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The Failure of John Maynard Keynes

The Failure of John Maynard Keynes

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Keynes' General Theory is here riddled chapter by chapter, line by line, with due account taken of the latest theoretical developments. The complete refutation of a vast network of fallacy can only be accomplished by someone thoroughly grounded in a sound positive theory. Henry Hazlitt has that groundwork. -Murray Rothbard
Keynes' General Theory is here riddled chapter by chapter, line by line, with due account taken of the latest theoretical developments. The complete refutation of a vast network of fallacy can only be accomplished by someone thoroughly grounded in a sound positive theory. Henry Hazlitt has that groundwork. -Murray Rothbard

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Section II of Chapter 2 is notable as the first attempt by
Keynes in the General Theory to disprove a fundamental
proposition of traditional economics-—that the most fre-
quent cause of unemployment is excessive wage-rates. This,
of course, for "classical" economics, is merely the parallel
of the proposition that the most frequent cause for an un-
sold surplus of a commodity is the refusal of sellers to accept
a price that will clear the market. If the proposition is not
true with regard to labor, it is not true with regard to com-
modities either. Both propositions rest upon the same line
of reasoning. Both are special cases of a wider proposition
covering both commodities and services.
It is instructive to notice that Keynes never challenges
this proposition head-on, or by any coherent and clear-cut
argument. He attacks it rather by a series of oblique sallies,
in which the argument is usually involved and obscure and
often clearly fallacious.
He begins by contending that "labor" is usually more in-
terested in its "money-wage" than in its "real wage":

Ordinary experience tells us, beyond doubt, that a situation
where labor stipulates (within limits) for a money-wage rather

18 THE FAILURE OF THE "NEW ECONOMICS"

than a real wage, so far from being a mere possibility, is the
normal case. Whilst workers will usually resist a reduction of
money-wages, it is not their practice to withdraw their labor
whenever there is a rise in the price of wage-goods (p. 9).

So far as the United States is concerned (and, I suspect,
so far as nearly every industrially advanced country is con-
cerned), this contention is already obsolete. The big Amer-
ican unions all have their ''economists" and "directors of
research," who are acutely aware of the monthly changes in
the official Consumer Price Index. As of January, 1958,
more than 4 million workers, moreover, mainly in the heavy
industries—steel, automobiles, railroads—had insisted on,
and secured, contracts providing for automatic wage in-
creases with increases in the cost of living.2

So while it is
true that unions will resist a fall in money wage-rates, even
if it is less than the fall in consumer prices, it is not true
that unions will acquiesce in stationary wage-rates when
consumer prices are rising.
Even if Keynes's contention, moreover, had been factu-
ally true, it would still have been irrelevant to the "classical"
contention. The classical contention is that if wage-rates
(whether considered in terms of money wage-rates or real
wage-rates) are above the level of the marginal productivity
of labor, there will be unemployment.
Why is Keynes so concerned to make this point about
"labor's" attitude toward money wage-rates and real
wage-rates respectively? The collectivist word "labor" im-
plies that we need not think in terms of what individual
workers would wish or do, but only in terms of what union
monopolists wish or do. He is concerned because he will
be later eager to prove that while it is "impossible" to per-
suade unions to accept a cut in money wage-rates, it will be
easy to deceive them into accepting a cut in real wage-rates
by the simple process of monetary inflation—erosion of the
purchasing power of the monetary unit. It will be noticed

2 Monthly Labor Review, U. S. Department of Labor, Dec, 1957.

POSTULATES OF KEYNESIAN ECONOMICS

19

that even this argument, however, tacitly accepts the ''classi-
cal" contention that the chief reason for unemployment is
the existence of wage-rates above the point of labor's mar-
ginal productivity.

Moreover, [Keynes goes on to maintain] the contention
that the unemployment which characterizes a depression is
due to a refusal by labor to accept a reduction of money-wages
is not clearly supported by the facts. It is not very plausible
to assert that unemployment in the United States in 1932 was
due either to labor obstinately refusing to accept a reduction
of money-wages or to its obstinately demanding a real wage
beyond what the productivity of the economic machine was
capable of furnishing (p. 9).

