Chapter 19 Unemployment and Wage Rates
Unemployment is caused by excessive wage rates.
If I were put to it to name the most confused and fantastic chapter in the whole of the general theory,
Theory, the choice would be difficult, but I doubt that anyone could successfully challenge
me if I named Chapter 19 on changes in money wages.
Its badness is, after all, not surprising, for it is here that Cain sets out to challenge
and deny what has become in the last two centuries the most strongly established principle in
in Economics, to which that if the price of any commodity or service is kept too high,
i.e. above the point of equilibrium, some of that commodity or service will remain unsold.
This is true of eggs, cheese, cotton, catallacts or labor.
When wage rates are too high, there will be unemployment.
Reducing the myriad wage rates to their respective equilibrium points may not in itself be a
sufficient step to the restoration of full employment, for there are other possible disequilibriums
to be considered, but it is an absolutely necessary step.
This is the elementary and inescapable truth that Keynes, with an incredible display of
of sophistry, irrelevance and complicated obfuscation tries to refute.
He begins, as is his habit, by affecting to state the classical theory of the matter,
and as is also his habit, he misstates it.
Then he discovers this theory to be question-begging and fallacious.
Next he applies his own method of analysis.
I spare the reader the quotation, but if he is interested in reading an argument that
outdoes Humpty Dumpty's best efforts in Alice in Wonderland or the complicated and bewildering
chain of causation of a Rube Goldberg cartoon, I direct his attention to the long paragraph
beginning at the top of page 261 and ending at the top of page 262.
Instead of trying to unsnarl this Gordian knot one loop at a time and calling attention
to each fallacy and irrelevance, which would only take us over ground we have already covered,
we shall economize time by bypassing it for the moment, as well as the whole chapter and
most of its appendix, and by quoting a couple of paragraphs from the last two pages of the
Appendix, in which Keynes contrasts his own views with those of A. C. Pigot.
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 Pigot
sums up his point of view.
With perfectly free competition among work people and labor perfectly mobile, the nature
The nature of the relation i.e. between the real wage rates for which people stipulate
and the demand function for labor 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, page 253, that unemployment is primarily due to a wage policy which fails
calls to adjust itself sufficiently to changes in the real demand function for labor.
Thus, Professor Pagot 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 Pagot has failed, if I am right, to include
in his formal scheme, pages 277 through 278.
There is a double advantage in starting our discussion of Chapter 19 with this quotation.
One, instead of giving us Keynes's misstatement, which would first have to be corrected, of
the classical theory of the relation of wage rates to unemployment, it at least gives us
Pigou's statement of the classical view in his own words.
And two, it contains the most compact and lucid statement that Keynes gives of his own
views on the subject.
Pigot's statement is the correct one.
Keynes's view is clearly incorrect, though it does contain one grain of truth in a bushel
of errors.
This grain of truth, it may be added, is not original with Keynes'.
Let us begin by seeing what qualifications are necessary in the Pigot Statement.
When Pigot speaks of everybody or everyone being employed, the word everybody must clearly
be interpreted in a restricted sense.
It cannot be speaking of those who do not need or do not want to work, or of children
or of the physically handicapped, or of criminals or lunatics, or those who are so incompetent,
Again, when Pigot declares that in stable conditions everybody will actually be employed,
He must have meant to say in equilibrium conditions. It is not stability, but the speed and precision
of wage adjustments that Pigot is really emphasizing. Relatively stable unemployment is possible
with a stable or frozen disequilibrium, as was shown both in Britain and the United States
in the period between 1925 and 1939.
Keynes capitalized on this, as we have seen, by giving it the self-contradictory name of
unemployment equilibrium.
The equilibrium that we should keep in mind need not be stable in the sense of static.
That is to say, it need not refer merely to the kind of equilibrium postulated in a stationary
or Evenly Rotating Economy. It can refer to a dynamic equilibrium postulated as being achieved by instantaneous and precise adjustments to changing conditions, or constantly being approached in practice in a free competitive economy.
