Neo­clas­si­cal Wage Restraint Mad­ness

Flattr this!

It had to hap­pen: neo­clas­si­cal econ­o­mists are now advis­ing that the antic­i­pated reces­sion will be much milder if only work­ers would accept wage cuts.

When I saw this cri­sis was immi­nent in Decem­ber 2005, one major fac­tor that moti­vated me to go pub­lic with my analy­sis was the cer­tainty that, when the cri­sis hit, neo­clas­si­cal econ­o­mists would either blame it on wages being too high (”the abo­li­tion of Work Choices caused the Depres­sion!”), or would sug­gest that wages should be cut to reduce the imbal­ance between the sup­ply of and demand for labour.

The cri­sis hit too early, and was far too global, for the abo­li­tion of Work Choices to “cop it sweet”. But yes­ter­day, in an OpEd in the Syd­ney Morn­ing Her­ald, Mark Davis reported that “Eco­nomic mod­ellers” had con­cluded that 1% cut in the rate of growth of wages will boost employ­ment growth by half a per­cent:

Eco­nomic mod­ellers reckon cut­ting aggre­gate wages growth by a per­cent­age point boosts employ­ment growth by half a per­cent­age point. Some think it boosts employ­ment more. In the cur­rent envi­ron­ment that could save more than 50,000 jobs.

Let’s extrap­o­late a bit here: given the stan­dard increases in pro­duc­tiv­ity and pop­u­la­tion, employ­ment growth of about 2.5 per­cent is needed to keep the unem­ploy­ment rate con­stant. So “eco­nomic mod­ellers” (i.e. neo­clas­si­cal econ­o­mists) reckon that a 5 per­cent cut in the rate of wages growth would trans­late into a 2.5 per­cent boost to the rate of growth of employ­ment.

Since those same mod­ellers are also antic­i­pat­ing growth slow­ing to about zero (but not neg­a­tive of course–that would mean a reces­sion, and as we all know, Aus­tralia is spe­cial and won’t suf­fer one), all we need to do to make sure Aus­tralia lucks out with both no reces­sion AND no rise in unem­ploy­ment is to … cut wages by one per­cent (since the cur­rent rate of growth of wages is close to 4 per­cent).

Non­sense. This is stan­dard neo­clas­si­cal eco­nomic think­ing that if one low­ers the price for a prod­uct (in this case, labour), more of it will be demanded. This think­ing has some rel­e­vance when the mar­ket in ques­tion is that for, say, apples (though the basic “sup­ply and demand” math­e­mat­ics is false). But when the mar­ket you are talk­ing about is Labour, even in the absence of debt, the think­ing is only half baked.

In an indi­rect way, the income that apple pro­duc­ers earn from sell­ing apples is a com­po­nent of the demand for apples–but the scale of that demand is triv­ial. Equally, in an indi­rect way, the income that work­ers earn from sell­ing their labour is a com­po­nent of the demand for labour–and here the scale of that demand is no longer triv­ial.

Reduc­ing real wages–and thus reduc­ing the capac­ity of work­ers to pur­chase out­put–may boost prof­its in real terms by skew­ing the dis­tri­b­u­tion of real income fur­ther in favour of cap­i­tal. But it will undoubt­edly impact on some cap­i­tal­ists badly–not mak­ers of sports cars per­haps, but cer­tainly those who run super­mar­ket chains–and the aggre­gate effect is a toss-up.

But as Keynes argued in the Gen­eral The­ory, a cut in money wages is highly unlikely to affect real wages in the same direc­tion. Since labour is an input to the pro­duc­tion of lit­er­ally every­thing, a gen­eral cut in money wages is likely to lead to a gen­eral fall in prices as well. Again, whether wages will fall more or less than prices becomes a toss-up.

Here Keynes made one of the few acknowl­edge­ments of what I regard as the real cause of the Great Depression–the unwind­ing of the debt bub­ble built up dur­ing the spec­u­la­tive mania of the 1920s (an issue that Irv­ing Fisher was far bet­ter on with his Debt Defla­tion The­ory of Great Depres­sions). Since Keynes accepted the neo­clas­si­cal notion about real wages and the demand for labour, he agreed with his con­ser­v­a­tive oppo­nents that real wages had to be cut to increase employ­ment. But he said there were two ways to attempt achieve this–directly by cut­ting money wages, or indi­rectly by caus­ing infla­tion.

The for­mer, he argued, would largely lead to fur­ther defla­tion, which “increases pro­por­tion­ately the bur­den of debt; whereas the method of pro­duc­ing the same result by increas­ing the quan­tity of money … has the oppo­site effect. Hav­ing regard to the exces­sive bur­den of many types of debt, it can only be an inex­pe­ri­enced per­son who would pre­fer the for­mer.”

