It would have been an advantage if the effects of a change in money-wages could have been discussed in an earlier chapter. For the classical theory has been accustomed to rest the supposedly self-adjusting character of the economic system on an assumed fluidity of money-wages; and, when there is rigidity, to lay on this rigidity the blame of maladjustment.
It was not possible, however, to discuss this matter fully until our own theory had been developed. For the consequences of a change in money-wages are complicated. A reduction in money-wages is quite capable in certain circumstances of affording a stimulus to output, as the classical theory supposes. My difference from this theory is primarily a difference of analysis; so that it could not be set forth clearly until the reader was acquainted with my own method.
The generally accepted explanation is, as I understand it, quite a simple one. It does not depend on roundabout repercussions, such as we shall discuss below. The argument simply is that a reduction in money-wages will cet. par. stimulate demand by diminishing the price of the finished product, and will therefore increase output and employment up to the point where the reduction which labour has agreed to accept in its money-wages is just offset by the diminishing marginal efficiency of labour as output (from a given equipment) is increased.
In its crudest form, this is tantamount to assuming that the reduction in money-wages will leave demand unaffected. There may be some economists who would maintain that there is no reason why demand should be affected, arguing that aggregate demand depends on the quantity of money multiplied by the income-velocity of money and that there is no obvious reason why a reduction in money-wages would reduce either the quantity of money or its income-velocity. Or they may even argue that profits will necessarily go up because wages have gone down. But it would, I think, be more usual to agree that the reduction in money-wages may have some effect on aggregate demand through its reducing the purchasing power of some of the workers, but that the real demand of other factors, whose money incomes have not been reduced, will be stimulated by the fall in prices, and that the aggregate demand of the workers themselves will be very likely increased as a result of the increased volume of employment, unless the elasticity of demand for labour in response to changes in money-wages is less than unity. Thus in the new equilibrium there will be more employment than there would have been otherwise except, perhaps, in some unusual limiting case which has no reality in practice.
It is from this type of analysis that I fundamentally differ; or rather from the analysis which seems to lie behind such observations as the above. For whilst the above fairly represents, I think, the way in which many economists talk and write, the underlying analysis has seldom been written down in detail.
It appears, however, that this way of thinking is probably reached as follows. In any given industry we have a demand schedule for the product relating the quantities which can be sold to the prices asked; we have a series of supply schedules relating the prices which will be asked for the sale of different quantities on various bases of cost; and these schedules between them lead up to a further schedule which, on the assumption that other costs are unchanged (except as a result of the change in output), gives us the demand schedule for labour in the industry relating the quantity of employment to different levels of wages, the shape of the curve at any point furnishing the elasticity of demand for labour. This conception is then transferred without substantial modification to industry as a whole; and it is supposed, by a parity of reasoning, that we have a demand schedule for labour in industry as a whole relating the quantity of employment to different levels of wages. It is held that it makes no material difference to this argument whether it is in terms of money-wages or of real wages. If we are thinking in terms of money-wages, we must, of course, correct for changes in the value of money; but this leaves the general tendency of the argument unchanged, since prices certainly do not change in exact proportion to changes in money-wages.
If this is the groundwork of the argument (and, if it is not, I do not know what the groundwork is), surely it is fallacious. For the demand schedules for particular industries can only be constructed on some fixed assumption as to the nature of the demand and supply schedules of other industries and as to the amount of the aggregate effective demand. It is invalid, therefore, to transfer the argument to industry as a whole unless we also transfer our assumption that the aggregate effective demand is fixed. Yet this assumption reduces the argument to an ignoratio elenchi. For, whilst no one would wish to deny the proposition that a reduction in money-wages accompanied by the same aggregate effective demand as before will be associated with an increase in employment, the precise question at issue is whether the reduction in money-wages will or will not be accompanied by the same aggregate effective demand as before measured in money, or, at any rate, by an aggregate effective demand which is not reduced in full proportion to the reduction in money-wages (i.e. which is somewhat greater measured in wage-units). But if the classical theory is not allowed to extend by analogy its conclusions in respect of a particular industry to industry as a whole, it is wholly unable to answer the question what effect on employment a reduction in money-wages will have. For it has no method of analysis wherewith to tackle the problem. Professor Pigou's Theory of Unemployment seems to me to get out of the classical theory all that can be got out of it; with the result that the book becomes a striking demonstration that this theory has nothing to offer, when it is applied to the problem of what determines the volume of actual employment as a whole.