Finally, while maladjustments in wage rates are usually the principal reason for unemployment, and can be the sole reason, other maladjustments can also cause unemployment, including maladjustments among particular prices and, here is the one germ of Keynesian truth, even though improbably, maladjustments in interest rates.
Suppose now, for the sake of clarity, we rephrase Pigot's summary in a more satisfactory form, retaining his own phrasing wherever that is acceptable.
With perfectly free competition among work people and laborer, perfectly mobile, there
will always be at work a strong tendency for wage rates to be so related to demand that
all employable persons who desire jobs are employed.
Hence, in conditions of equilibrium, all such persons 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, price and other, even interest rate, adjustments from being made instantaneously.
Now, if Keynes had been content to make merely these revisions, if he had been content merely to deny, in his quotation from Pigot,
the implication that wage adjustments are the sole adjustments needed to retain or restore full employment, his objection would have been correct, even if not original.
But Pigot's position as summarized by Keynes that most often unemployment is primarily due to a wage policy which fails to adjust itself sufficiently to changes in the real demand function for labor, page 278, is correct.
Keynes explicitly denies even this.
Keynes is definitely wrong, in short, when he maintains that
the real wage is not primarily determined by wage adjustments
but by the other forces of the system.
Page 278.
These other forces, it is true, even maladjustments in the interest rate,
must be taken into account whenever there is heavy unemployment,
But they are usually secondary to the unemployment caused by maladjustments in wage rates.
With this correct positive doctrine in mind, it may be worthwhile to examine some of the major fallacies which led Keynes to his false conclusions.
Perhaps the first and most important of these fallacies is Keynes's habitual confusion between hourly wage rates and total wage payments.
In common with, I fear, most writers on economics, he uses the loose word wages sometimes to mean wage rates and sometimes to mean total payrolls or total wage income.
The reader is seldom sure in which of these two radically different senses Keynes is using the word, and Keynes seldom seems to be sure himself.
I do not mean to imply that he always falls into this confusion. Sometimes the distinction is clear enough in his mind and explicit in the examples that he cites.
The confusion is nonetheless frequent enough to account for many of the otherwise inexplicable conclusions in the general theory.
This confusion is one of the prices that writers on economics pay for trying to use simpler, popular language.
It never occurs when they are discussing the prices of commodities.
of Commodities. It would not occur to even a moderately competent economist to assume that if an entrepreneur raised the price of his product 20%, his gross income would increase 20%.
If an individual entrepreneur engaged in the production of a homogeneous competitive product, such as copper, were arbitrarily to raise his price 20% above that of his competitors, his gross income instead of increasing 20% would probably disappear entirely.
None of his product would be sold, and even if the entrepreneur were a monopolist, or
if all the entrepreneurs in the same industry uniformly raised their prices by 20%, even
the man in the street knows that, assuming no other change in the supply or demand curve,
there would be a decline in the volume of sales.
The gross income of the individual entrepreneur would not increase in proportion to the price
In short, as far as commodities are concerned, there is no confusion in the popular mind
between prices, volume of sales, and gross income.
But in writing on labor, even many professional economists constantly confuse prices with
total income because they call both by the same name – wages.
Many economists, and this partly derives from Keynes, put forward a curious argument in
attempting to justify their double standard, or double set of economic principles, in the
discussion of prices and wages respectively.
They tell us without a smile that wages cannot be treated like other costs or other prices,
because wages are the worker's income, and if we cut this income we are not only being
We may seem cruel and inhuman, but we correspondingly reduce purchasing power and send the economy into a downward spiral.
Now, whatever is true in this statement is true not only of wages, but of all costs and all prices.
Everybody's monetary cost is somebody else's income.
The price of finished steel is a motor car manufacturer's cost, but, multiplied by tonnage, the steelmaker's income.