An “inex­pe­ri­enced per­son” indeed. Keynes used sev­eral epi­thets to refer to his intel­lec­tual oppo­nents in this sec­tion of the Gen­eral The­ory: “unjust per­son”, “fool­ish per­son”, “inex­pe­ri­enced per­son”. In every case, he meant the neo­clas­si­cal econ­o­mists of his day. Now their great-grand­chil­dren are repeat­ing the same fool­ish, inex­pe­ri­enced and unjust mantras today.

My let­ter cri­tiquing this neo­clas­si­cal non­sense was pub­lished in today’s Syd­ney Morn­ing Her­ald (Jan­u­ary 3rd 2009):

Giv­ing our pay pack­ets a shave would cost jobs

Jan­u­ary 3, 2009

Mark Davis’s sug­ges­tion that wage restraint would reduce the rise in unem­ploy­ment this year is non­sense (“Give your pay packet a shave and help save jobs”, Jan­u­ary 2).

Unem­ploy­ment will rise in 2009 not because work­ers were paid too much in 2008 (or ear­lier), but because house­holds and busi­nesses took on too much debt dur­ing a spec­u­la­tive bub­ble that has now burst. In the after­math, sane peo­ple attempt to reduce their debt but that means a reduc­tion in spend­ing, which causes unem­ploy­ment to rise.

To reduce that rise in unem­ploy­ment, you have to tackle the root cause by mak­ing it eas­ier to repay debt. Reduc­ing wages — even cut­ting the rate of growth of wages — will make that harder, not eas­ier, espe­cially since many of those who are trapped by debt are work­ers.

That Davis’s argu­ment is sup­ported by eco­nomic mod­ellers con­firms that the case is poorly thought out. These mod­ellers com­pletely failed to antic­i­pate the global finan­cial cri­sis because their neo­clas­si­cal mod­els ignored the role of debt.

John May­nard Keynes dis­cussed sim­i­larly naive think­ing dur­ing the Great Depres­sion. Though he agreed that real wages should fall, he said there were two avenues to achiev­ing it: caus­ing infla­tion, or reduc­ing wages.

Keynes argued that a fall in money wages would sim­ply cause prices to fall fur­ther, adding to the defla­tion that made the Depres­sion so intractable.

He con­cluded that given the exces­sive bur­den of debt and the fact that falling prices would make debt even harder to repay, “it can only be a fool­ish per­son who would pre­fer a flex­i­ble wage pol­icy to a flex­i­ble money pol­icy”.

Indeed.

About Steve Keen

I am Professor of Economics and Head of Economics, History and Politics at Kingston University London, and a long time critic of conventional economic thought. As well as attacking mainstream thought in Debunking Economics, I am also developing an alternative dynamic approach to economic modelling. The key issue I am tackling here is the prospect for a debt-deflation on the back of the enormous private debts accumulated globally, and our very low rate of inflation.
Bookmark the permalink.
  • tom­myt

    Thank you Steve for your com­ments on “wages”.

    I was wait­ing for the inevitable to hap­pen i.e. the polit­i­cal response to the ‘reces­sion they didn’t see’ appears to be “cut wages” so we can relieve unem­ploy­ment! It reminds me of the fraser years and the “razor gangs”! It was then the ‘mantra’ of the day! I guess from your analy­sis steve, I can under­stand why!Now we will do it all again I sus­pect and some polit­i­cal par­ties will be preach­ing it very soon to your t.v. screen in 2009! just watch and see as the unem­ploy­ment fig­ures climb again,
    the ‘pol­lie’ will look seri­ously into the cam­era and declare to all of us inno­cents ” If we in this coun­try are to get back to a lower unem­ploy­ment rate, we must look at low­er­ing our wages costs, employ­ers will employ more if the cost of that labour is lower and we can get the econ­omy mov­ing again..” Just wait fel­low blog­gers, be afraid, be very afraid, it is com­ing!!

  • clive

    Excel­lent Steve. If any­thing should be cut, it’s the price of some of the com­modi­ties con­nected with the build­ing indus­try they have been spi­ralling out of con­trol since the bub­ble began. We have been told time and time again that prices for steel (iron ore) cop­per etc. were just going through the roof we have been forced to con­tin­u­ally pay rises on those prod­ucts with increases nearly every month. Well the price of cop­per, iron ore, zinc etc. have fallen through the floor.…lets see some down­ward spi­ralling from man­u­fac­tur­ers — min­ers or is it just a one way thing … busi­ness makes the prof­its the com­mu­nity at large pays the losses. Their prod­ucts are not priced on scarcity they a priced on what the mar­ket can stand.…just plain old exploita­tion. They have made their big killing so now they want the work­ers to take on their losses. 