Let us, then, apply our own method of analysis to answering the problem. It falls into two parts. (i) Does a reduction in money-wages have a direct tendency, cet. par., to increase employment, 'cet. par.' being taken to mean that the propensity to consume, the schedule of the marginal efficiency of capital and the rate of interest are the same as before for the community as a whole? And (2) does a reduction in money-wages have a certain or probable.tendency to affect employment in a particular direction through its certain or probable repercussions on these three factors?
The first question we have already answered in the negative in the preceding chapters. For we have shown that the volume of employment is uniquely correlated with the volume ofeffective demand measured in wage-units, and that the effective demand, being the sum of the expected consumption and the expected investment, cannot change, if the propensity to consume, the schedule of marginal efficiency of capital and the rate of interest are all unchanged. If, without any change in these factors, the entrepreneurs were to increase employment as a whole, their proceeds will necessarily fall short of their supply-price.
Perhaps it will help to rebut the crude conclusion that a reduction in money-wages will increase employment 'because it reduces the cost of production', if we follow up the course of events on the hypothesis most favourable to this view, namely that at the outset entrepreneurs expect the reduction in money-wages to have this effect. It is indeed not unlikely that the individual entrepreneur, seeing his own costs reduced, will overlook at the outset the repercussions on the demand for his product and will act on the assumption that he will be able to sell at a profit a larger output than before. If, then, entrepreneurs generally act on this expectation, will they in fact succeed in increasing their profits? Only if the community's marginal propensity to consume is equal to unity, so that there is no gap between the increment of income and the increment of consumption; or if there is an increase in investment, corresponding to the gap between the increment of income and the increment of consumption, which will only occur if the schedule of marginal efficiencies of capital has increased relatively to the rate of interest. Thus the proceeds realised from the increased output will disappoint the entrepreneurs and employment will fall back again to its previous figure, unless the marginal propensity to consume is equal to unity or the reduction in money-wages has had the effect of increasing the schedule of marginal efficiencies of capital relatively to the rate of interest and hence the amount of investment. For if entrepreneurs offer employment on a scale which, if they could sell their output at the expected price, would provide the public with incomes out of which they would save more than the amount of current investment, entrepreneurs are bound to make a loss equal to the difference; and this will be the case absolutely irrespective of the level of money-wages. At the best, the date of their disappointment can only be delayed for the interval during which their own investment in increased working capital is filling the gap.
Thus the reduction in money-wages will have no lasting tendency to increase employment except by virtue of its repercussion either on the propensity to consume for the community as a whole, or on the schedule of marginal efficiencies of capital, or on the rate of interest. There is no method of analysing the effect of a reduction in money-wages, except by following up its possible effects on these three factors.
The most important repercussions on these factors are likely, in practice, to be the following:
(1) A reduction of money-wages will somewhat reduce prices. It will, therefore, involve some redistribution of real income (a) from wage-earners to other factors entering into marginal prime cost whose remuneration has not been reduced, and (b) from entrepreneurs to rentiers to whom a certain income fixed in terms of money has been guaranteed.
What will be the effect of this redistribution on the propensity to consume for the community as a whole? The transfer from wage-earners to other factors is likely to diminish the propensity to consume. The effect of the transfer from entrepreneurs to rentiers is more open to doubt. But if rentiers represent on the whole the richer section of the community and those whose standard of life is least flexible, then the effect of this also will be unfavourable. What the net result will be on a balance of considerations, we can only guess. Probably it is more likely to be adverse than favourable.
(2) If we are dealing with an unclosed system, and the reduction of money-wages is a reduction relatively to money-wages abroad when both are reduced to a common unit, it is evident that the change will be favourable to investment, since it will tend to increase the balance of trade. This assumes, of course, that the advantage is not offset by a change in tariffs, quotas, etc. The greater strength of the traditional belief in the efficacy of a reduction in money-wages as a means of increasing employment in Great Britain, as compared with the United States, is probably attributable to the latter being, comparatively with ourselves, a closed system.
(3) In the case of an unclosed system, a reduction of money-wages, though it increases the favourable balance of trade, is likely to worsen the terms of trade. Thus there will be a reduction in real incomes, except in the case of the newly employed, which may tend to increase the propensity to consume.