The price of iron ore or scrap steel is the finished steelmaker's cost, but the ironmine's or scrap dealer's income.
But if wage rates or steel prices or scrap prices are too high in relation to other prices or to supply and demand,
An increase in such wage rates or prices will not lead to a corresponding increase in the
total income of workers, or of steelmakers, or of scrap dealers.
And it may easily lead to a decrease in that total income through unemployment or a decline
in sales more than proportionate to the increase in price.
It is not merely a fallacy, therefore, but a sham humanitarianism and a cruel deception
Always to insist on wage rate increases, whether or not conditions justify them, and always to resist wage rate reductions, whether or not conditions require them.
Elasticity of demand for labor.
A second fallacy of Keynes's is that, even when he does explicitly distinguish between
wage rates and total wage income, he raises the question whether the demand for labor
is really elastic or not, or whether its elasticity can be greater than unity.
Now Paul Douglas and A. C. Pigot, as I have already pointed out in another connection,
had independently, before the appearance of the general theory, attempted a statistical answer to this question,
and had come with surprising agreement to the conclusion that the elasticity of the demand for labor is about negative 3.
This means that a 1% reduction in wages can mean a 3% increase in employment,
if wages have previously been above the marginal productivity of labor,
or, conversely, that a 1% increase in wages can mean a 3% reduction in employment if wages are above the marginal productivity of labor.
I have already pointed out that it is not possible to measure the elasticity of the demand for labor, or for anything else, statistically or mathematically.
Elasticity of demand is merely a misleading and unfortunate name for responsiveness of demand.
It is obviously impossible to know in advance precisely how the demand for any commodity or service will respond to a change in price.
There are too many factors in the situation, and these factors can never be assumed to be precisely the same for two successive months or minutes.
The concept of a measurable elasticity of demand, or of a predictable responsiveness of demand, is based on the tacit assumption that when the price of a commodity or service changes or is changed, the demand curve remains exactly where it was.
It can never, of course, be known whether this is in fact true.
A price may have gone up because the demand curve itself has gone up, in which case there may be no decrease in the amount demanded.
There may even be an increase in the amount demanded.
Or a price may have gone down because the demand curve itself has gone down,
In which case, there may be no increase in the amount demanded, and there may even be a decrease in the amount demanded.
Now, as the very existence of a demand curve or demand schedule is purely hypothetical,
as the slope or shape of this curve can never be in fact known, and as it can never be known precisely how much it has risen or fallen,
or in the fashionable technical jargon, moved to the right or to the left, it follows that the elasticity of demand for any commodity or service can never be determined by comparing changes in the amount sold with changes in price.
For these changes have occurred between two or more periods or moments of time, and we
can have no assurance whatever that the demand curve has itself remained the same between
those periods or moments of time.
The demand curve may meanwhile have shifted from one position to another, or changed its
shape or we may be on a different section of it.
There are still other dangers in the application of the elasticity of demand concept to labor.
We cannot legitimately speak, for example, of THE elasticity of the demand for labor,
for this will vary with every different kind of labor, almost with every firm, and with
every different set of conditions.
The responsiveness of employment of all building workers collectively to changes in wage rates,
For example, may be very high, whereas the responsiveness of employment of electrical
installation workers alone to changes in their wage rates may be very low, because the demand
for electricians is a joint demand with that for other building workers.
To speak of THE elasticity of the demand for labor, therefore, may be to speak of an almost
meaningless average.
If its dangers and limitations are kept constantly in mind, however, the elasticity of demand,
or better, the responsiveness of demand, can be a useful tool of thought.
The statistical investigations of Douglas and Pigot seem to raise at least a presumption
in favor of a usually high responsiveness of employment to changes in wage rates.
In any case, there is the strongest possible presumption in favor of letting free competitive
market forces decide the question.
When unemployment exists, it exists because there is disequilibrium somewhere.
The most likely place is in the wage rates of the occupations in which the unemployment
exists.