    In 2005 alone, the price of cop­per rose almost A$2000 per tonne
    against the sell price of the cop­per based prod­ucts
    over the course of the year.’ 

    http://www.neca.asn.au/filelibrary/VIC/The_Price_of_Copper.pdf

  • BrightSpark1

    Hello Steve Happy New Year

    You are too kind to these neo-clas­si­cal peo­ple. Your state­ment “That Davis’s argu­ment is sup­ported by eco­nomic mod­ellers con­firms that the case is poorly thought out”, could have been far more caus­tic by adding “and their mod­els lack math­e­mat­i­cal method and rigor”.

    As you have always said these peo­ple lack suf­fi­cient math­e­mat­i­cal knowl­edge to cre­ate such “mod­els”. Worst of all they con­tinue to kid them­selves and the MSM

    I think we should call neo-clas­si­cal eco­nom­ics ESP “Eco­nom­ics in the Sand Pit”.

    Please keep up the good work.

    Cheers

  • Bull­turned­bear

    Hi Steve and all. Happy new year.

    Wages nom­i­nal and real will fall over the next few years. I agree it won’t increase employ­ment. Wages will fall because unem­ploy­ment will rise. As unem­ploy­ment rises, work­ers will be will­ing to accept less and employ­ers will know that work­ers are des­per­ate and offer them less. Pric­ing is always set by demand.

  • al49er

    In a pre­vi­ous post I endeav­oured to high­light one of my points in rela­tion to view­ing the Global Finan­cial Cri­sis from a ‘soci­o­log­i­cal per­spec­tive’, by ask­ing “when was the last time you met a clerk?” 

    Most peo­ple post­ing to this site (very much self included) are great admir­ers of Steve and his work, espe­cially the way in which he can make com­plex con­cepts com­pre­hen­si­ble to the aver­age ‘bloke/sheila’ and the fact that he fore­saw this cri­sis, as far back as Decem­ber 2006 and has been lay­ing out it’s progress in chap­ter and verse since that time. And now we await the devel­op­ment and pre­sen­ta­tion of his solu­tions and mod­els e.g. the cur­rent ‘pure credit econ­omy’ model for sta­ble world mon­e­tary sys­tems and economies.

    Notwith­stand­ing, I am becom­ing more and more con­vinced that it is not pos­si­ble, or per­haps ‘suf­fi­cient’ is a bet­ter word,
    to develop or prof­fer eco­nomic and finan­cial sys­tems to under­pin the orderly oper­a­tion and con­duct of world economies, com­merce and trade (and thereby social devel­op­ment) with­out accom­pa­ny­ing notes on the rel­e­vant soci­o­log­i­cal reac­tions, atti­tudes and ram­i­fi­ca­tions.

    My par­tic­u­lar point in say­ing this is, that one of the ear­li­est indi­ca­tors that gave rise to my ques­tion­ing ‘what was hap­pen­ing’ in the world eco­nomic and finan­cial sys­tems, was the term “futures trad­ing”.
    Like most of the func­tions and ter­mi­nolo­gies, I’m still not fully famil­iar, but get­ting a bet­ter insight as things come ‘tum­bling down’. But it just seemed to me that ‘futures trad­ing’ had more in com­mon with gam­bling than it did, pro­duc­tive com­merce.

    Then grad­u­ally over 20 to 25 years (I don’t know the time­frame could be shorter or longer) it just appeared to me that “the nature of work was chang­ing”.
    Now of course part of that was obvi­ous and rea­son­able, to the extent that tech­nol­ogy has assisted mak­ing things sim­pler and more effi­cient and effec­tive and requir­ing less ‘pure man­power’. Like the dig­ging of a hole, unload­ing cargo ship, post­ing accounts etc etc. (make your own list)

    At the same time how­ever, it also occurred to me that this period coin­cided with a very impor­tant change in people’s views and con­duct, in par­tic­u­lar how they came to regard the ‘pur­suit of work’ and their expec­ta­tions in respect to all asso­ci­ated ele­ments (per­for­mance, respon­si­bil­i­ties, pro­mo­tion etc), and prob­a­bly remu­ner­a­tion above all. 

    It used to be of course that one got a posi­tion (through prior learn­ing, advanced study or appren­tice­ship for exam­ple), hope­fully in a cho­sen or desired field, then ini­tially set about estab­lish­ing them­selves in the role, the organ­i­sa­tion, the work­ing envi­ron­ment and amongst their peers. Then there was a period of ‘ of those par­tic­u­lar duties and respon­si­bil­i­ties (and that’s how things were seen ‘duties & respon­si­bil­i­ties’ etc)performance’and even ‘com­mit­ment to the com­pany’.
    Then over time, based on their per­for­mance or regret­tably their con­nec­tions, favouritism or whole range of other cri­te­ria, they pro­gressed, work­ing their way “up the lad­der” in that work­place, organ­i­sa­tion or field, or even shift­ing to another field, requir­ing their improved skills, knowl­edge and abil­i­ties.

