Index | What's New | Links | Introduction | Bibliography

PDF version of Section C.

C.9 Would laissez-faire capitalism reduce unemployment?

In order to answer this question, we must first have to point out that "actually existing capitalism" tries to manage unemployment to ensure a compliant and servile working class. This is done under the name of fighting "inflation" but, in reality, it about controlling wages and maintaining high profit rates for the capitalist class. Market discipline for the working class, state protection for the ruling class, in other words. As Edward Herman points out:

"Conservative economists have even developed a concept of a 'natural rate of unemployment,' a metaphysical notion and throwback to an eighteenth century vision of a 'natural order,' but with a modern apologetic twist. The natural rate is defined as the minimum unemployment level consistent with price level stability, but, as it is based on a highly abstract model that is not directly testable, the natural rate can only be inferred from the price level itself. That is, if prices are going up, unemployment is below the 'natural rate' and too low, whether the actual rate is 4, 8, or 10 percent. In this world of conservative economics, anybody is 'voluntarily' unemployed. Unemployment is a matter of rational choice: some people prefer 'leisure' over the real wage available at going (or still lower) wage rates . . .

"Apart from the grossness of this kind of metaphysical legerdemain, the very concept of a natural rate of unemployment has a huge built-in bias. It takes as granted all the other institutional factors that influence the price level-unemployment trade-off (market structures and independent pricing power, business investment policies at home and abroad, the distribution of income, the fiscal and monetary mix, etc.) and focuses solely on the tightness of the labour market as the controllable variable. Inflation is the main threat, the labour market (i.e. wage rates and unemployment levels) is the locus of the solution to the problem." [Beyond Hypocrisy, p. 94]

Unsurprisingly, Herman defines this "natural" rate as "the rate of unemployment preferred by the propertied classes." [Op. Cit., p. 156] The theory behind this is usually called the "Non-Accelerating Inflation Rate of Unemployment" (or NAIRU). Like many of the worse aspects of modern economics, the concept was raised Milton Friedman in the late 1960s. At around the same time, Edmund Phelps independently developed the theory (and gained the so-called "Nobel Prize" in economics for so doing in 2006). Both are similar and both simply repeat, in neo-classical jargon, the insight which critics of capitalism had argued for over a century: unemployment is a necessary aspect of capitalism for it is essential to maintaining the power of the boss over the worker. Ironically, therefore, modern neo-classical economics is based on a notion which it denied for over a century (this change may be, in part, because the ruling elite thinks it has won the class war and has, currently, no major political and social movements it has to refute by presenting a rosy picture of the system).

Friedman raised his notion of a "Natural Rate of Unemployment" in 1968. He rooted it in the neo-classical perspective of individual expectations rather than, say, the more realistic notion of class conflict. His argument was simple. There exists in the economy some "natural" rate associated with the real wage an ideal economy would produce (this is "the level that would be ground out by the Walrasian system of general equilibrium equations," to quote him). Attempts by the government to reduce actual unemployment below this level would result in rising inflation. This is because there would be divergence between the actual rate of inflation and its expected rate. By lowering unemployment, bosses have to raise wages and this draws unemployed people into work (note the assumption that unemployment is voluntary). However, rising wages were passed on by bosses in rising prices and so the real wage remains the same. This eventually leads to people leaving the workforce as the real wage has fallen back to the previous, undesired, levels. However, while the unemployment level rises back to its "natural" level, inflation does not. This is because workers are interested in real wages and, so if inflation is at, say, 2% then they will demand wage increases that take this into account. If they expect inflation to increase again then workers will demand more wages to make up for it, which in turn will cause prices to rise (although Friedman downplayed that this was because bosses were increasing their prices to maintain profit levels). This will lead to rising inflation and rising unemployment. Thus the expectations of individuals are the key.

For many economists, this process predicted the rise of stagflation in the 1970s and gave Friedman's Monetarist dogmas credence. However, this was because the "Bastard Keynesianism" of the post-war period was rooted in the same neo-classical assumptions used by Friedman. Moreover, they had forgotten the warnings of left-wing Keynesians in the 1940s that full unemployment would cause inflation as bosses would pass on wage rises onto consumers. This class based analysis, obviously, did not fit in well with the panglossian assumptions of neo-classical economics. Yet basing an analysis on individual expectations does not answer the question whether these expectations are meet. With strong organisation and a willingness to act, workers can increase their wages to counteract inflation. This means that there are two main options within capitalism. The first option is to use price controls to stop capitalists increasing their prices. However, this contradicts the scared laws of supply and demand and violates private property. Which brings us to the second option, namely to break unions and raise unemployment to such levels that workers think twice about standing up for themselves. In this case, workers cannot increase their money wages and so their real wages drop.

Guess which option the capitalist state went for? As Friedman made clear when he introduced the concept there was really nothing "natural" about the natural rate theory as it was determined by state policy:

"I do not mean to suggest that it is immutable and unchangeable. On the contrary, many of the market characteristics that determine its level are man-made and policy-made. In the United States, for example, legal minimum wage rates . . . and the strength of labour unions all make the natural rate of unemployment higher than it would otherwise be." ["The Role of Monetary Policy," pp. 1-17, American Economic Review, Vol. 68, No. 1, p. 9]

Thus the "natural" rate is really a social and political phenomenon which, in effect, measures the bargaining strength of working people. This suggests that inflation will fall when working class people are in no position to recoup rising prices in the form of rising wages. The "Natural Rate" is, in other words, about class conflict.

This can be seen when the other (independent) inventor of the "natural" rate theory won the so-called Nobel prize in 2006. Unsurprisingly, the Economist magazine was cock-a-hoop. ["A natural choice: Edmund Phelps earns the economics profession's highest accolade", Oct 12th 2006] The reasons why became clear. According to the magazine, "Phelps won his laurels in part for kicking the feet from under his intellectual forerunners" by presenting a (neo-classical) explanation for the breakdown of the so-called "Phillips curve." This presented a statistical trade-off between inflation and unemployment ("unemployment was low in Britain when wage inflation was high, and high when inflation was low"). The problem was that economists "were quick -- too quick -- to conclude that policymakers therefore faced a grand, macroeconomic trade-off" in which, due to "such a tight labour market, companies appease workers by offering higher wages. They then pass on the cost in the form of dearer prices, cheating workers of a higher real wage. Thus policy makers can engineer lower unemployment only through deception." Phelps innovation was to argue that "[e]ventually workers will cotton on, demanding still higher wages to offset the rising cost of living. They can be duped for as long as inflation stays one step ahead of their rising expectations of what it will be." The similarities with Friedman's idea are obvious. This meant that the "stable trade-off depicted by the Phillips curve is thus a dangerous mirage" which broke down in the 1970s with the rise of stagflation.

Phelps argued that there was a "natural" rate of unemployment, where "workers' expectations are fulfilled, prices turn out as anticipated, and they no longer sell their labour under false pretences." This "equilibrium does not, sadly, imply full employment" and so capitalism required "leaving some workers mouldering on the shelf. Given economists' almost theological commitment to the notion that markets clear, the presence of unemployment in the world requires a theodicy to explain it." The religious metaphor does seem appropriate as most economists (and The Economist) do treat the market like a god (a theodicy is a specific branch of theology and philosophy that attempts to reconcile the existence of evil in the world with the assumption of a benevolent God). And, as with all gods, sacrifices are required and Phelps’ theory is the means by which this is achieved. As the magazine noted: "in much of his work he contends that unemployment is necessary to cow workers, ensuring their loyalty to the company and their diligence on the job, at a wage the company can afford to pay" (i.e., one which would ensure a profit).

It is this theory which has governed state policy since the 1980s. In other words, government's around the world have been trying to "cow workers" in order to ensure their obedience ("loyalty to the company"). Unsurprisingly, attempts to lower the "natural rate" have all involved using the state to break the economic power of working class people (attacking unions, increasing interest rates to increase unemployment in order to temporarily "cow" workers and so on). All so that profits can be keep high in the face of the rising wages caused by the natural actions of the market!