This presumption is enormously increased when such wage rates are arbitrarily held at their
and their existing level by labor union insistence, which prevents free competitive market forces from operating in those occupations.
And this presumption must hold either until free competition for jobs and for workers is restored in those occupations,
or until the unions concerned have consented to a provisional reduction in wage rates to see whether such a reduction is followed by an increase in employment.
Of course, unemployment could be caused in one occupation by an excessive wage rate in another.
For example, some construction workers could be unemployed because wages and prices in the steel industry were too high.
It is even theoretically conceivable to make every concession to Keynes that the disequilibrium causing unemployment might be in some relationship among prices or even in interest rates.
But this is highly improbable unless such inappropriate prices are monopolistically controlled, or unless interest rates have been made excessive as a result of governmental monetary mismanagement.
Another type of error that runs through Keynes's chapter 19 is his consistent failure to state all the relevant assumptions in the hypothetical illustrations that he sets up,
and then, to come to a conclusion that could only be warranted on the basis of an assumption and often a self-contradictory one that he has failed to state.
When we are dealing with unemployment, for example, we must assume that there is a reason for the unemployment.
The most probable reason is that wage rates are too high, i.e. that they are above the point of equilibrium.
This may not be so, but it is certainly one of the hypotheses, if not the first hypothesis, that ought to be considered.
Keynes never considers it. His examples tacitly assume that wage rates are already at, or even below, the point of equilibrium.
Only on that assumption could he reach the conclusion, as he does, that a reduction of wage rates would mean a reduction of wage income,
income, either by not increasing employment in the least or by actually reducing it further.
Of course, if wage rates are already at or below the point of equilibrium, it would be
an act not only of injustice but of sheer folly to reduce them further.
But if, as it is enormously more plausible to assume, there is unemployment because wages
are above the point of equilibrium, then reduction of wage rates to the point of equilibrium
would both restore full employment and increase payrolls and the total income of the community.
Fallacies of Aggregative Economics
At the very beginning of chapter 19, Keynes professes to find a great invalid assumption
at the heart of the classical theory that a decline in wage rates that have been above
of the Equilibrium Point will restore employment.
He states the classical argument of how this will happen in a particular industry.
He wrongly states it by giving only a special case, not the general theory.
Then he pauses.
The classical theory, he says, has no way of extending its conclusions in respect of
a particular industry to industry as a whole.
except by a false analogy, p. 260. Therefore, it is wholly unable to answer the question
what effect on employment a reduction in money wages will have, p. 260. Where's the catch?
Keynes explains. 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
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
The question at issue is whether the reduction in money wages will or will not be accompanied by the same aggregate effective demand as measured before 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 wages.
i.e. which is somewhat greater measured in wage units, pages 259 through 260.
Now, the only reason this tangled argument is worth noticing at all is that such a tremendous to-do has been made about it by the Keynesians,
many of whom, indeed, think that this is the great flaw that Keynes has found in classical economics and the great contribution that he has made to economics.
Aggregate or aggregative economics, they tell us, has displaced special or partial economics, or the economics of the firm.
The macroscopic view has displaced the microscopic view.
Keynes's whole argument on this point is so confused that the chief difficulty in answering it is the difficulty of discovering just what the argument is.
Let us begin by looking again at the Keynesian term effective demand. We have
seen that there is no need for the adjective. It implies that there are two
kinds of demand, effective and ineffective. Ineffective demand could then
only mean desire unaccompanied by monetary purchasing power, but economists
have never called this demand. The term demand as used by economists has always
These meant effective demand and nothing else.
Inserting the adjective then adds nothing but confusion.
How then about the term aggregate demand?
Aggregate demand may be thought of in two senses, in terms of commodities or in terms
of money.
Abstracting from money, the aggregate demand for commodities is ultimately the aggregate
supply of commodities.
The supply of one commodity is the demand for another, and vice versa.