    Grad­u­ally how­ever in my obser­va­tion all of this began to change; the atti­tudes, expec­ta­tions, prac­tices, and the social and moral com­pass.
    Peo­ple weren’t going to wait a life­time to have what they saw as “there needs and expec­ta­tions and indeed dues” ful­filled.

    Sud­denly we heard descrip­tors like “the upwardly mobile”, “peo­ple going places in a hurry”, “the win­ners” (who were no longer indi­vid­u­als ful­fill­ing the first sec­ond and third places in the foot race). 

    This is when the ‘clerks’ began to dis­ap­pear and we got ‘admin­is­tra­tion man­agers’, ‘account direc­tors’; the ‘per­son­nel man­ager’ grad­u­ally became the direc­tor of ‘human resources’. 

    It might be eas­ier to describe the senior posi­tions of local coun­cil where I live. No ‘depart­men­tal man­agers’ here; we have the Chief Exec­u­tive then the fol­low­ing posi­tions all with the word ‘Direc­tor’ before them.
    The Direc­tor ‘Organ­i­sa­tion Sup­port’,
    ‘City Strat­egy’, ‘Plan­ning & Devel­op­ment’ (half under­stand­able that one !),
    ‘Com­mu­nity well-being’,
    ‘Pre­sen­ta­tion & Assets’, and the doozy of them all, “The Direc­tor of City Futures”.

    You get my drift and no doubt have myr­iad clas­sic exam­ples of your own.

    And of course titles like that war­ranted an appro­pri­ate ‘salary’. No! ’ remu­ner­a­tion pack­age’ car, credit card, phone etc etc and of course when you’re fin­ished doing the job you have been paid to do, there still needed to be the annual ‘bonus’.

    So what do you think hap­pens in the ‘gen­eral’ upper man­age­ment and ‘Exec­u­tive’ world.
    The whole thing goes crazy that’s what. The ulti­mate out­come being that you get peo­ple like “xxxxxxxx” (fill in the names of your own exam­ples) paid mil­lions of dol­lars to joined the com­pany, take it to new heights, then to actu­ally stuff it up and get paid extra ‘sep­a­ra­tion’ mil­lions when you leave.

    And where do we find the ‘cham­pi­ons of all cham­pi­ons’ in this ‘new found order of things’ — in the finance and money mar­kets of course — isn’t that what it is all about? ‘finance & money’ and “me”.

    I mean really, it’s not very hard from here to ‘fill in the dots’ and get to a posi­tion where it becomes much eas­ier to under­stand schemes like ‘ Sub Prime Loans’,
    ’Hedge Funds’, ‘Deriv­a­tives’, not to men­tion the cur­rency mar­kets them­selves and your real rip­pers like the ‘Ponzi Schemes’ and of course my favourite “Col­lat­er­alised Debt Oblig­a­tions” (I love that one !), etc etc etc (fill out your own list).

    Just think for a while about all the peo­ple (and we’re not talk­ing ‘clerks’ here) who have cre­ated and flogged this crap — false equity, “ghost assets” — esti­mated at US dol­lars 10,000 bil­lion.

    Now, pic­ture that fig­ure again for just a lit­tle while, then realise that it HAS NOT YET ‘come home to roost’ or more appro­pri­ately “hit the fan”, along with the for­eign exchange cri­sis, unem­ploy­ment and the resul­tant world­wide social cri­sis that will fol­low in its wake.

    Just to try and wrap up my point
    (ques­tion Steve), and appre­ci­at­ing that it’s not kosher to occupy too much space in any one individual’s post­ings on this site;
    find­ing a new work­able eco­nomic finan­cial model(s), which is part of Steve’s quest for the holy Grail, I sug­gest is only HALF the prob­lem, and prob­a­bly the minor half at that. 

    It was soci­o­log­i­cal change that got us here (via the cre­ation of new mod­els and schemes) and I would put, that with­out this more dif­fi­cult to achieve ‘soci­o­log­i­cal change’,
    it is IMPOSSIBLE to pro­duce a suc­cess­ful, workable/equitable finan­cial and eco­nomic model.
    Or do you think it is “chicken & egg”?

  • wisty

    So the mon­e­tary cause of the Great Depres­sion was debt, and defla­tion (i.e. wage cuts) will make this worse. I guess the other side of the coin of debt is the excess capac­ity and lack of inter­nal demand in the devel­op­ing world. Would a push towards greater equal­ity be the only way out of our cur­rent sit­u­a­tion? And what struc­tural ele­ments have caused this lack of inter­nal demand in the devel­op­ing world, and who can remove those obsta­cles?