Yet it must be stressed that Friedman's and Phelps' conclusions are hardly new. Anarchists and other socialists had been arguing since the 1840s that capitalism had no tendency to full employment either in theory or in practice. They have also noted how periods of full employment bolstered working class power and harmed profits. It is, as we stressed in section C.1.5, the fundamental disciplinary mechanism of the system. Somewhat ironically, then, Phelps got bourgeois economics highest prize for restating, in neo-classical jargon, the model of the labour market expounded by, say, Marx:

"If [capital’s] accumulation on the one hand increases the demand for labour, it increases on the other the supply of workers by 'setting them free', while at the same time the pressure of the unemployed compels those that are employed to furnish more labour, and therefore makes the supply of labour to a certain extent independent of the supply of labourers. The movement of the law of supply and demand of labour on this basis completes the despotism of capital. Thus as soon as the workers learn the secret of why it happens that the more they work, the more alien wealth they produce . . . as soon as, by setting up trade unions, etc., they try to organise a planned co-operation between employed and unemployed in order to obviate or to weaken the ruinous effects of this natural law of capitalistic production on their class, so soon capital and its sycophant, political economy, cry out at the infringement of the 'eternal' and so to speak 'sacred' law of supply and demand. Every combination of employed and unemployed disturbs the 'pure' action of this law. But on the other hand, as soon as . . . adverse circumstances prevent the creation of an industrial reserve army and, with it, the absolute dependence of the working-class upon the capitalist class, capital, along with its platitudinous Sancho Panza, rebels against the 'sacred' law of supply and demand, and tries to check its inadequacies by forcible means." [Capital, Vol. 1, pp. 793-4]

That the Economist and Phelps are simply echoing, and confirming, Marx is obvious. Modern economics, while disparaging Marx, has integrated this idea into its macro-economic policy recommendations by urging the state to manipulate the economy to ensure that "inflation" (i.e. wage rises) are under control. Economics has played its role of platitudinous sycophant well while Phelps' theory has informed state interference ("forcible means") in the economy since the 1980s, with the expected result that wages have failed to keep up with rising productivity and so capital as enriched itself at the expense of labour (see section C.3 for details). The use of Phelps' theory by capital in the class war is equally obvious -- as was so blatantly stated by The Economist and the head of the American Federal Reserve during this period:

"there's supporting testimony from Alan Greenspan. Several times during the late 1990s, Greenspan worried publicly that, as unemployment drifted steadily lower the 'pool of available workers' was running dry. The dryer it ran, the greater risk of 'wage inflation,' meaning anything more than minimal increases. Productivity gains took some of the edge of this potentially dire threat, said Greenspan, and so did 'residual fear of job skill obsolescence, which has induced a preference for job security over wage gains' . . . Workers were nervous and acting as if the unemployment rate were higher than the 4% it reached in the boom. Still, Greenspan was a bit worried, because . . . if the pool stayed dry, 'Significant increases in wages, in excess of productivity growth, [would] inevitably emerge, absent the unlikely repeal of the law of supply and demand.' Which is why Greenspan & Co. raised short-term interest rates by about two points during 1999 and the first half of 2000. There was no threat of inflation . . . nor were there any signs of rising worker militancy. But wages were creeping higher, and the threat of the sack was losing some of its bite." [Doug Henwood, After the New Economy, pp. 206-7]

Which is quite ironic, given that Greenspan's role in the economy was, precisely, to "repeal" the "law of supply and demand." As one left-wing economist puts it (in a chapter correctly entitled "The Workers Are Getting Uppity: Call In the Fed!"), the Federal Reverse (like all Central Banks since the 1980s) "worries that if too many people have jobs, or if it is too easy for workers to find jobs, there will be upward pressure on wages. More rapid wage growth can get translated into more rapidly rising prices -- in other words, inflation. So the Fed often decides to raise interest rates to slow the economy and keep people out of work in order to keep inflation from increasing and eventually getting out of control." However, "[m]ost people probably do not realise that the Federal Reserve Board, an agency of the government, intervenes in the economy to prevent it from creating too many jobs. But there is even more to the story. When the Fed hits the brakes to slow job growth, it is not doctors, lawyers, and CEOs who end up without jobs. The people who lose are those in the middle and the bottom -- sales clerks, factory workers, custodians, and dishwashers. These are the workers who don’t get hired or get laid off when the economy slows or goes into a recession." [The Conservative Nanny State, p. 31] Thus the state pushes up unemployment rates to slow wage growth, and thereby relieve inflationary pressure. The reason should be obvious:

"In periods of low unemployment, workers don't only gain from higher wages. Employers must make efforts to accommodate workers' various needs, such as child care or flexible work schedules, because they know that workers have other employment options. The Fed is well aware of the difficulties that employers face in periods of low unemployment. It compiles a regular survey, called the 'Beige Book,' of attitudes from around the country about the state of the economy. Most of the people interviewed for the Beige Book are employers.

"From 1997 to 2000, when the unemployment rate was at its lowest levels in 30 years, the Beige Book was filled with complaints that some companies were pulling workers from other companies with offers of higher wages and better benefits. Some Beige Books reported that firms had to offer such non-wage benefits as flexible work hours, child care, or training in order to retain workers. The Beige Books give accounts of firms having to send buses into inner cities to bring workers out to the suburbs to work in hotels and restaurants. It even reported that some employers were forced to hire workers with handicaps in order to meet their needs for labour.

"From the standpoint of employers, life is much easier when the workers are lined up at the door clamouring for jobs than when workers have the option to shop around for better opportunities. Employers can count on a sympathetic ear from the Fed. When the Fed perceives too much upward wage pressure, it slams on the brakes and brings the party to an end. The Fed justifies limiting job growth and raising the unemployment rate because of its concern that inflation may get out of control, but this does not change the fact that it is preventing workers, and specifically less-skilled workers, from getting jobs, and clamping down on their wage growth." [Op. Cit., pp. 32-3]

This has not happened by accident. Lobbying by business, as another left-wing economist stresses, "is directed toward increasing their economic power" and business "has been a supporter of macroeconomic policies that have operated the economy with higher rates of unemployment. The stated justification is that this lowers inflation, but it also weakens workers' bargaining power." Unsurprisingly, "the economic consequence of the shift in the balance of power in favour of business . . . has served to redistribute income towards profits at the expense of wages, thereby lowering demand and raising unemployment." In effect, the Federal Reserve "has been using monetary policy as a form of surrogate incomes policy, and this surrogate policy has been tilted against wages in favour of profits" and so is regulating the economy "in a manner favourable to business." [Thomas I. Palley, Plenty of Nothing, p. 77, p. 111 and pp. 112-3] That this is done under the name of fighting inflation should not fool us:

"Mild inflation is often an indication that workers have some bargaining strength and may even have the upper hand. Yet, it is at exactly this stage that the Fed now intervenes owning to its anti-inflation commitment, and this intervention raises interest rates and unemployment. Thus, far from being neutral, the Fed's anti-inflation policy implies siding with business in the ever-present conflict between labour and capital over distribution of the fruits of economic activity . . . natural-rate theory serves as the perfect cloak for a pro-business policy stance." [Op. Cit., p. 110]

In a sense, it is understandable that the ruling class within capitalism desires to manipulate unemployment in this way and deflect questions about their profit, property and power onto the state of the labour market. High prices can, therefore, be blamed on high wages rather than high profits, rents and interest while, at the same time, workers will put up with lower hours and work harder and be too busy surviving to find the time or the energy to question the boss's authority either in theory or in practice. So managing the economy by manipulating interest rates to increase unemployment levels when required allows greater profits to be extracted from workers as management hierarchy is more secure. People will put up with a lot in the face of job insecurity. As left-wing economist Thomas Balogh put it, full employment "generally removes the need for servility, and thus alters the way of life, the relationship between classes . . . weakening the dominance of men over men, dissolving the master-servant relation. It is the greatest engine for the attainment by all of human dignity and greater equality." [The Irrelevance of Conventional Economics, p. 47]

Which explains, in part, why the 1960s and 1970s were marked by mass social protest against authority rather than von Hayek's "Road to Serfdom." It also explains why the NAIRU was so enthusiastically embraced and applied by the ruling class. When times are hard, workers with jobs think twice before standing up to their bosses and so work harder, for longer and in worse conditions. This ensures that surplus value is increased relative to wages (indeed, in the USA, real wages have stagnated since 1973 while profits have grown massively). In addition, such a policy ensures that political discussion about investment, profits, power and so on ("the other institutional factors") are reduced and diverted because working class people are too busy trying to make ends meet. Thus the state intervenes in the economy to stop full employment developing to combat inflation and instability on behalf of the capitalist class.

