What Keynes Meant by "Involuntary Unemployment"

Robert Waldmann

Mark Thoma linked to a post at my personal blog about the history of economic thought 101, what did Keynes write in “The General Theory of Employment, Interest and Money.” So I guess my next effort at humiliatingly elementary history of thought should be here. After the jump.

When contemporary economists speak of “involuntary unemployment” we mean that there are three agents, a worker, an unemployed person and an employer, that the unemployed person would be glad to work for a wage lower (perhaps slightly lower) than the one paid to the worker and the employer would be glad to employ the unemployed person at that lower wage (perhaps laying of the worker). With this definition, involuntary unemployment can occur because labor unions force employers to pay a high wage even if there are people who would accept a lower wage. This case is an example of the “Insider/outsider” model of involuntary unemployment.

Keynes meant something else. He would have called that unemployment voluntary because “labour as a whole” or the workers or the working class were unwilling to supply labour at a lower wage. Not being Scott Sumner and not being willing to accuse Paul Krugman of intellectual dishonesty under the assumption that the links he puts in his posts ar purely decorative, I shall click Krugman’s link.

Here Keynes is explaining what he calls “the classical theory.”

the fact that the population generally is seldom doing as much work as it would like to do on the basis of the current wage? For, admittedly, more labour would, as a rule, be forthcoming at the existing money-wage if it were demanded. The classical school reconcile this phenomenon with their second postulate by arguing that, while the demand for labour at the existing money-wage may be satisfied before everyone willing to work at this wage is employed, this situation is due to an open or tacit agreement amongst workers not to work for less, and that if labour as a whole would agree to a reduction of money-wages more employment would be forthcoming. If this is the case, such unemployment, though apparently involuntary, is not strictly so, and ought to be included under the above category of ‘voluntary’ unemployment due to the effects of collective bargaining, etc.

So to Keynes unemployment due to nominal wage rigidity and unemployment due to collective bargaining were ‘voluntary’ unemployment. The quotes are not scare quotes. He is quoting other economists (principally Pigou) and he uses the word with that sense throughout The General Theory of Employment, Interest, and Money.

This means that self declared “New Keynesians” would be called “classicals” by Keynes.

Keynes argued that there can be cases in which “labour as a whole” can’t obtain more employment by agreeing to a reduction of money-wages (what we call nominal wages). Basically he argues (assumes really) that firms will cut prices if workers accept lower wages (he definitely assumed flexible prices and basically pretty much assumed perfect competition in product markets). So the immediate effect of the lower nominal wage would be the same real wage and a lower price level. The effect of this is equivalent to the effect of an increase in the money supply. The increase of the money supply won’t cause increased employment if the economy is in a liquidity trap.

So far Keynes has presented a general theory which really isn’t all that much more general. He would just say that the arguments which he called classical require the qualifier “so long as the economy isn’t in a liquidity trap, that is so long as safe short term interest rates aren’t essentially zero” and then consider the other case.

This isn’t the end of the story. For one thing, if a small open economy is on the gold standard, the money supply can automatically shrink when the price level falls so the real money supply stays the same (oddly exactly this point was very much stressed by Sumner once). For another, even without a gold standard a central bank which targets nominal interest rates will respond to the reduction of the price level by reducing the money supply. This can imply that downward wage flexibility causes reduced employment as it causes deflation which means that the constant nominal interest rate corresponds to a higher real interest rate and lower investment for given GDP growth.

However, it shows reckless disregard for the truth to claim that what Keynes wrote about the classicals was dishonest, because those classicals were essentially New Keynesians. It is equally reckless to say that what Krugman wrote “the other side in this debate generally adheres, more or less, to something like what Keynes called the “classical theory” of employment, in which employment and output are basically determined by the supply side. ” is dishonest.

He specified that he meant what Keynes called “the classical theory” making it clear to anyone with normal linguistic skills (including Gricean maxims) that other people use the phrase with another meaning. And that and gave a link which no one could be expected to actually click since Krugman has only occasionally stressed that the links are not decorative (indeed maybe only once).

Now everyone is sloppy sometimes. But Sumner was reckless and sloppy when accusing others of intellectual integrity and has earned some quiet time.

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