  • Bull­turned­bear

    Hi Al49er,

    At the begin­ning of 2008 I heard a term that was new to me. Old to many though. Socio­nom­ics is the study of psy­chol­ogy and how social mood leads the econ­omy and not fol­lows. Eg, The main­stream belief is that the media releases news and the mar­kets fol­low. Or the RBA changes inter­est rates and the mar­ket reacts. The Sociono­mists argue that the mar­ket (herd) psy­chol­ogy is what causes the change in inter­est rates or the media in the first place. To explain this you need to see that the RBA is endoge­nous and a part of the same herd. The herd gets too bullish/positive, so peo­ple invest, spend, bor­row and the money sup­ply expands too fast. This is seen in the econ­omy as price infla­tion, so the RBA raises rates to slow infla­tion. There­fore the herd change caused the RBA to Act. 

    I believe this ties in with your argu­ment Al. The social mood changed dra­mat­i­cally in a short period of time. Every­one couldn’t wait. Many thought they could get rich overnight. most bor­rowed heav­ily to achieve their goals. The sociono­mist say that this was the out­work­ing of an extreme (in a his­tor­i­cal sense) in pos­i­tive herd sen­ti­ment. The result of this extreme bull­ish­ness was the asset and debt mania of the last 35 years. 

    The sociono­mists then go on to say that his­tor­i­cally after times of extreme bull­ish­ness the herd must cor­rect their behav­iour and the herd becomes extremely bear­ish. This will cause a mas­sive change in social behav­iour where peo­ple will reject debt and embrace fear and risk aver­sion.

    Obvi­ously there is so much more to it.

  • Hi al49er,

    Minsky’s “Finan­cial Insta­bil­ity Hypoth­e­sis” is a the­ory about people’s behav­iour chang­ing over time in response to ini­tially sta­ble eco­nomic con­di­tions. Putting that in math­e­mat­i­cal form in a sim­u­la­tion is rather more dif­fi­cult, but in essence that’s what I have done in my own mod­els of his hypoth­e­sis.

    There are ways in which mod­el­ling behav­iour will always be beyond the ken, but the essence of “sta­bil­ity is desta­bil­is­ing” can be cap­tured.

  • Hi Bull­turned­bear,

    Again, the socioe­co­nom­ics crowd is famil­iar to me. I have pub­lished in their jour­nal (The Jour­nal of Socioe­co­nom­ics), though only a com­men­tary rather than an aca­d­e­mic paper. They are still strug­gling to express their views in coher­ent ways, but they with the behav­ioural eco­nom­ics crowd in gen­eral will play a role in the reshap­ing of eco­nomic the­ory after this neo­clas­si­cal deba­cle.

  • clive

    The num­ber one dri­ver is GREED. Is it right to esca­late the price of prawns in your own coun­try because another has new found wealth and is pre­pared to pay any­thing to get them…sending the species to con­tin­u­ally lower lev­els. Is it right to esca­late the price of export com­modi­ties to such an extent that man­u­fac­tur­ing in your own coun­try is non exis­tent because the other coun­try has such a lowly paid work force they are pre­pared to be ripped off for the com­modi­ties in order to flood the world with cheap prod­ucts you can’t com­pete with. Does this serve your coun­try in the long run. If a cyclone occurs in your com­mu­nity and the price to paint a house was $10000 and now esca­lates to $60000 is that sup­ply and demand or greed. This is more than sup­ply and demand it’s prof­i­teer­ing. Some where along the way we all pay for it in the end. In increased insur­ance pre­mi­ums, depleted resources, and a morally bank­rupt pop­u­la­tion.
    We’ve headed down the US route “it’s all about the $”.
    Here’s one more term for ‘Al49er’ “Edu­ca­tion Indus­try” I thought Henry Parkes told us it was a ‘right’.

  • clive

    Hello Steve, On the topic of mod­els, NPR US has this Arti­cle about… ‘Bernanke’s 1980s Com­puter Model Pre­dicts Cri­sis’ Called the ‘finan­cial accel­er­a­tor’.

    It would appear the model was miss­ing ‘The Min­sky Moment’ oth­er­wise we may have avoided this mess.

    This is a good line…
    ’In other words, the model con­sid­ers exactly what’s hap­pen­ing now, as finan­cial insti­tu­tions fold or run for shel­ter in larger firms. Mod­el­ing is nec­es­sar­ily an unex­act sci­ence. “Ulti­mately, we would like to make pre­cise pre­dic­tions,” Gertler says. “Yes, we know the econ­omy will get into trou­ble, or can get into trou­ble under these forces. But we’d like to say how much.”