That this state manipulation is considered consistent with the "free market" says a lot about the bankruptcy of the capitalist system and its defenders. But, then, for most defenders of the system state intervention on behalf of capital is part of the natural order, unlike state intervention (at least in rhetoric) on behalf of the working class (and shows that Kropotkin was right to stress that the state never practices "laissez-faire" with regard to the working class -- see section D.1). Thus neo-liberal capitalism is based on monetary policy that explicitly tries to weaken working class resistance by means of unemployment. If "inflation" (i.e. labour income) starts to increase, interest rates are raised so causing unemployment and, it is hoped, putting the plebes back in their place. In other words, the road to private serfdom has been cleared of any barriers imposed on it by the rise of the working class movement and the policies of social democracy implemented after the Second World War to stop social revolution. This is the agenda pursued so strongly in America and Britain, imposed on the developing nations and urged upon Continental Europe.

Although the aims and results of the NAIRU should be enough to condemn it out of hand, it can be dismissed for other reasons. First and foremost, this "natural" rate is both invisible and can move. This means trying to find it is impossible (although it does not stop economists trying, and then trying again when rate inflation and unemployment rates refute the first attempt, and then trying again and again). In addition, it is a fundamentally a meaningless concept -- you can prove anything with an invisible, mobile value -- it is an non-refutable concept and so, fundamentally, non-scientific. Close inspection reveals natural rate theory to be akin to a religious doctrine. This is because it is not possible to conceive of a test that could possibly falsify the theory. When predictions of the natural rate turn out wrong (as they repeatedly have), proponents can simply assert that the natural rate has changed. That has led to the most recent incarnation of the theory in which the natural rate is basically the trend rate of unemployment. Whatever trend is observed is natural -- case closed.

Since natural rate theory cannot be tested, a sensible thing would be to examine its assumptions for plausibility and reasonableness. However, Milton Friedman’s early work on economic methodology blocks this route as he asserted that realism and plausibility of assumptions have no place in economics. With most economists blindly accepting this position, the result is a church in which entry is conditional on accepting particular assumptions about the working of markets. The net effect is to produce an ideology, an ideology which survives due to its utility to certain sections of society.

If this is the case, and it is, then any attempts to maintain the "natural" rate are also meaningless as the only way to discover it is to watch actual inflation levels and raising interest rates appropriately. Which means that people are being made unemployed on the off-chance that the unemployment level will drop below the (invisible and mobile) "natural" rate and harm the interests of the ruling class (high inflation rates harms interest incomes and full employment squeezes profits by increasing workers' power). This does not seem to bother most economists, for whom empirical evidence at the best of times is of little consequence. This is doubly true with the NAIRU, for with an invisible, mobile value, the theory is always true after the fact -- if inflation rises as unemployment rises, then the natural rate has increased; if inflation falls as unemployment rises, it has fallen! As post-Keynesian economist James K. Galbraith noted in his useful critique of the NAIRU, "as the real unemployment rate moves, the apparent NAIRU moves in its shadow" and its "estimates and re-estimates seem largely a response to predictive failure. We still have no theory, and no external evidence, governing the fall of the estimated NAIRU. The literature simply observes that inflation hasn't occurred and so the previous estimate must have been too high." He stresses, economists have held "to a concept in the face of twenty years of unexplained variation, predictive failure, and failure of the profession to coalesce on procedural issues." [Created Unequal, p. 180] Given that most mainstream economists subscribe to this fallacy, it just shows how the "science" accommodates itself to the needs of the powerful and how the powerful will turn to any old nonsense if it suits their purpose. A better example of supply and demand for ideology could not be found.

So, supporters of "free market" capitalism do have a point, "actually existing capitalism" has created high levels of unemployment. What is significant is that most supporters of capitalism consider that this is a laissez-faire policy! Sadly, the ideological supporters of pure capitalism rarely mention this state intervention on behalf of the capitalist class, preferring to attack trade unions, minimum wages, welfare and numerous other "imperfections" of the labour market which, strangely, are designed (at least in rhetoric) to benefit working class people. Ignoring that issue, however, the question now arises, would a "purer" capitalism create full employment?

First, we should point out that some supporters of "free market" capitalism (most notably, the "Austrian" school) claim that real markets are not in equilibrium at all, i.e. that the nature state of the economy is one of disequilibrium. As we noted in section C.1.6, this means full employment is impossible as this is an equilibrium position but few explicitly state this obvious conclusion of their own theories and claim against logic that full employment can occur (full employment, it should be stressed, has never meant 100% employment as they will always be some people looking for a job and so by that term we mean close to 100% employment). Anarchists agree: full employment can occur in "free market" capitalism but not for ever nor even for long periods. As the Polish socialist economist Michal Kalecki pointed out in regards to pre-Keynesian capitalism, "[n]ot only is there mass unemployment in the slump, but average employment throughout the cycle is considerably below the peak reached in the boom. The reserve of capital equipment and the reserve army of unemployed are typical features of capitalist economy at least throughout a considerable part of the [business] cycle." [quoted by Malcolm C. Sawyer, The Economics of Michal Kalecki, pp. 115-6]

It is doubtful that "pure" capitalism will be any different. This is due to the nature of the system. What is missing from the orthodox analysis is an explicit discussion of class and class struggle (implicitly, they are there and almost always favour the bosses). Once this is included, the functional reason for unemployment becomes clear. It serves to discipline the workforce, who will tolerate being bossed about much more with the fear that unemployment brings. This holds down wages as the threat of unemployment decreases the bargaining power of workers. This means that unemployment is not only a natural product of capitalism, it is an essential part of it.

So cycles of short periods approaching full employment and followed by longer periods of high unemployment are actually a more likely outcome of pure capitalism than continued full employment. As we argued in sections C.1.5 and C.7.1 capitalism needs unemployment to function successfully and so "free market" capitalism will experience periods of boom and slump, with unemployment increasing and decreasing over time (as can be seen from 19th century capitalism). So as Juliet Schor, a labour economist, put it, usually "employers have a structural advantage in the labour market, because there are typically more candidates ready and willing to endure this work marathon [of long hours] than jobs for them to fill." Under conditions of full-employment "employers are in danger of losing the upper hand" and hiring new workers "suddenly becomes much more difficult. They are harder to find, cost more, and are less experienced." These considerations "help explain why full employment has been rare." Thus competition in the labour market is "typically skewed in favour of employers: it is a buyers market. And in a buyer's market, it is the sellers who compromise." In the end, workers adapt to this inequality of power and instead of getting what they want, they want what they get (to use Schor's expression). Under full employment this changes. In such a situation it is the bosses who have to start compromising. And they do not like it. As Schor notes, America "has never experienced a sustained period of full employment. The closest we have gotten is the late 1960s, when the overall unemployment rate was under 4 percent for four years. But that experience does more to prove the point than any other example. The trauma caused to business by those years of a tight labour market was considerable. Since then, there has been a powerful consensus that the nation cannot withstand such a low rate of unemployment." Hence the support for the NAIRU to ensure that "forced idleness of some helps perpetuate the forced overwork of others." [The Overworked American, p. 71, p. 75, p. 129, pp. 75-76 and p. 76]

So, full employment under capitalism is unlikely to last long (nor would full employment booms fill a major part of the business cycle). In addition, it should be stressed that the notion that capitalism naturally stays at equilibrium or that unemployment is temporary adjustments is false, even given the logic of capitalist economics. As Proudhon argued:

"The economists admit it [that machinery causes unemployment]: but here they repeat their eternal refrain that, after a lapse of time, the demand for the product having increased in proportion to the reduction in price [caused by the investment], labour in turn will come finally to be in greater demand than ever. Undoubtedly, with time, the equilibrium will be restored; but I must add again, the equilibrium will be no sooner restored at this point than it will be disturbed at another, because the spirit of invention never stops." [System of Economical Contradictions, pp. 200-1]

That capitalism creates permanent unemployment and, indeed, needs it to function is a conclusion that few, if any, pro-"free market" capitalists subscribe to. Faced with the empirical evidence that full employment is rare in capitalism, they argue that reality is not close enough to their theories and must be changed (usually by weakening the power of labour by welfare "reform" and reducing "union power"). Thus reality is at fault, not the theory (to re-quote Proudhon, "Political economy -- that is, proprietary despotism -- can never be in the wrong: it must be the proletariat." [Op. Cit. p. 187]) So if unemployment exists, then its because real wages are too high, not because capitalists need unemployment to discipline labour (see section C.9.2 for evidence that this argument is false). Or if real wages are falling as unemployment is rising, it can only mean that the real wage is not falling fast enough -- empirical evidence is never enough to falsify logical deductions from assumptions!