We are back to Say's law. And Say's law is always true. In fact, it is a truism when
we assume prices and production to be in equilibrium. Under such conditions, aggregate demand follows
from aggregate supply. But Keynes and McKaynesians reject aggregative economics in the one sense
in which it is both true and useful. If the aggregate demand is thought of in terms of
If it is invalid, as Keynes contends, to argue from what happens in a particular industry to industry as a whole, then it is no less invalid to argue from what happens in a particular firm to what happens in a whole industry.
But as a matter of fact, the invalidity exists only in Keynes's mind and is a result of the confusion of his own thinking.
Let us begin with a single industry and see what happens.
There are two main cases to be considered.
The first is that in a closed domestic industry in which prices are too high because wage rates are too high,
and therefore the market is contracted and there is unemployment,
suppose wage rates are reduced enough to allow prices to be reduced enough to restore the market and restore full employment in that industry.
There is then both more employment in that industry and more production, therefore more total wages and more gross income, therefore more purchasing power for the goods of other industries.
So, restoring employment in that industry through cutting wage rates, i.e., cutting them just enough to make the re-employment possible, has not merely left aggregate effective demand where it was.
Let us call this industry A. Suppose now that the same thing happens in industry B. Then
the increase in the effective demand of industry B for the products of all other industries,
Banking, A, must add still further to the aggregate effect of demand, and so also if
we go on to consider industries C, D, E, N. Keynes has simply raised a pseudo-problem.
The other case, which Keynes does not consider, would be in an open international industry,
as for example, copper. Here the price would be fixed internationally, with allowance
The American copper industry would not be able to lower the world price, proportionately,
or perhaps even significantly, by lowering its own wages.
But if there were unemployment in the American copper industry, it would be, assuming the
mines themselves were not inferior to those elsewhere, because wage rates were too high.
They would have to be cut to make employment and the reopening of the mines possible.
If a cutting wages did, proportionately or more than proportionately, restore employment
in the American copper industry, however, obviously the effect would be to increase
the effective demand of the workers and owners in that industry for the products of other
American industries.
Again, Keynes's problem becomes a pseudo-problem, created merely by his own confusion, not
Not by some gap or missing link in classical theory.
The Attack on Flexible Wage Rates
But the chapter on wages is crammed with confusions and fallacies.
One of the most incredible is Keynes's argument against permitting flexibility of wage rates.
This flies in the face of everything that has been learned about economics and the advantages
of a free economy in the last two centuries.
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-around 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.
page 269. Such a statement fairly takes one's breath away. Laissez-faire means non-adjustment.
Laissez-faire means inflexibility. Authoritarianism means flexibility. Flexibility means rigidity.
One thinks of George Orwell's 1984, where war is peace, ignorance is strength, and freedom
as Slavery, nor is the implied approval in the foregoing quotation of totalitarian economic
controls to be dismissed as a mere momentary fancy.
In the preface that Keynes wrote in September 1936 to the German edition of his General
Theory, he tried to sell his system to Nazi Germany by writing,
The theory of aggregate production that is the goal of the following book can be much
Much more easily applied to the conditions of a totalitarian state than the theory of
the production and distribution of a given output turned out under the conditions of
free competition and of a considerable degree of laissez-faire.
Keynes in brief does not believe in a free market, does not believe in a free and flexible
economy.
In his eyes, the very virtues of a free economy become its vices.
In a socialized community, where wage policy is settled by decree, there is no means of
securing uniform wage reductions for every class of labor.
The result can only be brought about by a series of gradual irregular changes, justifiable
on no criterion of social justice or economic expediency.
Page 267 If important classes are to have their remuneration
Now, in a free, non-statist, non-socialist, non-totalitarian economy, wages do not and
cannot adjust themselves and block, as a unit, by some neat fixed round uniform percentage.
Nor do prices adjust themselves and block, by a uniform percentage or as a unit.
Nor does production adjust itself and block or as a unit.