(4) If the reduction of money-wages is expected to be a reduction relatively to money-wages in the future, the change will be favourable to investment, because as we have seen above, it will increase the marginal efficiency of capital; whilst for the same reason it may be favourable to consumption. If, on the other hand, the reduction leads to the expectation, or even to the serious possibility, of a further wage-reduction in prospect, it will have precisely the opposite effect. For it will diminish the marginal efficiency of capital and will lead to the postponement both of investment and of consumption.
(5) The reduction in the wages-bill, accompanied by some reduction in prices and in money-incomes generally, will diminish the need for cash for income and business purposes; and it will therefore reduce pro tanto the schedule of liquidity-preference for the community as a whole. Cet. par. this will reduce the rate of interest and thus prove favourable to investment. In this case, however, the effect of expectation concerning the future will be of an opposite tendency to those just considered under (4). For, if wages and prices are expected to rise again later on, the favourable reaction will be much less pronounced in the case of long-term loans than in that of short-term loans. If, moreover, the reduction in wages disturbs political confidence by causing popular discontent, the increase in liquidity-preference due to this cause may more than offset the release of cash from the active circulation.
(6) Since a special reduction of money-wages is always advantageous to an individual entrepreneur or industry, a general reduction (though its actual effects are different) may also produce an optimistic tone in the minds of entrepreneurs, which may break through a vicious circle of unduly pessimistic estimates of the marginal efficiency of capital and set things moving again on a more normal basis of expectation. On the other hand, if the workers make the same mistake as their employers about the effects of a general reduction, labour troubles may offset this favourable factor; apart from which, since there is, as a rule, no means of securing a simultaneous and equal reduction of money-wages in all industries, it is in the interest of all workers to resist a reduction in their own particular case. In fact, a movement by employers to revise money-wage bargains downward will be much more strongly resisted than a gradual and automatic lowering of real wages as a result of rising prices.
(7) On the other hand, the depressing influence on entrepreneurs of their greater burden of debt may partly offset any cheerful reactions from the reduction of wages. Indeed if the fall of wages and prices goes far, the embarrassment of those entrepreneurs who are heavily indebted may soon reach the point of insolvency,— with severely adverse effects on investment. Moreover the effect of the lower price-level on the real burden of the national debt and hence on taxation is likely to prove very adverse to business confidence.
This is not a complete catalogue of all the possible reactions of wage reductions in the complex real world. But the above cover, I think, those which are usually the most important.
If, therefore, we restrict our argument to the case of a closed system, and assume that there is nothing to be hoped, but if anything the contrary, from the repercussions of the new distribution of real incomes on the community's propensity to spend, it follows that we must base any hopes of favourable results to employment from a reduction in money-wages mainly on an improvement in investment due either to an increased marginal efficiency of capital under (4) or a decreased rate of interest under (5). Let us consider these two possibilities in further detail.
The contingency, which is favourable to an increase in the marginal efficiency of capital, is that in which money-wages are believed to have touched bottom, so that further changes are expected to be in the upward direction. The most unfavourable contingency is that in which money-wages are slowly sagging downwards and each reduction in wages serves to diminish confidence in the prospective maintenance of wages. When we enter on a period of weakening effective demand, a sudden large reduction of money-wages to a level so low that no one believes in its indefinite continuance would be the event most favourable to a strengthening of effective demand. But this could only be accomplished by administrative decree and is scarcely practical politics under a system of free wage-bargaining. On the other hand, it would be much better that wages should be rigidly fixed and deemed incapable of material changes, than that depressions should be accompanied by a gradual downward tendency of money-wages, a further moderate wage reduction being expected to signalise each increase of; say, 1 per cent in the amount of unemployment. For example, the effect of an expectation that wages are going to sag by, say, 2 per cent in the coming year will be roughly equivalent to the effect of a rise of 2 per cent in the amount of interest payable for the same period. The same observations apply mutatis mutandis to the case of a boom.
It follows that with the actual practices and institutions of the contemporary world it is more expedient to aim at a rigid money-wage policy than at a flexible policy responding by easy stages to changes in the amount of unemployment;— so far, that is to say, as the marginal efficiency of capital is concerned. But is this conclusion upset when we turn to the rate of interest?