(As an aside, it is one of amazing aspects of the "science" of economics that empirical evidence is never enough to refute its claims. As the Post-Keynesian economist Nicholas Kaldor once pointed out, "[b]ut unlike any scientific theory, where the basic assumptions are chosen on the basis of direct observation of the phenomena the behaviour of which forms the subject-matter of the theory, the basic assumptions of economic theory are either of a kind that are unverifiable. . . or of a kind which are directly contradicted by observation." [Further Essays on Applied Economics, pp. 177-8])

Of course, reality often has the last laugh on any ideology. For example, since the late 1970s and early 1980s right-wing capitalist parties have taken power in many countries across the world. These regimes made many pro-free market reforms, arguing that a dose of market forces would lower unemployment, increase growth and so on. The reality proved somewhat different. For example, in the UK, by the time the Labour Party under Tony Blair come back to office in 1997, unemployment (while falling) was still higher than it had been when the last Labour government left office in 1979 (this in spite of repeated redefinitions of unemployment by the Tories in the 1980s to artifically reduce the figures). 18 years of labour market reform had not reduced unemployment even under the new definitions. This outcome was identical to New Zealand's neo-liberal experiment, were its overall effect was unimpressive, to say the least: lower growth, lower productivity and feeble real wage increases combined with rising inequality and unemployment. Like the UK, unemployment was still higher in 1997 than it had been in 1979. Over a decade of "flexible" labour markets had increased unemployment (more than doubling it, in fact, at one point as in the UK under Thatcher). It is no understatement to argue, in the words of two critics of neo-liberalism, that the "performance of the world economy since capital was liberalised has been worse than when it was tightly controlled" and that "[t]hus far, [the] actual performance [of liberalised capitalism] has not lived up to the propaganda." [Larry Elliot and Dan Atkinson, The Age of Insecurity, p. 274 and p. 223] In fact, as Palley notes, "wage and income growth that would have been deemed totally unsatisfactory a decade ago are now embraced as outstanding economic performance." [Op. Cit., p. 202]

Lastly, it is apparent merely from a glance at the history of capitalism during its laissez-faire heyday in the 19th century that "free" competition among workers for jobs does not lead to full employment. Between 1870 and 1913, unemployment was at an average of 5.7% in the 16 more advanced capitalist countries. This compares to an average of 7.3% in 1913-50 and 3.1% in 1950-70. [Takis Fotopoulos, "The Nation-State and the Market", pp. 37-80, Society and Nature, Vol. 2, No. 2, p. 61] If laissez-faire did lead to full employment, these figures would, surely, be reversed.

As discussed above, full employment cannot be a fixed feature of capitalism due to its authoritarian nature and the requirements of production for profit. To summarise, unemployment has more to do with private property than the wages of our fellow workers or any social safety nets working class movements have managed to pressure the ruling class to accept. However, it is worthwhile to discuss why the "free market" capitalist is wrong to claim that unemployment within their system will not exist for long periods of time. In addition, to do so will also indicate the poverty of their theory of, and "solution" to, unemployment and the human misery they would cause. We do this in the next section.

C.9.1 Would cutting wages reduce unemployment?

The "free market" capitalist (i.e., neo-classical, neo-liberal or "Austrian") argument is that unemployment is caused by the real wage of labour being higher than the market clearing level. The basic argument is that the market for labour is like any other market and as the price of a commodity increases, the demand for it falls. In terms of labour, high prices (wages) causes lower demand (unemployment). Workers, it is claimed, are more interested in money wages than real wages (which is the amount of goods they can buy with their money wages). This leads them to resist wage cuts even when prices are falling, leading to a rise in their real wages and so they price themselves out of work without realising it. From this analysis comes the argument that if workers were allowed to compete 'freely' among themselves for jobs, real wages would decrease and so unemployment would fall. State intervention (e.g. unemployment benefit, social welfare programmes, legal rights to organise, minimum wage laws, etc.) and labour union activity are, according to this theory, the cause of unemployment, as such intervention and activity forces wages above their market level and so force employers to "let people go." The key to ending unemployment is simple: cut wages.

This position was brazenly put by "Austrian" economist Murray Rothbard. He opposed any suggestion that wages should not be cut as the notion that "the first shock of the depression must fall on profits and not on wages." This was "precisely the reverse of sound policy since profits provide the motive power for business activity." [America's Great Depression, p. 188] Rothbard's analysis of the Great Depression is so extreme it almost reads like a satirical attack on the laissez-faire position as his hysterical anti-unionism makes him blame unions for the depression for, apparently, merely existing (even in an extremely weakened state) for their influence was such as to lead economists and the President to recommend to numerous leading corporate business men not to cut wages to end the depression (wages were cut, but not sufficiently as prices also dropped as we will discuss in the next section). It should be noted that Rothbard takes his position on wage cutting despite of an account of the business cycle rooted in bankers lowering interest rates and bosses over-investing as a result (see section C.8). So despite not setting interest rates nor making investment decisions, he expected working class people to pay for the actions of bankers and capitalists by accepting lower wages! Thus working class people must pay the price of the profit seeking activities of their economic masters who not only profited in good times, but can expect others to pay the price in bad ones. Clearly, Rothbard took the first rule of economics to heart: the boss is always right.

The chain of logic in this explanation for unemployment is rooted in many of the key assumptions of neo-classical and other marginalist economics. A firm's demand for labour (in this schema) is the marginal physical product of labour multiplied by the price of the output and so it is dependent on marginal productivity theory. It is assumed that there are diminishing returns and marginal productivity as only this produces a downward-sloping labour demand curve. For labour, it is assumed that its supply curve is upwards slopping. So it must be stressed that marginal productivity theory lies at the core of "free market" capitalist theories of output and distribution and so unemployment as the marginal product of labour is interpreted as the labour demand curve. This enforces the viewpoint that unemployment is caused by wages being too high as firms adjust production to bring the marginal cost of their products (the cost of producing one more item) into equality with the product's market-determined price. So a drop in labour costs theoretically leads to an expansion in production, producing jobs for the "temporarily" unemployed and moving the economy toward full-employment. So, in this theory, unemployment can only be reduced by lowering the real wages of workers currently employed. Thus the unfettered free market would ensure that all those who want to work at the equilibrium real wage will do so. By definition, any people who were idle in such a pure capitalism would be voluntarily enjoying leisure and not unemployed. At worse, mass unemployment would be a transitory disturbance which will quickly disappear if the market is flexible enough and there are no imperfections in it (such as trade unions, workers' rights, minimum wages, and so on).

Sadly for these arguments, the assumptions required to reach it are absurd as the conclusions (namely, that there is no involuntary unemployment as markets are fully efficient). More perniciously, when confronted with the reality of unemployment, most supporters of this view argue that it arises only because of government-imposed rigidities and trade unions. In their "ideal" world without either, there would, they claim, be no unemployment. Of course, it is much easier to demand that nothing should be done to alleviate unemployment and that workers' real wages be reduced when you are sitting in a tenured post in academia save from the labour market forces you wish others to be subjected to (in their own interests).

This perspective suffered during the Great Depression and the threat of revolution produced by persistent mass unemployment meant that dissident economists had space to question the orthodoxy. At the head of this re-evaluation was Keynes who presented an alternative analysis and solution to the problem of unemployment in his 1936 book The General Theory of Employment, Interest and Money (it should be noted that the Polish socialist economist Michal Kalecki independently developed a similar theory a few years before Keynes but without the neo-classical baggage Keynes brought into his work).

