages don't fall. This raises real wages, and the profit maximizing level of output falls. Given that lower level of output, the price level falls enough to sell this reduced level of output, but less than in proportion to the drop in nominal expenditure. With constant money wages and a lower price level, real wages have risen. The firms employ less labor in a way that is perfectly consistent with the lower production. It is basic micro-profit maximization."
      However there are some drawbacks:

      "The reduction in wages reduce costs and increases the surpluses in product markets. Firms would like to sell more, but because they cannot reduce prices, their actual sales and production remain at the lower depressed level."

      Not to worry:

      "Assuming the supply of labor has the usual positive slope, then once real wages are low enough, the quantity of labor supplied falls enough to match the lower quantity demanded. If the supply of labor is perfectly inelastic or worse, has a positive slope, then real wages would drop to zero. Of course, that is the region where Malthusian effects--starvation--will reduce population enough so that the quantity of labor supplied matches the demand. In other words, real wages turn perfectly elastic at subsistence in the long run."

    "However, there is another process at work that will tend to clear up the surplus of labor. As real wages fall, it becomes more profitable to utilize more labor intensive production methods. Even assuming output doesn't rise, it will become profitable to use more labor to produce it at lower real wages."

    "If the supply of labor is assumed to be perfectly inelastic, (workers need jobs,) then real wages fall to a level where the quantity of labor demanded matches quantity supplied. Less capital intensive production methods will be used. Labor productivity falls enough so that full employment of labor results from producing the demand-constrained level of output. (Hopefully, the market clears at wages higher than starvation levels.)"

     So at worst subsistence might bring supply back in with demand. Still, Woolsey is no pure libertarian! A true libertarian would never say anything so bleeding heart as "Hopefuly the market clears at wages higher than starvation levels."  A true libertarian wouldn't bat an eyelash as Caplan himself doesn't in asking Keynesians to admit that they should "never want wages to rise."

   Caplan doesn't blanch in speaking for his admiration of Singapore ability to deny Krugman and prove that it is possible to cut wages. Sure but they have an advantage-no elections.

   In American we do. And no GOPer, no matter how remorselessly cool to the needs of the average American, no matter how glacial in their libertarianism can forget that-today in the Wall Street Journalwe have John Taylor writing an editorial that goes as far as claiming that a big part of the supposed "uncertainty" that is interfering with the recovery is due to the uncertainty of having the temporary payroll tax cut. So the House GOP is doing God's Work! Letting the tax cut expire will increase growth!

   I'd love to see the campaign where a Republican-with someone like Caplan or Sumner as his adviser-declares that U.S. workers get way too much and need to have wage discipline imposed on them. He will do this by the first act after he is inaugurated-he will craft the bill to cut the minimum wage to-whatever level Scott Sumner would think it not extravagant, and will give the poor "some skin in the game."

   Cutting the minimum wage could help cut wages, though it would be no panacea-more discipline would be needed. Maybe giving federal workers and mandatory wage cut that keeps up with the cost of inflation every year-so maybe 2.5%; that's far higher than Bernanke and company would ever dream of letting the inflation rate get.

    There's a reason why Caplan won't see this. Singapore is a dictatorship and there's no election to worry about.



  1. 4th line: did you mean "Sumner's" rather than "Caplan's"? Because I don't think Bryan Caplan is a monetarist, of any type.

  2. Yes, I think you're right. I kind of thought of him as being it as I read about him at Bill Woolsey-who does do good analysis.