In a free economy there are literally millions of different prices, millions of individual
No wage rates, thousands of classes of wage rates, prices of hundreds of thousands of
different commodities of different grades and at different points.
In a free economy, there are millions of daily adjustments of one wage rate to another, of
one price to another, of this wage rate to that price, of that price to this wage rate.
There is constantly going on in a free economy, in brief, an almost infinite number of mutual
Adjustments. This is how the economy works. This is how it keeps in dynamic equilibrium.
This is how the balance of production is maintained among thousands of different goods and services
to meet the changing needs and desires of millions of different consumers.
But all this conflicts with the simplistic theories of Keynes. He thinks in aggregates
and Averages and abstractions which are mental constructs that have lost touch with reality.
He thinks, in short, in lumps. He deals only in his own lump concepts like average level
of wages, average level of prices, aggregate demand, aggregate supply. Production itself
is regarded as being divided only into a few big lumps called industries. Sometimes production
and is even regarded as one big homogeneous lump.
Keynes cannot understand a free economy precisely because it does not consist of such lumps.
Having reduced everything to averages, he cannot understand any adjustment.
He is even against any adjustment that is not a uniform adjustment of each of these
averages blocks lumps to the other.
And announcing such a free and flexible adjustment of individual prices and wage rates and outputs
as unjust and inexpedient, Keynes does not seem to realize that he is by implication accepting
as both economically and ethically right the previous interrelationship of prices and wage
rates.
If only a simultaneous and equal reduction of money wages in all industries, page 264,
is to be tolerated if a series of gradual irregular changes in wages is justifiable
on no criterion of social justice or economic expediency, page 267, then it must be because
the previous relationship of wage rate to wage rate was precisely what it ought to have been.
This is defending the status quo with a vengeance. In brief, Keynes forms a ridiculously
The oversimplified theory of how a free enterprise economy ought to work.
And because it does not work that way, he denounces it.
Then he goes on to self-contradictory arguments to prove that reducing wage rates to bring
them more into line with economic realities would reduce or violently disturb prices and
production, and that the way to stabilize the economy is to refuse to allow free or
piecemeal adjustments to take place.
Page 269 Inflation vs. piecemeal adjustment Having decided that piecemeal adjustment of
wage rates is unjust, Keynes decides that the best way to get a uniform reduction of
wage rates is by a little deception, i.e. by inflating or debasing the money supply
so as to raise prices.
It appears that only a foolish person would prefer a flexible wage policy to a flexible
money policy, page 268, and it can only be an unjust person who would prefer a flexible
wage policy to a flexible money policy, page 268.
In brief, a person must be both foolish and unjust, not to prefer inflation, i.e. debasement
of the Monetary Unit to Adjustment of Individual Wage Rates to a Change in Prices or Conditions
of Supply and Demand.
And one of the advantages of a flexible money policy is that one can thereby systematically
cheat creditors and so reduce the burden of debt, page 268, and, of course, having regard
to the excessive burden of many types of debt, it can only be an inexperienced person, pages
Sources 268 through 269, who would hesitate to fleece creditors by paying them off in
a debased currency rather than make honest wage adjustments.
Because Keynes with his lump aggregate thinking is opposed to restoring employment or equilibrium
by small, gradual, piecemeal adjustments, he can only advocate sudden, overall violent
adjustments.
Either we must simultaneously, he argues, slash the wages of everybody by a flat uniform
percentage in totalitarian fashion, or we must achieve the same result by inflating
the money supply and raising the price level so that everybody's real wages are slashed
by the same percentage.
But the irony of this is that if only a small specific adjustment is needed in one sector
of the Economy, the violent remedy that Keynes recommends will be quite ineffective.
Let us assume a situation, for example, in which all wage rates are at equilibrium levels
except wages in the building trades, which are 10% above equilibrium levels.