The reader will notice that there is no argument here,
merely assertion. "It is not very plausible." That is, it is
not very plausible to Keynes, which proves nothing. Most
of us require something more than ex cathedra pronounce-
ments.

A trick that Keynes uses here and elsewhere is the attempt
to discredit a doctrine by overstating it. The causes of the
1929 crisis, and of the depression from 1930 to 1940, were
complex. I shall not try to go into all of them here. But I
do not know of any serious economist who maintained or
maintains that the initiating cause of the 1929 crisis was ex-
cessive wage-rates. What responsible economists did and do
assert is that once the crisis had developed, and demand and
prices had collapsed, it was necessary for wage-rates to ad-
just themselves to the reduced level of demand and of
prices if mass unemployment was to be averted. It was the
failure of this wage adjustment to occur that led to pro-
longed mass unemployment for ten years.
The insistence of unions on excessive2

wage-rates, it is

2 Whenever I speak of "excessive" wage-rates I refer, of course, merely to
wage-rates that exceed the marginal productivity of labor. The term "excessive"
must not be taken to imply moral disapprobation of such wage-rates. But it does
imply that, whenever such wage-rates exist, there will be unemployment and a
failure of the whole body of workers to receive the maximum total wage-income
that conditions otherwise make possible.

20 THE FAILURE OF THE "NEW ECONOMICS"

true, may not always be a full explanation of total unem-
ployment at any given time. But it is always part of the
explanation. Though it is not always a sufficient cause, it
cannot be dismissed also (as Keynes dismisses it) as a neces-
sary
cause. Rigidity or stickiness of contractual interest
rates and rents, or unusual uncertainty or fear among buy-
ers and consumers, may also be causes. But they are likely
to be temporary causes. The longer mass unemployment is
prolonged, the more warranted we are in assigning excessive
wage-rates as the dominant cause of it.
Even Keynes feels the need of offering reasons why he
finds the attribution of unemployment to excessive wage-
rates "not very plausible." But the reasons he offers are
either fallacious or contrary to established fact. In explana-
tion of the passage I have just quoted, he goes on:

Wide variations are experienced in the volume of employ-
ment without any apparent change either in the minimum
real demands of labor or in its productivity. Labor is not
more truculent in the depression than in the boom—far from
it. Nor is its physical productivity less. These facts from ex-
perience are a prima facie ground for questioning the ade-
quacy of the classical analysis (p. 9).

Are they? Keynes has here tumbled into a glaring fallacy.
The absence of change in physical productivity is com-
pletely irrelevant to money wage-rates. What counts in eco-
nomics is only value productivity—and value productivity
stated in this case, of course, in monetary terms. If the
marginal productivity of a worker is a given unit of a com-
modity that previously sold for $10, and the price of that
unit has now fallen to $5, then the marginal value pro-
ductivity of that worker, even though he is turning out
the same number of units, has fallen by half. If we assume
that this fall in prices has been general, and that this repre-
sents the average fall, then the worker who insists on retain-
ing his old money wage-rate is in effect insisting on a 100
per cent increase in his real wage-rate.

POSTULATES OF KEYNESIAN ECONOMICS

21

Whether the worker is " truculent" or not is entirely
beside the point. If prices fall by 50 per cent, and unions
will accept a wage cut, but o£ no more than 25 per cent,
then the unions are in effect demanding an increase in real
wage-rates of 50 per cent. The only way they can get it, and
retain full employment, is by an increase of 50 per cent in
their physical (or "real" value) marginal productivity to
make up for the drop in the price of the individual unit
of the commodity they help to produce.
The passage I have just quoted is in itself prima facie
ground for questioning the adequacy of the whole Keynes-
ian analysis.