Somewhat ironically, given the abuse he has suffered at the hands of the right (and some of his self-proclaimed followers), Keynes took the assumptions of neo-classical economics on the labour market as the starting point of his analysis. As such, critics of Keynes's analysis generally misrepresent it. For example, right-liberal von Hayek asserted that Keynes "started from the correct insight that the regular cause of extensive unemployment is real wages that are too high. The next step consisted in the proposition that a direct lowering of money wages could be brought about only by a struggle so painful and prolonged that it could not be contemplated. Hence he concluded that real wages must be lowered by the process of lowering the value of money," i.e. by inflation. Thus "the supply of money must be so increased as to raise prices to a level where the real value of the prevailing money wage is no longer greater than the productivity of the workers seeking employment." [The Constitution of Liberty, p. 280] This is echoed by libertarian Marxist Paul Mattick who presented an identical argument, stressing that for Keynes "wages were less flexible than had been generally assumed" and lowering real wages by inflation "allowed for more subtle ways of wage-cutting than those traditionally employed." [Marx and Keynes, p. 7]

Both are wrong. These arguments are a serious distortion of Keynes's argument. While he did start by assuming the neo-classical position that unemployment was caused by wages being too high, he was at pains to stress that even with ideally flexible labour markets cutting real wages would not reduce unemployment. As such, Keynes argued that unemployment was not caused by labour resisting wage cuts or by "sticky" wages. Indeed, any "Keynesian" economist who does argue that "sticky" wages are responsible for unemployment shows that he or she has not read Keynes -- Chapter two of the General Theory critiques precisely this argument. Taking neo-classical economists at its word, Keynes analyses what would happen if the labour market were perfect and so he assumes the same model as his neo-classical opponents, namely that unemployment is caused by wages being too high and there is flexibility in both commodity and labour markets. As he stressed, his "criticism of the accepted [neo-]classical theory of economics has consisted not so much in finding logical flaws in its analysis as in pointing out that its tacit assumptions are seldom or never satisfied, with the result that it cannot solve the economic problems of the actual world." [The General Theory, p. 378]

What Keynes did was to consider the overall effect of cutting wages on the economy as a whole. Given that wages make up a significant part of the costs of a commodity, "if money-wages change, one would have expected the [neo-]classical school to argue that prices would change in almost the same proportion, leaving the real wage and the level of unemployment practically the same as before." However, this was not the case, causing Keynes to point out that they "do not seem to have realised that . . . their supply curve for labour will shift bodily with every movement of prices." This was because labour cannot determine its own real wage as prices are controlled by bosses. Once this is recognised, it becomes obvious that workers do not control the cost of living (i.e., the real wage). Therefore trade unions "do not raise the obstacle to any increase in aggregate employment which is attributed to them by the [neo-]classical school." So while workers could, in theory, control their wages by asking for less pay (or, more realistically, accepting any wage cuts imposed by their bosses as the alternative is unemployment) they do not have any control over the prices of the goods they produce. This means that they have no control over their real wages and so cannot reduce unemployment by pricing themselves into work by accepting lower wages. Given these obvious facts, Keynes concluded that there was "no ground for the belief that a flexible wage policy is capable of continuous full employment . . . The economic system cannot be made self-adjusting along these lines." [Op. Cit., p. 12, pp. 8-9, p. 15 and p. 267] As he summarised:

"the contention that the unemployment which characterises a depression is due to a refusal by labour 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 labour obstinately refusing to accept a reduction of money-wages or to its demanding a real wage beyond what the productivity of the economic machine was capable of furnishing . . . Labour is not more truculent in the depression than in the boom -- far from it. Nor is its physical productivity less. These facts from experience are a prima facie ground for questioning the adequacy of the [neo-]classical analysis." [Op. Cit., p. 9]

This means that the standard neo-classical argument was flawed. While cutting wages may make sense for one firm, it would not have this effect throughout the economy as is required to reduce unemployment as a whole. This is another example of the fallacy of composition. What may work with an individual worker or firm will not have the same effect on the economy as a whole for cutting wages for all workers would have a massive effect on the aggregate demand for their firms products.

For Keynes and Kalecki, there were two possibilities if wages were cut. One possibility, which Keynes considered the most likely, would be that a cut in money wages across the whole economy would see a similar cut in prices. The net effect of this would be to leave real wages unchanged. The other assumes that as wages are cut, prices remain prices remained unchanged or only fell by a small amount (i.e. if wealth was redistributed from workers to their employers). This is the underlying assumption of "free market" argument that cutting wages would end the slump. In this theory, cutting real wages would increase profits and investment and this would make up for any decline in working class consumption and so its supporters reject the claim that cutting real wages would merely decrease the demand for consumer goods without automatically increasing investment sufficiently to compensate for this.

However, in order make this claim, the theory depends on three critical assumptions, namely that firms can expand production, that they will expand production, and that, if they do, they can sell their expanded production. This theory and its assumptions can be questioned. To do so we will draw upon David Schweickart's excellent summary. [Against Capitalism, pp. 105-7]

The first assumption states that it is always possible for a company to take on new workers. Yet increasing production requires more than just labour. Tools, raw materials and work space are all required in addition to new workers. If production goods and facilities are not available, employment will not be increased. Therefore the assumption that labour can always be added to the existing stock to increase output is plainly unrealistic, particularly if we assume with neo-classical economics that all resources are fully utilised (for an economy operating at less than full capacity, the assumption is somewhat less inappropriate).

Next, will firms expand production when labour costs decline? Hardly. Increasing production will increase supply and eat into the excess profits resulting from the fall in wages (assuming, of course, that demand holds up in the face of falling wages). If unemployment did result in a lowering of the general market wage, companies might use the opportunity to replace their current workers or force them to take a pay cut. If this happened, neither production nor employment would increase. However, it could be argued that the excess profits would increase capital investment in the economy (a key assumption of neo-liberalism). The reply is obvious: perhaps, perhaps not. A slumping economy might well induce financial caution and so capitalists could stall investment until they are convinced of the sustained higher profitability will last.

This feeds directly into the last assumption, namely that the produced goods will be sold. Assuming that money wages are cut, but prices remain the same then this would be a cut in real wages. But when wages decline, so does worker purchasing power, and if this is not offset by an increase in spending elsewhere, then total demand will decline. However, it can be argued that not everyone's real income would fall: incomes from profits would increase. But redistributing income from workers to capitalists, a group who tend to spend a smaller portion of their income on consumption than do workers, could reduce effective demand and increase unemployment. Moreover, business does not (cannot) instantaneously make use of the enlarged funds resulting from the shift of wages to profit for investment (either because of financial caution or lack of existing facilities). In addition, which sane company would increase investment in the face of falling demand for its products? So when wages decline, so does workers' purchasing power and this is unlikely to be offset by an increase in spending elsewhere. This will lead to a reduction in aggregate demand as profits are accumulated but unused, so leading to stocks of unsold goods and renewed price reductions. This means that the cut in real wages will be cancelled out by price cuts to sell unsold stock and unemployment remains. In other words, contrary to neo-classical economics, a fall in wages may result in the same or even more unemployment as aggregate demand drops and companies cannot find a market for their goods. And so, "[i]f prices do not fall, it is still worse, for then real wages are reduced and unemployment is increased directly by the fall in the purchase of consumption goods." [Joan Robinson, Further Contributions to Economics, p. 34]

The "Pigou" (or "real balance") effect is another neo-classical argument that aims to prove that (in the end) capitalism will pass from slump to boom quickly. This theory argues that when unemployment is sufficiently high, it will lead to the price level falling which would lead to a rise in the real value of the money supply and so increase the real value of savings. People with such assets will have become richer and this increase in wealth will enable people to buy more goods and so investment will begin again. In this way, slump passes to boom naturally.