There will then probably be unemployment, not only in the building trades themselves,
But also, say, in the steel, cement, brick and lumber industries, because of the falling
off in demand from the building trades.
And there will be some unemployment in the television, camera, clothing and other trades
because of the unemployment in the building trades and the consequent fall in retail business.
The whole situation could be cured by a 10% cut in building wages alone, which would show
show up in the average for all industry, say, as a cut of less than 1% in wage rates.
But such a cut in building wages alone, in Keynesian theory, would be gradual and irregular
and hence unjust and inexpedient.
For Keynesian theory is not interested at all in particular adjustments.
It sees them merely as disturbing factors.
Therefore, Keynes's remedy would be a 10% debasement of the monetary unit to raise prices and living costs.
In other words, he would wish to raise all prices 10% and cut everybody's real wage about 10%.
But if he could succeed in doing this, the outcome would not cure the situation.
For after all, these adjustments had been made, wages in the building trades would still be 10% too high
When the temporary effects of the inflation had worked themselves out, the unemployment
would return, because the same maladjustment within the wage-price structure would exist.
I began the last paragraph by saying, if he could succeed in doing this, I meant, if he
could succeed in his declared goal of cutting all real wage rates by a uniform 10 percent.
But of course, this is not what inflation of the money supply would be likely to do.
Unless the inflation were brought about chiefly by an increase in loans or subsidies to the
construction industry itself, a more probable effect of a general monetary inflation would
be to increase other wages and prices to bring them approximately abreast of, that is to
say, more nearly in equilibrium with, wages and prices in the construction industry.
This is what would happen, that is, if the Keynesian scheme worked as planned.
But even if it did, what would this mean?
If wages in the construction industry constitute 9% of all wages, then the Keynesian remedy,
at its best, would involve raising 91% of all money wages 10% in order to avoid asking
the receivers of 10% of money wages to accept a 10% cut.
The Keynesian remedy, in short, is like changing the lock to avoid changing to the right key,
or like adjusting the piano to the stool instead of the stool to the piano.
And even so, it is unlikely to be more than temporarily successful.
For new maladjustments and disequilibria would be almost certain to occur at the higher
scale of price.
These, under the Keynesian ground rules, would have to be corrected by still further inflation,
or so ad infinitum.
Always what is relevant to economic equilibrium and full employment is the relationship of
particular wage rates to other wage rates, of particular prices to other prices, and
of particular wages to particular prices.
Never of averages to averages or of the wage level to the price level.
Such mathematical averages or average levels do not exist in the real world.
They are mental constructs, they are fictions, they conceal the real maladjustments in any
given economic situation, or make them appear to cancel out.
They do not really cancel out, however.
If we use an index number of 100 to represent each equilibrium wage rate respectively in
four different industries, then if industry A has a wage rate index of 80, industry B
of 90, Industry C of 110 and Industry D of 120, their average index number would be 100.
A Keynesian statistician relying on averages and aggregates would declare wages to be in
equilibrium. Yet the wage rate of none of these four industries would be in equilibrium.
The solution for a restoration of equilibrium and full employment would be a mutual and
and multiple adjustment of particular wage rates. It would not be to raise the whole level to an index number of 120 so as not to hurt the feelings or disturb the prejudices of the union leaders in Industry D.
It is important, finally, to point out that no real adjustments of wages or prices are ever made, upward or downward, in the flat uniform simultaneous way in which Keynes implies they are made or ought to be made.
I present on pages 284 and 285 two charts prepared for a 1948 publication by the National Industrial
Conference Board.
These show the percentage changes in average hourly earnings of workers in 25 manufacturing
industries over two different periods.
Let us see first of all what happened in the earlier period when wages were falling.
Chart 1.
In the period from 1929 to 1932, there was an average decline in hourly earnings in all
25 industries of 15.6%. But the decline was different in each of the 25 industries, ranging
from only 2.1% in the least affected to 29% in the most affected. Turn to chart 2 and
Let us see what happened in the longer period, from 1929 to 1939, when wages were dominantly
rising. In this period, the average rise in all 25 industries was 22%, but the rise was
different in each of the 25 industries, ranging from 3.6% in the least affected to 37.1% in
It is worth making some additional observations about these charts.