    Does the model say the econ­omy is head­ing for dooms­day, unless there’s an inter­ven­tion? Gertler pauses, then says, “Uh, roughly speak­ing, yes.” ’

    http://www.npr.org/templates/story/story.php?storyId=95076198

  • plp15

    Happy New Year, Steve & Blog­gers,

    Thanks for the stuff on Ponzi Math – haven’t absorbed it all yet.

    The scari­est thing about Davis’s SMH arti­cle is that it demon­strates the lim­ited com­pre­hen­sion of peo­ple in posi­tions of influ­ence. In nor­mal times, we can stut­ter along with mud­dle-headed lead­er­ship. At times like this, the down-side risks are just too great.

    I am with Brighspark1 on this one, Steve – you were far too kind. 

    The world econ­omy is on a very slip­pery slope. The pun­dits say they are close to hav­ing things under con­trol, with mas­sive forth­com­ing fis­cal stim­u­la­tion pack­ages, etc. But a quick look at the way this has evolved is instruc­tive: Willem Buiter wrote, in Decem­ber 2007”
    “While a slow­down is unavoid­able – and, in the case of the United States, nec­es­sary and desir­able for the restora­tion of exter­nal bal­ance – a reces­sion is not.”
    Yet in a March 2008 paper, he wrote:
    “Eco­nomic prospects for the United States are poor, but nowhere near as bad as the grow­ing crescendo of the moans emit­ted by the losers in the inside asset reval­u­a­tion game would have us believe.”
    It seems that things were a lot worse than Mr. Buiter thought, in both Decem­ber and March. No dis­re­spect for Mr. Buiter – I still read his stuff. But it illus­trates how seri­ously things have been mis-judged. 

    Keynes was smart enough to see the feed­back loops in economies. From a super­fi­cial per­spec­tive, the econ­omy has pos­i­tive feed­back loops. Engi­neers know that neg­a­tive feed­back loops are poten­tially sta­ble, and pos­i­tive feed­back loops are inher­ently unsta­ble. That implies that the Econ­omy need GOOD man­age­ment.

    To my sim­ple mind, Aus­tralia faces a huge risk due to our over­priced hous­ing. There is a hous­ing short­age, which has kept us out of USA-like trou­ble for now. But if unem­ploy­ment grows to the point where a sig­nif­i­cant num­ber of mort­gagors can­not meet their com­mit­ments, we will be in for the same wipe­out as the USA — fore­clo­sures, forc­ing hous­ing prices down, reduced demand, increased unem­ply­ment, more fore­clo­sures, etc.. This risk is so high in the cur­rent cli­mate that it scares the hell out of me to think that our “Lead­ers” may be insen­si­tive to it. So, unin­formed med­dling with employ­ment is the last thing we want.

    Steve, you may well couch that argu­ment in much more eso­teric terms, but please let me know if I am bark­ing up the wrong tree.

    The ques­tion I would like to put to every­one is, how do we ensure that our “Lead­ers” at the helm do not turn us broad­side to the approach­ing tsunami, and stuff up every­thing? Sorry, I don’t see Hope and Prayer as an effec­tive solu­tion.

  • al49er

    hi ‘bull­turned­bear’, the first part of your post did tie in with my argu­ment as did ‘clive’s’proposition that it is GREED.

    But of course it is much much deeper and com­plex than all of this and I was very inter­ested Steve/‘bullturnedbear’to look up the Jour­nal of Socioe­co­nom­ics. The very sci­en­tific level of the papers pub­lished together with the required sub­scrip­tion to access them, pre­vented me going any fur­ther, but it is nice to see from my per­spec­tive that
    there is a ‘for­mal branch’ that con­sid­ers the atti­tudes and actions of peo­ple from soci­o­log­i­cal stand­point in the con­sid­er­a­tion of the mod­el­ling of eco­nom­ics.

    Bull­turned­bear’ you also con­nected to cen­tral ten­ant of my point in say­ing “The social mood changed dra­mat­i­cally in a short period of time”.

    It is this ‘change’ in my mind that will be cen­tral to any return to a ratio­nal and rea­son­ably struc­tured mon­e­tary and eco­nomic sys­tem, not just the model that man­ages to ‘win the day’. 

    For those of you who get the ‘Week­end Aus­tralian’ there is a very good arti­cle in the Inquirer sec­tion on page 17 titled “Return to Self-reliance”.
    Essen­tially it is a syn­op­sis of an Aus­tralian based British ‘futur­ist’ who was “per­suaded to make 10 con­vic­tions for 2009”. Now whilst I’m not always that enam­oured of some of these sor­cer­ers who’ve found the beau­ti­ful niche and income for them­selves by mak­ing ‘con­sid­ered pre­dic­tions’ osten­si­bly to help the busi­nesses that employ them, I found some of the propo­si­tions that he was putting were very much in line with my own think­ing and pre­dic­tions i.e. that indi­vid­u­als, com­mu­ni­ties and nation’s think­ing and actions were going to need to change markedly before we get back to any form of “sta­bil­ity”.