However, this argument is flawed in many ways. In reply, Michal Kalecki argued that, firstly, Pigou had "assumed that the banking system would maintain the stock of money constant in the face of declining incomes, although there was no particular reason why they should." If the money stock changes, the value of money will also change. Secondly, that "the gain in money holders when prices fall is exactly offset by the loss to money providers. Thus, whilst the real value of a deposit in bank account rises for the depositor when prices fell, the liability represented by that deposit for the bank also rises in size." And, thirdly, "that falling prices and wages would mean that the real value of outstanding debts would be increased, which borrowers would find it increasingly difficult to repay as their real income fails to keep pace with the rising real value of debt. Indeed, when the falling prices and wages are generated by low levels of demand, the aggregate real income will be low. Bankruptcies follow, debts cannot be repaid, and a confidence crisis was likely to follow." In other words, debtors may cut back on spending more than creditors would increase it and so the depression would continue as demand did not rise. [Malcolm C. Sawyer, The Economics of Michal Kalecki, p. 90]

So, the traditional neo-classical reply that investment spending will increase because lower costs will mean greater profits, leading to greater savings, and ultimately, to greater investment is weak. Lower costs will mean greater profits only if the products are sold, which they might not be if demand is adversely affected. In other words, a higher profit margins do not result in higher profits due to fall in consumption caused by the reduction of workers purchasing power. And, as Michal Kalecki argued, wage cuts in combating a slump may be ineffective because gains in profits are not applied immediately to increase investment and the reduced purchasing power caused by the wage cuts causes a fall in sales, meaning that higher profit margins do not result in higher profits. Moreover, as Keynes pointed out long ago, the forces and motivations governing saving are quite distinct from those governing investment. Hence there is no necessity for the two quantities always to coincide. So firms that have reduced wages may not be able to sell as much as before, let alone more. In that case they will cut production, add to unemployment and further reduce demand. This can set off a vicious downward spiral of falling demand and plummeting production leading to depression, a process described by Kropotkin (nearly 40 years before Keynes made the same point in The General Theory):

"Profits being the basis of capitalist industry, low profits explain all ulterior consequences.

"Low profits induce the employers to reduce the wages, or the number of workers, or the number of days of employment during the week. . . As Adam Smith said, low profits ultimately mean a reduction of wages, and low wages mean a reduced consumption by the worker. Low profits mean also a somewhat reduced consumption by the employer; and both together mean lower profits and reduced consumption with that immense class of middlemen which has grown up in manufacturing countries, and that, again, means a further reduction of profits for the employers." [Fields, Factories and Workshops Tomorrow, p. 33]

So, as is often the case, Keynes was simply including into mainstream economics perspectives which had long been held by critics of capitalism and dismissed by the orthodoxy. Keynes' critique of Say's Law essentially repeated Marx's while Proudhon pointed out in 1846 that "if the producer earns less, he will buy less" and this will "engender . . . over-production and destitution." This was because "though the workmen cost [the capitalist] something, they are [his] customers: what will you do with your products, when driven away by [him], they shall consume no longer?" This means that cutting wages and employment would not work for they are "not slow in dealing employers a counter-blow; for if production excludes consumption, it is soon obliged to stop itself." [System of Economical Contradictions, p. 204 and p. 190] Significantly, Keynes praised Proudhon's follower Silvio Gesell for getting part of the answer and for producing "an anti-Marxian socialism" which the "future will learn more from" than Marx. [Op. Cit., p. 355]

So far our critique of the "free market" position has, like Keynes's, been within the assumptions of that theory itself. More has to be said, though, as its assumptions are deeply flawed and unrealistic. It should be stressed that while Keynes's acceptance of much of the orthodoxy ensured that at least some of his ideas become part of the mainstream, Post-Keynesians like Joan Robinson would latter bemoan the fact that he sought a compromise rather than clean break with the orthodoxy. This lead to the rise of the post-war neo-classical synthesis, the so-called "Keynesian" argument that unemployment was caused by wages being "sticky" and the means by which the right could undermine social Keynesianism and ensure a return to neo-classical orthodoxy.

Given the absurd assumptions underlying the "free market" argument, a wider critique is possible as it reflects reality no more than any other part of the pro-capitalist ideology which passes for mainstream economics.

As noted above, the argument that unemployment is caused by wages being too high is part of the wider marginalist perspective. Flaws in that will mean that its explanation of unemployment is equally flawed. So it must be stressed that the marginalist theory of distribution lies at the core of its theories of both output and unemployment. In that theory, the marginal product of labour is interpreted as the labour demand curve as the firm's demand for labour is the marginal physical product of labour multiplied by the price of the output and this produces the viewpoint that unemployment is caused by wages being too high. So given the central role which marginal productivity theory plays in the mainstream argument, it is useful to start our deeper critique by re-iterating that, as indicated in section C.2, Joan Robinson and Piero Sraffa had successfully debunked this theory in the 1950s. "Yet for psychological and political reasons," notes James K. Galbraith, "rather than for logical and mathematical ones, the capital critique has not penetrated mainstream economics. It likely never will. Today only a handful of economists seem aware of it." ["The distribution of income", pp. 32-41, Richard P. F. Holt and Steven Pressman (eds.), A New Guide to Post Keynesian Economics, p. 34] Given that this underlies the argument that high wages cause high unemployment, it means that the mainstream argument for cutting wages has no firm theoretical basis.

It should also be noted that the assumption that adding more labour to capital is always possible flows from the assumption of marginal productivity theory which treats "capital" like an ectoplasm and can be moulded into whatever form is required by the labour available (see section C.2.5 for more discussion). Hence Joan Robinson's dismissal of this assumption, for "the difference between the future and the past is eliminated by making capital 'malleable' so that mistakes can always be undone and equilibrium is always guaranteed. . . with 'malleable' capital the demand for labour depends on the level of wages." [Contributions to Modern Economics, p. 6] Moreover, "labour and capital are not often as smoothly substitutable for each other as the [neo-classical] model requires . . . You can't use one without the other. You can't measure the marginal productivity of one without the other." Demand for capital and labour is, sometimes, a joint demand and so it is often to adjust wages to a worker's marginal productivity independent of the cost of capital. [Hugh Stretton, Economics: A New Introduction, p. 401]

Then there is the role of diminishing returns. The assumption that the demand curve for labour is always downward sloping with respect to aggregate employment is rooted in the notion that industry operates, at least in the short run, under conditions of diminishing returns. However, diminishing returns are not a feature of industries in the real world. Thus the assumption that the downward slopping marginal product of labour curve is identical to the aggregate demand curve for labour is not true as it is inconsistent with empirical evidence. "In a system at increasing returns," noted one economist, "the direct relation between real wages and employment tends to render the ordinary mechanism of wage adjustment ineffective and unstable." [Ferdinando Targetti, Nicholas Kaldor, p. 344] In fact, as discussed in section C.1.2, without this assumption mainstream economics cannot show that unemployment is, in fact, caused by real wages being too high (along with many other things).

Thus, if we accept reality, we must end up "denying the inevitability of a negative relationship between real wages and employment." Post-Keynesian economists have not found any empirical links between the growth of unemployment since the early in 1970s and changes in the relationship between productivity and wages and so there is "no theoretical reason to expect a negative relationship between employment and the real wage, even at the level of the individual firm." Even the beloved marginal analysis cannot be used in the labour market, as "[m]ost jobs are offered on a take-it-or-leave-it basis. Workers have little or no scope to vary hours of work, thereby making marginal trade-offs between income and leisure. There is thus no worker sovereignty corresponding to the (very controversial) notion of consumer sovereignty." Over all, "if a relationship exists between aggregate employment and the real wage, it is employment that determines wages. Employment and unemployment are product market variables, not labour market variables. Thus attempts to restore full employment by cutting wages are fundamentally misguided." [John E. King, "Labor and Unemployment," pp. 65-78, Holt and Pressman (eds.), Op. Cit., p. 68, pp. 67-8, p. 72, p. 68 and p. 72] In addition:

"Neo-classical theorists themselves have conceded that a negative relationship between the real wage and the level of employment can be established only in a one-commodity model; in a multi-commodity framework no such generalisation is possible. This confines neo-classical theory to an economy without money and makes it inapplicable to a capitalist or entrepreneurial economy." [Op. Cit., p. 71]

And, of course, the whole analysis is rooted in the notion of perfect competition. As Nicholas Kaldor mildly put it:

"If economics had been a 'science' in the strict sense of the word, the empirical observation that most firms operate in imperfect markets would have forced economists to scrap their existing theories and to start thinking on entirely new lines . . . unfortunately economists do not feel under the same compulsion to maintain a close correspondence between theoretical hypotheses and the facts of experience." [Further Essays on Economic Theory ad Policy, p. 19]

Any real economy is significantly different from the impossible notion of perfect competition and "if there exists even one monopoly anywhere in the system . . . it follows that others must be averaging less than the marginal value of their output. So to concede the existence of monopoly requires that one either drop the competitive model entirely or construct an elaborate new theory . . . that divides the world into monopolistic, competitive, and subcompetitive ('exploited') sectors." [James K. Galbraith, Created Unequal, p. 52] As noted in section C.4.3, mainstream economists have admitted that monopolistic competition (i.e., oligopoly) is the dominant market form but they cannot model it due to the limitations of the individualistic assumptions of bourgeois economics. Meanwhile, while thundering against unions the mainstream economics profession remains strangely silent on the impact of big business and pro-capitalist monopolies like patents and copyrights on distribution and so the impact of real wages on unemployment.