It is, therefore, on the effect of a falling wage- and price-level on the demand for money that those who believe in the self-adjusting quality of the economic system must rest the weight of their argument; though I am not aware that they have done so. If the quantity of money is itself a function of the wage- and price-level, there is indeed, nothing to hope in this direction. But if the quantity of money is virtually fixed, it is evident that its quantity in terms of wage-units can be indefinitely increased by a sufficient reduction in money-wages; and that its quantity in proportion to incomes generally can be largely increased, the limit to this increase depending on the proportion of wage-cost to marginal prime cost and on the response of other elements of marginal prime cost to the falling wage-unit.
We can, therefore, theoretically at least, produce precisely the same effects on the rate of interest by reducing wages, whilst leaving the quantity of money unchanged, that we can produce by increasing the quantity of money whilst leaving the level of wages unchanged. It follows that wage reductions, as a method of securing full employment, are also subject to the same limitations as the method of increasing the quantity of money. The same reasons as those mentioned above, which limit the efficacy of increases in the quantity of money as a means of increasing investment to the optimum figure, apply mutatis mutandis to wage reductions. Just as a moderate increase in the quantity of money may exert an inadequate influence over the long-term rate of interest, whilst an immoderate increase may offset its other advantages by its disturbing effect on confidence; so a moderate reduction in money-wages may prove inadequate, whilst an immoderate reduction might shatter confidence even if it were practicable.
There is, therefore, no ground for the belief that a flexible wage policy is capable of maintaining a state of continuous full employment;— any more than for the belief that an open-market monetary policy is capable, unaided, of achieving this result. The economic system cannot be made self-adjusting along these lines.
If, indeed, labour were always in a position to take action (and were to do so), whenever there was less than full employment, to reduce its money demands by concerted action to whatever point was required to make money so abundant relatively to the wage-unit that the rate of interest would fall to a level compatible with full employment, we should, in effect, have monetary management by the trade unions, aimed at full employment, instead of by the banking system.
Nevertheless while a flexible wage policy and a flexible money policy come, analytically, to the same thing, inasmuch as they are alternative means of changing the quantity of money in terms of wage-units, in other respects there is, of course, a world of difference between them. Let me briefly recall to the reader's mind the four outstanding considerations.
(i) Except in a socialised community where wage-policy is settled by decree, there is no means of securing uniform wage reductions for every class of labour. The result can only be brought about by a series of gradual, irregular changes, justifiable on no criterion of social justice or economic expedience, and probably completed only after wasteful and disastrous struggles, where those in the weakest bargaining position will suffer relatively to the rest. A change in the quantity of money, on the other hand, is already within the power of most governments by open-market policy or analogous measures. Having regard to human nature and our institutions, it can only be a foolish person who would prefer a flexible wage policy to a flexible money policy, unless he can point to advantages from the former which are not obtainable from the latter. Moreover, other things being equal, a method which it is comparatively easy to apply should be deemed preferable to a method which is probably so difficult as to be impracticable.
(ii) If money-wages are inflexible, such changes in prices as occur (i.e. apart from 'administered' or monopoly prices which are determined by other considerations besides marginal cost) will mainly correspond to the diminishing marginal productivity of the existing equipment as the output from it is increased. Thus the greatest practicable fairness will be maintained between labour and the factors whose remuneration is contractually fixed in terms of money, in particular the rentier class and persons with fixed salaries on the permanent establishment of a firm, an institution or the State. If important classes are to have their remuneration fixed in terms of money in any case, social justice and social expediency are best served if the remunerations of all factors are somewhat inflexible in terms of money. Having regard to the large groups of incomes which are comparatively inflexible in terms of money, it can only be an unjust person who would prefer a flexible wage policy to a flexible money policy, unless he can point to advantages from the former which are not obtainable from the latter.
(iii) The method of increasing the quantity of money in terms of wage-units by decreasing the wage-unit increases proportionately the burden of debt; whereas the method of producing the same result by increasing the quantity of money whilst leaving the wage-unit unchanged 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.
(iv) If a sagging rate of interest has to be brought about by a sagging wage-level, there is, for the reasons given above, a double drag on the marginal efficiency of capital and a double reason for putting off investment and thus postponing recovery.