    For some years I have put the propo­si­tion that each gen­er­a­tion changes in a cer­tain way and level from its pre­de­ces­sor, but that in the last cou­ple there has been a quan­tum leap, to the extent that we have, to a very sub­stan­tial degree, lost many of the qual­i­ties of char­ac­ter that existed with our fore­bears.

    If we do as many believe, suf­fer a world ‘Depres­sion’ I don’t think that as a peo­ple we will han­dle it any­where near as well
    as they did in the 1930s, and beyond.

    The term ‘dis­ci­pline’ has vir­tu­ally been ban­ished from our lex­i­con with spe­cific excep­tions when ‘cel­e­brat­ing’ sports stars !
    (heroes –gee the use of that term makes me sick), and com­ment­ing on what a dis­ci­plined train­ing regime they have. 

    yeah well, it’s all right for those sort of peo­ple to be dis­ci­plined, but I shouldn’t have to be told ‘how to’ or be ‘expected’ to behave, con­trol my bor­row­ing, spend­ing, expec­ta­tions, eat­ing habits, exer­cis­ing, other health­care etc etc, like we don’t dis­ci­pline our chil­dren any­more do we, that was stopped a long time ago”. ! ! !

    So if you get the chance and the ref­er­ence above, I found it to be a good read and fair indi­ca­tor of sorts of changes we’re going to need to make from a soci­o­log­i­cal point of view in order to address this “global finan­cial cri­sis”.

    Oh and ‘clive ’ you might need to expand a lit­tle more on the new term you had for me
    “edu­ca­tion indus­try”. Whilst I am mar­ried to a teacher ( a good one!) I still didn’t quite get the full thrust of your angle.

  • BrightSpark1

    Steve

    That arti­cle on the NPR web­site quoted by clive. Do you know if Bernanke has pub­lished details of this model? I had an LOL expe­ri­ence, talk about hubris! How about the claim that the model is applic­a­ble to the cur­rent cri­sis!

    From the pic­ture of the “math” it only seems to include some sim­ple alge­bra with gamma and sigma func­tions, no cal­cu­lus, no DEs, no trans­fer func­tions, and no Laplace trans­forms.

    When is every­body going to wake up? When are they going to realise that they are talk­ing to the wrong peo­ple?

  • Hi Brightspark,

    I’m down­load­ing the Bernanke papers right now. The first one was “A gen­eral equi­lib­rium model of bank­ing”, which should give you some idea of what to expect.

    Tech­ni­cally it started as a dif­fer­ence equa­tion model in which they con­sider the con­di­tions under which equi­lib­rium applies, and it includes dis­count­ing of future expected income flows so there are some infi­nite sums there too. In later ver­sions it became an inte­gral model–again dri­ven by the work­ing out of con­di­tions under which equi­lib­rium would apply.

    A sug­ges­tion for you: I would love to see an engi­neer take apart the maths that econ­o­mists use in the GE mod­els. Would you like to have the papers for­warded for a bit of foren­sic math­e­mat­ics?

  • nicko

    I’m not sure I fully grasp the con­cepts in this arti­cle & their con­se­quences.

    Intu­itively I’d say wage cuts would increase employ­ment in an indi­vid­ual case. I imag­ine what would hap­pen if I lost my job (a real pos­si­bil­ity right now) then had trou­ble get­ting an equiv­a­lent or bet­ter (pay­ing) one in the cur­rent cli­mate. What would I do?

    I imag­ine that in the very worst case (akin to the 1930’s depres­sion) I could take odd jobs for ~$3 an hour(in con­tra­ven­tion of min­i­mum wage pol­icy). Work a 60 hour week this adds up to $180 (about the same as the dole — I’m too proud to take it). This would be enough to house & feed me (I don’t have a fam­ily to sup­port).

    I also imag­ine that there would be just about unlim­ited demand for labour in Aus­tralia at these rates, espe­cially if the work force was pre­pared to move to areas of higher employ­ment.

    Given this extreme case(with all of its assump­tions) how can it be pos­si­ble that wage cuts (in this case a 90% wage cut) ulti­mately wouldn’t increase employ­ment?

    I do under­stand the role of debt in this cur­rent cri­sis (debt wasn’t included as an assump­tion in my extreme case). Let’s say I had a decent amount of debt to ser­vice and a fam­ily to sup­port. Clearly I couldn’t do it on $3 an hour no mat­ter how many hours I worked. I’d either have to default on my debt or allow the gov­ern­ment to inflate it (and my wage) away. This then raises a num­ber of ques­tions:

    * Isn’t mon­e­tary infla­tion & spec­u­la­tion what caused these issues in the first place?
    * Doesn’t infla­tion always lead to spec­u­la­tion in favour of pro­duc­tive activ­ity?
    * Do we not have abun­dant exam­ples of the per­ils of infla­tion (eg Zim­babwe) ?
    * If peo­ple know that debts get inflated away at the first sign of trou­ble there is no incen­tive to be respon­si­ble with debt. There is also no incen­tive to save. In a sense sav­ing becomes spec­u­lat­ing to pre­serve the buy­ing power of your sav­ings.