The range of changes in individual hourly earnings is even greater than the charts show.
Each of the 25 solid lines on each chart is itself an average of hourly earnings in a
particular industry, and conceals the range within that industry.
Students will no doubt be quick to point out that the decline in hourly earnings between
1929 and 1932 did not prevent, and they will no doubt contend that it even intensified,
the decline in employment and output in that period.
But several points may be made on the other side.
First, there is nothing in the charts to show that the declines were greatest in the industries
where they were most needed to restore employment and production.
Secondly, changes in hourly earnings are likely to be much greater than changes in hourly
wage rates.
This is because when volume of business is low, overtime rates tend to disappear, and
when volume of business is high, overtime rates tend to pile up.
This gives an exaggerated impression both ways of changes in standard time wage rates.
In fact, the hourly earnings may change widely in either direction without any change in
standard wage rates.
Thirdly, wage rates are not the only factor governing the volume of employment at any
moment.
Possibly from a purely hypothetical point of view, there is always some wage rate, however
low, capable of assuring full employment under almost any condition.
But in practice, supplementary adjustments will be necessary.
In practice also, no adjustment can be instantaneous or sufficiently quick to assure full employment
at all times, even with assumed flexible wage rates.
Finally, the striking increase in hourly earnings between 1929 and 1939, which of course meant
And an even more striking increase between 1932 and 1939 certainly did not wipe out
unemployment or brain full recovery.
On the contrary, the period was one of continued mass unemployment.
In the ten years from 1931 to 1940, there was average unemployment of 10 million, or
18.6% of the total working force.
A Class Theory of Unemployment
Keynes's preference for general monetary inflation over piecemeal wage and price adjustments
is the result of still other major fallacies.
He does not realize that the government cannot cheat creditors through inflation if the creditors
have full advanced knowledge of the government's intentions.
He does not realize that a planned inflation cannot be gradual or controlled, but will
get out of hand the moment the plan is known.
And he does not realize that when prices are falling because costs of production are falling,
the price fall does not endanger profit margins or employment.
And bound up with these is still another major fallacy.
So Keynes has poured more derision on Ricardo than perhaps on any other economist.
He has himself adopted a primitive, Ricardian cost-of-production theory of prices, according
to which a nation can artificially hold up its price level by holding up its wage level
p. 268 and 271.
To explain this fallacy, after Menger, Jevons, Boehm-Bawerk, Wickstede, Knight, Mises, would
take too long.
It is better to refer the Keynesians to some good modern textbook.
Nor shall I go at length into the reasons why unemployment is not caused, as Keynes
Mises insists primarily by maladjustments between the rate of interest, the marginal
efficiency of capital and investment.
It is sufficient to point out not only that his theory of interest is completely false,
but that interest rates are extremely fluid and flexible, that they are determined by
full competition among lenders as well as borrowers, and are not held rigid by compulsory
Collective Bargaining, Union Monopolies and Mass Picket Lines.
It is more instructive to inquire why Keynes put forward this extremely complicated and
implausible theory.
And here we may have to answer that, citing as he did with the immemorial labor union
insistence that employment is not caused by excessive wage rates, he had to come up with
some theory as to what does cause it.
And as he couldn't blame the labor union leaders, what more natural and politically
convenient than to blame the moneylenders, the creditors and the rich?
Like Marxism, this is a class theory of the business cycle, a class theory of unemployment.
As in Marxism, the capitalists become the scapegoats, with the sole difference that
the chief villains are the moneylenders rather than the employers.
And that, I suspect, rather than any new discoveries of technical analysis, is the real secret
of the tremendous vogue of the general theory.
It is the 20th century's Das Kapital.