"It would be interesting to see the results of a statistical
enquiry," writes Keynes, "into the actual relationship be-
tween changes in money-wages and changes in real wages"
(pp. 9-10). But without waiting for the results, he proceeds
to tell the reader what they would be: "When money-wages
are rising ... it will be found that real wages are falling;
and when money-wages are falling, real wages are rising"
(p. 10). The second half of this statement is historically
correct. The first half, in the modern world, is demonstra-
bly not correct. The statistical results which Keynes ex-
pressed such an interest in seeing already existed, but he
did not bother to look them up. Let us cite a few.
In the eighteen-year period between 1939 and 1957,
weekly wages in manufacturing in the United States, ac-
cording to the figures of the Department of Labor, rose
from $23.86 in 1939 to $82.39 in 1957, an increase of 245
per cent. This compared with an increase in the official
Consumer Price Index for the same period of only 102 per
cent, making an increase in real weekly wages in the period
of 71 per cent. The comparison is not very different if we
take hourly wage-rates as the base of comparison instead of
weekly wages. These rose from 63 cents an hour in 1939 to
$2.07 in 1957, an increase of 229 per cent. In other words,
when money-wages were rising in this period, real wages
were also rising. Whatever historic foundation there may

22

THE FAILURE OF THE "NEW ECONOMICS"

be for the traditional belief that in an inflation prices rise
first and wages lag behind, the proposition has not been true
for the United States, or for many other countries, in the
last twenty years.
The second half of Keynes's proposition, that "when
money-wages are falling, real wages are rising" is, however,
generally true. It is not easy to find in American statistical
history extensive periods when money-wages were falling,
but two such periods do exist in recent times—between
1920 and 1922, and between 1929 and 1933. I append a
comparison for a selected series of years taken from a table
published by the government3

comparing average hourly
earnings of workers in manufacturing industries in "cur-
rent prices," i.e., in terms of the actual money wage-rates
paid, and in "1954 prices," i.e., in terms of "real" wage-
rates, or money wage-rates expressed in terms of a dollar of
assumed constant purchasing power:

Year

Current Prices

1954 Prices

1920

$0,555

$0,743

1921

.515

.773

1922

.487

.780

1923

.522

.822

1924

.547

.859

1929

.566

.886

1930

.552

.887

1931

.515

.910

1932

.446

.876

1933

.442

.917

1934

.532

1.068

Let us look first at the period from 1920 to 1924. Be-
tween 1920 and 1922 there was a substantial drop in money
wage-rates; yet they did not drop as much as consumer
prices, and therefore real wage-rates, or wage-rates in "con-

31955 Historical and Descriptive Supplement to Economic Indicators. Pre-
pared for the Joint Committee on the Economic Report by the Committee Staff
and the Office of Statistical Standards, Bureau of the Budget, p. 29.

POSTULATES OF KEYNESIAN ECONOMICS

23

stant dollars," actually increased between 1920 and 1922.
Beginning in 1923, money wage-rates started up again; but
real wages also rose, once more refuting Keynes's proposi-
tion that "when money-wages are rising ... it will be found
that real wages are falling."
Take, now, the period between 1929 and 1934. From
1929 to 1933 money wage-rates fell; but real wage-rates rose.
There was a sole exception between the years 1931 and
1932; but it did not change the comparative trend over the
whole period. Between 1933 and 1934, however, there was
a dramatic jump both in money wage-rates and in real
wage-rates, once more contradicting Keynes's "law."
It is only fair to point out that this jump in both money
and real wage-rates in 1934 was the direct result of govern-
mental intervention—the National Recovery Administra-
tion codes put into effect under government pressure in the
first years of the New Deal. But it is precisely this jump
in both money and real wage-rates that helps to explain
the continuance of mass unemployment throughout the
Thirties. This again is a statistical disproof of Keynes's
central thesis that unemployment has nothing to do with
the height of wage-rates—or even that unemployment is
rather owing to wage-rates being too low than to their be-
ing too high. From 1931 through 1939 both money wage-
rates and real wage-rates rose. Money wage-rates rose from
51 cents an hour in 1931 to 63 cents in 1939. In constant
(1954) prices, real wage-rates rose from 91 in 1931 to 122
in 1939. What was the result? In that ten-year period there
was an average annual unemployment of 10 million men
and women.