It follows, therefore, that if labour were to respond to conditions of gradually diminishing employment by offering its services at a gradually diminishing money-wage, this would not, as a rule, have the effect of reducing real wages and might even have the effect of increasing them, through its adverse influence on the volume of output. The chief result of this policy would be to cause a great instability of prices, so violent perhaps as to make business calculations futile in an economic society functioning after the manner of that in which we live. To suppose that a flexible wage policy is a right and proper adjunct of a system which on the whole is one of laissez-faire, is the opposite of the truth. It is only in a highly authoritarian society, where sudden, substantial, all-round changes could be decreed that a flexible wage policy could function with success. One can imagine it in operation in Italy, Germany or Russia, but not in France, the United States or Great Britain.
If, as in Australia, an attempt were made to fix real wages by legislation, then there would be a certain level of employment corresponding to that level of real wages; and the actual level of employment would, in a closed system, oscillate violently between that level and no employment at all, according as the rate of investment was or was not below the rate compatible with that level; whilst prices would be in unstable equilibrium when investment was at the critical level, racing to zero whenever investment was below it, and to infinity whenever it was above it. The element of stability would have to be found, if at all, in the factors controlling the quantity of money being so determined that there always existed some level of money-wages at which the quantity of money would be such as to establish a relation between the rate of interest and the marginal efficiency of capital which would maintain investment at the critical level. In this event employment would be constant (at the level appropriate to the legal real wage) with money-wages and prices fluctuating rapidly in the degree just necessary to maintain this rate of investment at the appropriate figure. In the actual case of Australia, the escape was found, partly of course in the inevitable inefficacy of the legislation to achieve its object, and partly in Australia not being a closed system, so that the level of money-wages was itself a determinant of the level of foreign investment and hence of total investment, whilst the terms of trade were an important influence on real wages.
In the light of these considerations I am now of the opinion that the maintenance of a stable general level of money-wages is, on a balance of considerations, the most advisable policy for a closed system; whilst the same conclusion will hold good for an open system, provided that equilibrium with the rest of the world can be secured by means of fluctuating exchanges. There are advantages in some degree of flexibility in the wages of particular industries so as to expedite transfers from those which are relatively declining to those which are relatively expanding. But the money-wage level as a whole should be maintained as stable as possible, at any rate in the short period.
This policy will result in a fair degree of stability in the price-level;— greater stability, at least, than with a flexible wage policy. Apart from 'administered' or monopoly prices, the price-level will only change in the short period in response to the extent that changes in the volume of employment affect marginal prime costs; whilst in the long period they will only change in response to changes in the cost of production due to new techniques and new or increased equipment.
It is true that, if there are, nevertheless, large fluctuations in employment, substantial fluctuations in the price-level will accompany them. But the fluctuations will be less, as I have said above, than with a flexible wage policy.
Thus with a rigid wage policy the stability of prices will be bound up in the short period with the avoidance of fluctuations in employment. In the long period, on the other hand, we are still left with the choice between a policy of allowing prices to fall slowly with the progress of technique and equipment whilst keeping wages stable, or of allowing wages to rise slowly whilst keeping prices stable. On the whole my preference is for the latter alternative, on account of the fact that it is easier with an expectation of higher wages in future to keep the actual level of employment within a given range of full employment than with an expectation of lower wages in future, and on account also of the social advantages of gradually diminishing the burden of debt, the greater ease of adjustment from decaying to growing industries, and the psychological encouragement likely to be felt from a moderate tendency for money-wages to increase. But no essential point of principle is involved, and it would lead me beyond the scope of my present purpose to develop in detail the arguments on either side.
Professor Pigou in his Theory of Unemployment makes the volume of employment to depend on two fundamental factors, namely (i) the real rates of wages for which workpeople stipulate, and (2) the shape of the Real Demand Function for Labour. The central sections of his book are concerned with determining the shape of the latter function. The fact that workpeople in fact stipulate, not for a real rate of wages, but for a money-rate, is not ignored; but, in effect, it is assumed that the actual money-rate of wages divided by the price of wage-goods can be taken to measure the real rate demanded.
The equations which, as he says, 'form the starting point of the enquiry' into the Real Demand Function for Labour are given in his Theory of Unemployment, p. 90. Since the tacit assumptions, which govern the application of his analysis, slip in near the outset of his argument, I will summarise his treatment up to the crucial point.
