Chapter 19
CHANGES IN MONEY-WAGES
I
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.
II
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,¾with 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;¾so 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;¾any 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.
III
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;¾greater 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.