    * Does not all of this come down to what is ulti­mately a philosph­i­cal argu­ment, namely which is the lesser evil: defla­tion or infla­tion?

  • Bull­turned­bear

    Hi Nicko,

    You missed what Mark Davis was propos­ing. He was propos­ing a 1% wage cut (not 90%) for all employed work­ers. That, based on his the­ory would cre­ate a fur­ther 50,000 jobs. BULL!!!

    As Steve pointed out. In a cli­mate of falling demand, (which means peo­ple spend less and save more) a drop in wages would lead to a fur­ther fall in spend­ing and there­fore reduce prof­its of employ­ers and prob­a­bly lead to higher unem­ploy­ment (not grow employ­ment as sug­gested).

    What you were dis­cussing was once you had lost a job you would be happy to work for less money to get a new one. I agree. I would too.

    Inter­est­ingly, if real wages fell by 90% in Aus­tralia, most if not all busi­nesses would fail. Unem­ploy­ment would trend to mas­sive lev­els as con­sump­tion would crash dra­mat­i­cally. Peo­ple would only be sur­viv­ing on gov­ern­ment hand­outs. That would be an unimag­in­ably extreme depres­sion.

    This is because busi­nesses build stock lev­els, man­u­fac­tur­ers build capac­ity and ser­vice busi­nesses build capac­ity all to meet an expected demand for their prod­ucts and ser­vices. If that demand crashes dra­mat­i­cally, those busi­nesses can become insol­vent overnight. Banks would fail because nobody could repay their loans. Depos­i­tors would lose all their sav­ings as the banks failed. Leav­ing no money left in the sys­tem. The price of goods then crash because nobody has money to pay for any­thing. This is what hap­pened in the Great Depres­sion. Only wages fell by 20 to 30% that time. I think.

    There is no doubt that infla­tion is by far the lesser of two evils. The ques­tion I would like answered is “How on earth can we avoid defla­tion this time?”. Heli­copter Ben or Glenn Stevens have no hope of stop­ping the down­ward spi­rals in employ­ment and demand that have already begun.

  • icon­o­clast

    Greet­ings all. Happy new year!

    As has been stated by oth­ers on this blog, Steve you have been far far to lenient with these clowns.

    The fun­da­men­tal prob­lem with these peo­ple is that they do not ‘infer’ well; that is, as a class, they lack crit­i­cal think­ing skills, logic! Sim­ply, they fail to exe­cute sim­ply syl­lo­gisms.

    There should be a pre­req­ui­site in their edu­ca­tional cur­ricu­lum that, at least, pro­vides them with an intro­duc­tion to log­i­cal think­ing!

  • Dear Icon­o­clast,

    Believe me that I am far from lenient with neo­clas­si­cal econ­o­mists in my aca­d­e­mic and other cri­tiques. There is a limit how­ever in what one can get pub­lished in a let­ter to the edi­tor of a major news­pa­per! So my lan­guage in this post was mild, but my opin­ion of neo­clas­si­cal the­ory con­tin­ues to be derisory.

  • BrightSpark1

    Helo Steve
    Yes I would like to see the details of this Bernanke “model” and have ago at tak­ing it apart. I have for some time been very skep­ti­cal of this neo-clas­si­cal method­ol­ogy and your book is the only con­tem­po­rary book on eco­nom­ics that I have respect for. 

    I have found all other con­tem­po­rary books that I have seen wonting in detail and based on false premises. You take these false premises apart in “Debunk­ing Eco­nom­ics”, this is very refresh­ing. I would enjoy exam­in­ing this neo-clas­si­cal appli­ca­tion of math­e­mat­ics from an engineer’s per­spec­tive.

  • I look for­ward to your eval­u­a­tions Brightspark, and as I noted when I sent you the files, I’ll post your com­men­tary here. It should make for an inter­est­ing read!

  • Defla­tion­ist

    The only solu­tion to this mess is the com­plete elim­i­na­tion of debt, and the mas­sive redis­tri­b­u­tion of the accu­mu­lated wealth of the “elite”. Good luck with that. The debts will be wiped out, but what is to restart the engine of pro­duc­tion? Not the “work­ing peo­ple”, as so many of them will be try­ing to sur­vive on the scraps. We are in for a world of pain.…litterally and fig­u­ra­tively!!