Professor Pigou divides industries into those 'engaged in making wage-goods at home and in making exports the sale of which creates claims to wage-goods abroad' and the 'other' industries: which it is convenient to call the wage-goods industries and the non-wage-goods industries respectively. He supposes x men to be employed in the former and y men in the latter. The output in value of wage-goods of the x men he calls F(x); and the general rate of wages F'(x). This, though he does not stop to mention it, is tantamount to assuming that marginal wage-cost is equal to marginal prime cost. Further, he assumes that x + y = φ(x), i.e. that the number of men employed in the wage-goods industries is a function of total employment. He then shows that the elasticity of the real demand for labour in the aggregate (which gives us the shape of our quaesitum, namely the Real Demand Function for Labour) can be written
φ'(x) F'(x)
Er = ——— × ————
φ(x) F"(x)
So far as notation goes, there is no significant difference between this and my own modes of expression. In so far as we can identify Professor Pigou's wage-goods with my consumption-goods, and his 'other goods' with my investment-goods, it follows that his F(x) / F'(x), being the value of the output of the wage-goods industries in terms of the wage-unit, is the same as my Cw. Furthermore, his function is (subject to the identification of wage-goods with consumption-goods) a function of what I have called above the employment multiplier k'. For
Δx = k'Δy,
so that
1
φ'(x) = 1 + ——
k
Thus Professor Pigou's 'elasticity of the real demand for labour in the aggregate' is a concoction similar to some of my own, depending partly on the physical and technical conditions in industry (as given by his function F) and partly on the propensity to consume wage-goods (as given by his function φ); provided always that we are limiting ourselves to the special case where marginal labour-cost is equal to marginal prime cost.
To determine the quantity of employment, Professor Pigou then combines with his 'real demand for labour', a supply function for labour. He assumes that this is a function of the real wage and of nothing else. But, as he has also assumed that the real wage is a function of the number of men x who are employed in the wage-goods industries, this amounts to assuming that the total supply of labour at the existing real wage is a function of x and of nothing else. That is to say, n = χ(x), where n is the supply of labour available at a real wage F'(x).
Thus, cleared of all complication, Professor Pigou's analysis amounts to an attempt to discover the volume of actual employment from the equations
x + y = φ(x)
and n = χ(x).
But there are here three unknowns and only two equations. It seems clear that he gets round this difficulty by taking n = x + y. This amounts, of course, to assuming that there is no involuntary unemployment in the strict sense, i.e. that all labour available at the existing real wage is in fact employed. In this case x has the value which satisfies the equation
φ(x) = χ(x)
and when we have thus found that the value of x is equal to (say) n1, y must be equal to χ(n1) − n1, and total employment n is equal to (n1).
It is worth pausing for a moment to consider what this involves. It means that, if the supply function of labour changes, more labour being available at a given real wage (so that n1 + dn1 is now the value of x which satisfies the equation φ(x) = χ(x)), the demand for the output of the non-wage-goods industries is such that employment in these industries is bound to increase by just the amount which will preserve equality between φ(n1 + dn1) and χ(n1 + dn1). The only other way in which it is possible for aggregate employment to change is through a modification of the propensity to purchase wage-goods and non-wage-goods respectively such that there is an increase of y accompanied by a greater decrease of x.
The assumption that n = x + y means, of course, that labour is always in a position to determine its own real wage. Thus, the assumption that labour is in a position to determine its own real wage, means that the demand for the output of the non-wage-goods industries obeys the above laws. In other words, it is assumed that the rate of interest always adjusts itself to the schedule of the marginal efficiency of capital in such a way as to preserve full employment. Without this assumption Professor Pigou's analysis breaks down and provides no means of determining what the volume of employment will be. It is, indeed, strange that Professor Pigou should have supposed that he could furnish a theory of unemployment which involves no reference at all to changes in the rate of investment (i.e. to changes in employment in the non-wage-goods industries) due, not to a change in the supply function of labour, but to changes in (e.g.) either the rate of interest or the state of confidence.
His title the 'Theory of Unemployment' is, therefore, something of a misnomer. His book is not really concerned with this subject. It is a discussion of how much employment there will be, given the supply function of labour, when the conditions for full employment are satisfied. The purpose of the concept of the elasticity of the real demand for labour in the aggregate is to show by how much full employment will rise or fall corresponding to a given shift in the supply function of labour. Or — alternatively and perhaps better — we may regard his book as a non-causative investigation into the functional relationship which determines what level of real wages will correspond to any given level of employment. But it is not capable of telling us what determines the actual level of employment; and on the problem of involuntary unemployment it has no direct bearing.