Before we proceed further with a direct consideration of
Keynes's argument on this point, it may be more profitable
to digress a moment to consider the kind of argument, and
particularly the set of assumptions, with which we have to
deal. It is pertinent here to make three observations:
1. When Keynes writes about "classical theory" or "tra-
ditional theory," it almost invariably turns out that what

24

THE FAILURE OF THE "NEW ECONOMICS"

he is discussing is neither of these, strictly speaking, but
some caricature, or the specific theories of the " Cambridge
school" (consisting mainly of Marshall, Edgeworth, and
Pigou) in which he was brought up.
2. This school never quite rid itself of a cost-of-produc-
tion theory of prices, and neither did Keynes.
3. Keynes is even inferior to the Cambridge economists
he criticizes in his addiction to lump thinking, in-block
thinking.

Once we recognize the existence of these assumptions in
Keynes's thinking we can economize our detailed criticism.
We can ignore many of his criticisms of the theories of
Marshall and Pigou, for example, because those theories
had already been superseded by the best economic thought
long prior to the appearance of the General Theory. And
we need not waste too much time over Keynes's criticisms
when we find that these themselves rest on crude lump
thinking. Keynes writes on page 11, for example: "The tra-
ditional theory maintains, in short, that the wage bargains
between the entrepreneurs and the workers determine the
real wage."
(His italics.) Now there is no such thing as
"the" real wage. Neither is there any such thing as "the
general level of money-wages" (pp. 10, 12, 13, etc.). "The"
wage, real or money, is a figment of the bad economist's
imagination. It is a violent oversimplification that assumes
away the thousands of differences in individual wages and
salaries that make up reality.
In the same way, "the general level of wages," like "the
general level of prices" (both of which concepts are central
to Keynes's thought), has no existence in reality. It is a
statistician's construct, a mathematical average which has a
limited value in simplifying certain problems. But it simpli-
fies away some of the chief dynamic problems in economics.
The same relationship between an average of prices and an
average of wages in two different periods may conceal gross
changes in the relationship of specific prices to specific
wages. It is precisely the latter that may be relevant to

POSTULATES OF KEYNESIAN ECONOMICS

25

equilibrium or the lack o£ it, to the health o£ specific in-
dustries, to full employment or to substantial unemploy-
ment.

The word "level" can give rise to an additional false
assumption—that prices and wages rise or fall evenly or
uniformly. It is precisely their failure to do so that creates
most o£ the problems of inflation or deflation. It is also the
failure of specific prices or wages to rise or fall as much as
the average that permits the continuous structural changes
in production and in the labor force necessary for continu-
ous economic efficiency and progress.
Keynes writes on page 13:

There may be no method available to labor as a whole
whereby it can bring the wage-goods equivalent of the general
level o£ money-wages into conformity with the marginal dis-
utility o£ the current volume of employment. There may
exist no expedient by which labor as a whole can reduce its
real wage to a given figure by making revised money bargains
with the entrepreneurs. This will be our contention.

I shall not attempt here to analyze thoroughly this highly
implausible contention. It is enough to point out, for the
moment, that "labor" does not act or do anything else "as
a whole," any more than "business" does. "Labor" certainly
doesn't set "its" wage-rate. There are thousands o£ differ-
ent wage-rates being set every working day, sometimes in-
dustry by industry, more often company by company, or
union by union, and most often individual by individual.
Even an industry-wide union sets, not a single uniform rate,
but a complicated scale of rates, fixed by "classifications."
The whole dilemma that Keynes presents, as we shall
later see, exists not in the real world of economics, but in
his own confused method of thinking.

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