All this means that "neither the demand for labour nor the supply of labour depends on the real wage. It follows from this that the labour market is not a true market, for the price associated with it, the wage rate, is incapable of performing any market-clearing function, and thus variations in the wage rate cannot eliminate unemployment." [King, Op. Cit., p. 65] As such, the "conventional economic analysis of markets . . . is unlikely to apply" to the labour market and as a result "wages are highly unlikely to reflect workers' contributions to production." This is because economists treat labour as no different from other commodities yet "economic theory supports no such conclusion." At its most basic, labour is not produced for profit and the "supply curve for labour can 'slope backward' -- so that a fall in wages can cause an increase in the supply of workers." In fact, the idea of a backward sloping supply curve for labour is just as easy to derive from the assumptions used by economists to derive their standard one. This is because workers may prefer to work less as the wage rate rises as they will be better off even if they do not work more. Conversely, very low wage rates are likely to produce a very high supply of labour as workers need to work more to meet their basic needs. In addition, as noted at the end of section C.1.4, economic theory itself shows that workers will not get a fair wage when they face very powerful employers unless they organise unions. [Steve Keen, Debunking Economics, pp. 111-2 and pp. 119-23]

Strong evidence that this model of the labour market can be found from the history of capitalism. Continually we see capitalists turn to the state to ensure low wages in order to ensure a steady supply of labour (this was a key aim of state intervention during the rise of capitalism, incidentally). For example, in central and southern Africa mining companies tried to get locals to labour. They had little need for money, so they worked a day or two then disappeared for the rest of the week. To avoid simply introducing slavery, some colonial administrators introduced and enforced a poll-tax. To earn enough to pay it, workers had to work a full week. [Hugh Stretton, Op. Cit., p. 403] Much the same was imposed on British workers at the dawn of capitalism. As Stephen Marglin points out, the "indiscipline of the labouring classes, or more bluntly, their laziness, was widely noted by eighteenth century observers." By laziness or indiscipline, these members of the ruling class meant the situation where "as wages rose, workers chose to work less." In economic terms, "a backward bending labour supply curve is a most natural phenomenon as long as the individual worker controls the supply of labour." However, "the fact that higher wages led workers to choose more leisure . . . was disastrous" for the capitalists. Unsurprisingly, the bosses did not meekly accept the workings of the invisible hand. Their "first recourse was to the law" and they "utilised the legislative, police and judicial powers of the state" to ensure that working class people had to supply as many hours as the bosses demanded. ["What do Bosses do?", pp. 60-112, Review of Radical Political Economy, Vol. 6, No. 2, pp. 91-4]

This means that the market supply curve "could have any shape at all" and so economic theory "fails to prove that employment is determined by supply and demand, and reinforces the real world observation that involuntary unemployment can exist" as reducing the wage need not bring the demand and supply of labour into alignment. While the possibility of backward-bending labour supply curves is sometimes pointed out in textbooks, the assumption of an upward sloping supply curve is taken as the normal situation but "there is no theoretical -- or empirical -- justification for this." Sadly for the world, this assumption is used to draw very strong conclusions by economists. The standard arguments against minimum wage legislation, trade unions and demand management by government are all based on it. Yet, as Keen notes, such important policy positions "should be based upon robust intellectual or empirical foundations, rather than the flimsy substrate of mere fancy. Economists are quite prone to dismiss alternative perspectives on labour market policy on this very basis -- that they lack any theoretical or empirical foundations. Yet their own policy positions are based as much on wishful thinking as on wisdom." [Op. Cit., pp. 121-2 and p. 123]

Within a capitalist economy the opposite assumption to that taken by economics is far more likely, namely that there is a backward sloping labour supply curve. This is because the decision to work is not one based on the choice between wages and leisure made by the individual worker. Most workers do not choose whether they work or not, and the hours spent working, by comparing their (given) preferences and the level of real wages. They do not practice voluntary leisure waiting for the real wage to exceed their so-called "reservation" wage (i.e. the wage which will tempt them to forsake a life of leisure for the disutility of work). Rather, most workers have to take a job because they do not have a choice as the alternative is poverty (at best) or starvation and homelessness (at worse). The real wage influences the decision on how much labour to supply rather than the decision to work or not. This is because as workers and their families have a certain basic living standard to maintain and essential bills which need to be paid. As earnings increase, basic costs are covered and so people are more able to work less and so the supply of labour tends to fall. Conversely, if real earnings fall because the real wage is less then the supply of labour may increase as people work more hours and/or more family members start working to make enough to cover the bills (this is because, once in work, most people are obliged to accept the hours set by their bosses). This is the opposite of what happens in "normal" markets, where lower prices are meant to produce a decrease in the amount of the commodity supplied. In other words, the labour market is not a market, i.e. it reacts in different ways than other markets (Stretton provides a good summary of this argument [Op. Cit., pp. 403-4 and p. 491]).

So, as radical economists have correctly observe, such considerations undercut the "free market" capitalist contention that labour unions and state intervention are responsible for unemployment (or that depressions will easily or naturally end by the workings of the market). To the contrary, insofar as labour unions and various welfare provisions prevent demand from falling as low as it might otherwise go during a slump, they apply a brake to the downward spiral. Far from being responsible for unemployment, they actually mitigate it. For example, unions, by putting purchasing power in the hands of workers, stimulates demand and keeps employment higher than the level it would have been. Moreover, wages are generally spent immediately and completely whilst profits are not. A shift from profits to wages may stimulate the economy since more money is spent but there will be a delayed cut in consumption out of profits. [Malcolm Sawyer, The Economics of Michal Kalecki, p. 118] All this should be obvious, as wages (and benefits) may be costs for some firms but they are revenue for even more and labour is not like other commodities and reacts in changes in price in different ways.

Given the dynamics of the labour "market" (if such a term makes much sense given its atypical nature), any policies based on applying "economics 101" to it will be doomed to failure. As such, any book entitled Economics in One Lesson must be viewed with suspicion unless it admits that what it expounds has little or no bearing to reality and urges the reader to take at least the second lesson. Of course, a few people actually do accept the simplistic arguments that reside in such basic economics texts and think that they explain the world (these people usually become right-"libertarians" and spend the rest of their lives ignoring their own experience and reality in favour of a few simple axioms). The wage-cutting argument (like most of economics) asserts that any problems are due to people not listening to economists and that there is no economic power, there are no "special interests" -- it is just that people are stupid. Of course, it is irrelevant that it is much easier to demand that workers' real wages be reduced when you are sitting in a tenured post in academia. True to their ideals and "science", it is refreshing to see how many of these "free market" economists renounce tenure so that their wages can adjust automatically as the market demand for their ideologically charged comments changes.

So when economic theories extol suffering for future benefits, it is always worth asking who suffers, and who benefits. Needless to say, the labour market flexibility agenda is anti-union, anti-minimum wage, and anti-worker protection. This agenda emerges from theoretical claims that price flexibility can restore full employment, and it rests dubious logic, absurd assumptions and on a false analogy comparing the labour market with the market for peanuts. Which, ironically, is appropriate as the logic of the model is that workers will end up working for peanuts! As such, the "labour market" model has a certain utility as it removes the problem of institutions and, above all, power from the perspective of the economist. In fact, institutions such as unions can only be considered as a problem in this model rather than a natural response to the unique nature of the labour "market" which, despite the obvious differences, most economists treat like any other.