If Professor Pigou were to deny the possibility of involuntary unemployment in the sense in which I have defined it above, as, perhaps, he would, it is still difficult to see how his analysis could be applied. For his omission to discuss what determines the connection between x and y, i.e. between employment in the wage-goods and non-wage-goods industries respectively, still remains fatal.
Moreover, he agrees that within certain limits labour in fact often stipulates, not for a given real wage, but for a given money-wage. But in this case the supply function of labour is not a function of F'(x) alone but also of the money-price of wage-goods;— with the result that the previous analysis breaks down and an additional factor has to be introduced, without there being an additional equation to provide for this additional unknown. The pitfalls of a pseudo-mathematical method, which can make no progress except by making everything a function of a single variable and assuming that all the partial differentials vanish, could not be better illustrated. For it is no good to admit later on that there are in fact other variables, and yet to proceed without re-writing everything that has been written up to that point. Thus if (within limits) it is a money-wage for which labour stipulates, we still have insufficient data, even if we assume that n = x + y, unless we know what determines the money-price of wage-goods. For, the money-price of wage-goods will depend on the aggregate amount of employment. Therefore we cannot say what aggregate employment will be, until we know the money-price of wage-goods; and we cannot know the money-price of wage-goods until we know the aggregate amount of employment. We are, as I have said, one equation short. Yet it might be a provisional assumption of a rigidity of money-wages, rather than of real wages, which would bring our theory nearest to the facts. For example, money-wages in Great Britain during the turmoil and uncertainty and wide price fluctuations of the decade 1924−1934 were stable within a range of 6 per cent, whereas real wages fluctuated by more than 20 per cent. A theory cannot claim to be a general theory, unless it is applicable to the case where (or the range within which) money-wages are fixed, just as much as to any other case. Politicians are entitled to complain that money-wages ought to be highly flexible; but a theorist must be prepared to deal indifferently with either state of affairs. A scientific theory cannot require the facts to conform to its own assumptions.
When Professor Pigou comes to deal expressly with the effect of a reduction of money-wages, he again, palpably (to my mind), introduces too few data to permit of any definite answer being obtainable. He begins by rejecting the argument (op. cit. p. 101) that, if marginal prime cost is equal to marginal wage-cost, non-wage-earners' incomes will be altered, when money-wages are reduced, in the same proportion as wage-earners', on the ground that this is only valid, if the quantity of employment remains unaltered — which is the very point under discussion. But he proceeds on the next page (op. cit. p. 102) to make the same mistake himself by taking as his assumption that 'at the outset nothing has happened to non-wage-earners money-income', which, as he has just shown, is only valid if the quantity of employment does not remain unaltered-which is the very point under discussion In fact, no answer is possible, unless other factors are included in our data.
The manner in which the admission, that labour in fact stipulates for a given money-wage and not for a given real wage (provided that the real wage does not fall below a certain minimum), affects the analysis, can also be shown by pointing out that in this case the assumption that more labour is not available except at a greater real wage, which is fundamental to most of the argument, breaks down. For example, Professor Pigou rejects (op. cit. p. 75) the theory of the multiplier by assuming that the rate of real wages is given, i.e. that, there being already full employment, no additional labour is forthcoming at a lower real wage. Subject to this assumption, the argument is, of course, correct. But in this passage Professor Pigou is criticising a proposal relating to practical policy; and it is fantastically far removed from the facts to assume, at a time when statistical unemployment in Great Britain exceeded 2,000,000 (i.e. when there were 2,000,000 men willing to work at the existing money-wage), that any rise in the cost of living, however moderate, relatively to the money-wage would cause the withdrawal from the labour market of more than the equivalent of all these 2,000,000 men.
It is important to emphasise that the whole of Professor Pigou's book is written on the assumption that any rise in the cost of living, however moderate, relatively to the money-wage will cause the withdrawal from the labour market ofa number of workers greater than that of all the existing unemployed.
Moreover, Professor Pigou does not notice in this passage (op. cit. p. 75) that the argument, which he advances against 'secondary' employment as a result of public works, is, on the same assumptions, equally fatal to increased 'primary' employment from the same policy. For if the real rate of wages ruling in the wage-goods industries is given, no increased employment whatever is possible — except, indeed, as a result of non-wage-earners reducing their consumption of wage-goods. For those newly engaged in the primary employment will presumably increase their consumption of wage-goods which will reduce the real wage and hence (on his assumptions) lead to a withdrawal of labour previously employed elsewhere. Yet Professor Pigou accepts, apparently, the possibility of increased primary employment. The line between primary and secondary employment seems to be the critical psychological point at which his good common sense ceases to overbear his bad theory.
The difference in the conclusions to which the above differences in assumptions and in analysis lead can be shown by the following important passage in which Professor Pigou sums up his point of view: 'With perfectly free competition among workpeople and labour perfectly mobile, the nature of the relation (i.e. between the real wage-rates for which people stipulate and the demand function for labour) will be very simple. There will always be at work a strong tendency for wage-rates to be so related to demand that everybody is employed. Hence, in stable conditions everyone will actually be employed. The implication is that such unemployment as exists at any time is due wholly to the fact that changes in demand conditions are continually taking place and that frictional resistances prevent the appropriate wage adjustments from being made instantaneously.'
He concludes (op. cit. p. 253) that unemployment is primarily due to a wage policy which fails to adjust itself sufficiently to changes in the real demand function for labour. Thus Professor Pigou believes that in the long run unemployment can be cured by wage adjustments; whereas I maintain that the real wage (subject only to a minimum set by the marginal disutility of employment) is not primarily determined by 'wage adjustments' (though these may have repercussions) but by the other forces of the system, some of which (in particular the relation between the schedule of the marginal efficiency of capital and the rate of interest) Professor Pigou has failed, if I am right, to include in his formal scheme.
Finally, when Professor Pigou comes to the 'Causation of Unemployment' he speaks, it is true, of fluctuations in the state of demand, much as I do. But he identifies the state of demand with the Real Demand Function for Labour, forgetful of how narrow a thing the latter is on his definition. For the Real Demand Function for Labour depends by definition (as we have seen above) on nothing but two factors, namely (1) the relationship in any given environment between the total number of men employed and the number who have to be employed in the wage-goods industries to provide them with what they consume, and (2) the state of marginal productivity in the wage-goods industries. Yet in Part V of his Theory of Unemployment fluctuations in the state of 'the real demand for labour' are given a position of importance. The 'real demand for labour' is regarded as a factor which is susceptible of wide short-period fluctuations (op. cit. Part V, chaps. vi.−xii.), and the suggestion seems to be that swings in 'the real demand for labour' are, in combination with the failure of wage policy to respond sensitively to such changes, largely responsible for the trade cycle. To the reader all this seems, at first, reasonable and familiar. For, unless he goes back to the definition, 'fluctuations in the real demand for labour' will convey to his mind the same sort of suggestion as I mean to convey by 'fluctuations in the state of aggregate demand'. But if we go back to the definition of the 'real demand for labour', all this loses its plausibility. For we shall find that there is nothing in the world less likely to be subject to sharp short-period swings than this factor.
Professor Pigou's 'real demand for labour' depends, by definition, on nothing but F(x), which represents the physical conditions of production in the wage-goods industries, and (x), which represents the functional relationship between employment in the wage-goods industries and total employment corresponding to any given level of the latter. It is difficult to see a reason why either of these functions should change, except gradually over a long period. Certainly there seems no reason to suppose that they are likely to fluctuate during a trade cycle. For F(x) can only change slowly, and, in a technically progressive community, only in the forward direction; whilst (x) will remain stable, unless we suppose a sudden outbreak of thrift in the working classes, or, more generally, a sudden shift in the propensity to consume. I should expect, therefore, that the real demand for labour would remain virtually constant throughout a trade cycle. I repeat that Professor Pigou has altogether omitted from his analysis the unstable factor, namely fluctuations in the scale of investment, which is most often at the bottom of the phenomenon of fluctuations in employment.
I have criticised at length Professor Pigou's theory of unemployment not because he seems to me to be more open to criticism than other economists of the classical school; but because his is the only attempt with which I am acquainted to write down the classical theory of unemployment precisely. Thus it has been incumbent on me to raise my objections to this theory in the most formidable presentment in which it has been advanced.
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