To conclude, a cut in wages may deepen any slump, making it deeper and longer than it otherwise would be. Rather than being the solution to unemployment, cutting wages will make it worse (we will address the question of whether wages being too high actually causes unemployment in the first place, in the next section). Given that, as we argued in section C.8.2, inflation is caused by insufficient profits for capitalists (they try to maintain their profit margins by price increases) this spiralling effect of cutting wages helps to explain what economists term "stagflation" -- rising unemployment combined with rising inflation (as seen in the 1970s). As workers are made unemployed, aggregate demand falls, cutting profit margins even more and in response capitalists raise prices in an attempt to recoup their losses. Only a very deep recession can break this cycle (along with labour militancy and more than a few workers and their families).

Thus the capitalist solution to crisis is based on working class people paying for capitalism's contradictions. For, according to the mainstream theory, when the production capacity of a good exceeds any reasonable demand for it, the workers must be laid off and/or have their wages cut to make the company profitable again. Meanwhile the company executives -- the people responsible for the bad decisions to build lots of factories -- continue to collect their fat salaries, bonuses and pensions, and get to stay on to help manage the company through its problems. For, after all, who better, to return a company to profitability than those who in their wisdom ran it into bankruptcy? Strange, though, no matter how high their salaries and bonuses get, managers and executives never price themselves out of work.

All this means that working class people have two options in a slump -- accept a deeper depression in order to start the boom-bust cycle again or get rid of capitalism and with it the contradictory nature of capitalist production which produces the business cycle in the first place (not to mention other blights such as hierarchy and inequality). In the end, the only solution to unemployment is to get rid of the system which created it by workers seizing their means of production and abolishing the state. When this happens, then production for the profit of the few will be ended and so, too, the contradictions this generates.

C.9.2 Is unemployment caused by wages being too high?

As we noted in the last section, most capitalist economic theories argue that unemployment is caused by wages being too high. Any economics student will tell you that labour is like any other commodity and so if its price is too high then there will be less demand for it, so producing an excess supply of it on the market. Thus high wages will reduce the quantity of labour demanded and so create unemployment -- a simple case of "supply and demand."

>From this theory we would expect that areas and periods with high wages will also have high levels of unemployment. Unfortunately for the theory, this does not seem to be the case. Even worse for it, high wages are generally associated with booms rather than slumps and this has been known to mainstream economics since at least 1939 when in March of that year The Economic Journal printed an article by Keynes about the movement of real wages during a boom in which he evaluated the empirical analysis of two labour economists (entitled "Relative Movements of Real Wages and Output" this is contained as an Appendix of most modern editions of The General Theory).

These studies showed that "when money wages are rising, real wages have usually risen too; whilst, when money wages are falling, real wages are no more likely to rise than to fall." Keynes admitted that in The General Theory he was "accepting, without taking care to check the facts", a "widely held" belief. He discussed where this belief came from, namely leading 19th century British economist Alfred Marshall who had produced a "generalisation" from a six year period between 1880-86 which was not true for the subsequent business cycles of 1886 to 1914. He also quotes another leading economist, Arthur Pigou, from 1927 on how "the upper halves of trade cycles have, on the whole, been associated with higher rates of real wages than the lower halves" and indicates that he provided evidence on this from 1850 to 1910 (although this did not stop Pigou reverting to the "Marshallian tradition" during the Great Depression and blaming high unemployment on high wages). [The General Theory, p. 394, p. 398 and p. 399] Keynes conceded the point, arguing that he had tried to minimise differences between his analysis and the standard perspective. He stressed that while he assumed countercyclical real wages his argument did not depend on it and given the empirical evidence provided by labour economists he accepted that real wages were pro-cyclical in nature.

The reason why this is the case is obvious given the analysis in the last section. Labour does not control prices and so cannot control its own real wage. Looking at the Great Depression, it seems difficult to blame it on workers refusing to take pay cuts when by 1933 "wages and salaries in U.S. manufacturing were less than half their 1929 levels and, in automobiles and steel, were under 40 percent of the 1929 levels." In Detroit, there had been 475,000 auto-workers. By 1931 "almost half has been laid off." [William Lazonick, Competitive Advantage on the Shop Floor, p. 271] The notion of all powerful unions or workers' resistance to wage cuts causing high unemployment hardly fits these facts. Peter Temin provides information on real wages in manufacturing during the depression years. Using 1929 as the base year, weekly average real wages (i.e., earnings divided by the consumer price index) fell each year to reach a low of 85.5% by 1932. Hourly real wages remained approximately constant (rising to 100.1% in 1930 and then 102.6% in 1931 before falling to 99% in 1932). The larger fall in weekly wages was due to workers having a shorter working week. The "effect of shorter hours and lower wages was to decrease the income of employed workers." Thus the notion that lowering wages will increase employment seems as hard to support as the notion that wages being too high caused the depression in the first place. Temin argues, "no part of the [neo-]classical story is accurate." [Did Monetary Forces Cause the Great Depression?, pp. 139-40] It should be noted that the consensus of economists is that during this period the evidence seems to suggest that real wages did rise overall. This was because the prices of commodities fell faster than did the wages paid to workers. Which confirms Keynes, as he had argued that workers cannot price themselves into work as they have no control over prices. However, there is no reason to think that high real wages caused the high unemployment as the slump itself forced producers to cut prices (not to mention wages). Rather, the slump caused the increase in real wages.

Since then, economists have generally confirmed that real wage are procyclical. In fact, "a great deal of empirical research has been conducted in this area -- research which mostly contradicts the neo-classical assumption of an inverse relation between real wages and employment." [Ferdinando Targetti, Nicholas Kaldor, p. 50] Nicholas Kaldor, one of the first Keynesians, also stressed that the notion that there is an inverse relationship between real wages and employment is "contradicted by numerous empirical studies which show that, in the short period, changes in real wages are positively correlated with changes in employment and not negatively." [Further Essays on Economic Theory and Policy, p. 114fn] As Hugh Stretton summarises in his excellent introductory text on economics:

"In defiance of market theory, the demand for labour tends strongly to vary with its price, not inversely to it. Wages are high when there is full employment. Wages -- especially for the least-skilled and lowest paid -- are lowest when there is least employment. The causes chiefly run from the employment to the wages, rather than the other way. Unemployment weakens the bargaining power, worsens the job security and working conditions, and lowers the pay of those still in jobs.

"The lower wages do not induce employers to create more jobs . . . most business firms have no reason to take on more hands if wages decline. Only empty warehouses, or the prospect of more sales can get them to do that, and these conditions rarely coincide with falling employment and wages. The causes tend to work the other way: unemployment lowers wages, and the lower wages do not restore the lost employment." [Economics: A New Introduction, pp. 401-2]

Will Hutton, the British neo-Keynesian economist, summarises research by two other economists that suggests high wages do not cause unemployment:

"the British economists David Blanchflower and Andrew Oswald [examined] . . . the data in twelve countries about the actual relation between wages and unemployment -- and what they have discovered is another major challenge to the free market account of the labour market. Free market theory would predict that low wages would be correlated with low local unemployment; and high wages with high local unemployment.

"Blanchflower and Oswald have found precisely the opposite relationship. The higher the wages, the lower the local unemployment -- and the lower the wages, the higher the local unemployment. As they say, this is not a conclusion that can be squared with free market text-book theories of how a competitive labour market should work." [The State We're In, p. 102]

Unemployment was highest where real wages were lowest and nowhere had falling wages being followed by rising employment or falling unemployment. Blanchflower and Oswald stated that their conclusion is that employees "who work in areas of high unemployment earn less, other things constant, than those who are surrounded by low unemployment." [The Wage Curve, p. 360] This relationship, the exact opposite of that predicted by "free market" capitalist economics, was found in many different countries and time periods, with the curve being similar for different countries. Thus, the evidence suggests that high unemployment is associated with low earnings, not high, and vice versa.

Looking at less extensive evidence, if minimum wages and unions cause unemployment, why did the South-eastern states of the USA (with a lower minimum wage and weaker unions) have a higher unemployment rate than North-western states during the 1960s and 1970s? Or why, when the (relative) minimum wage declined under Reagan and Bush in the 1980s, did chronic unemployment accompany it? [Allan Engler, The Apostles of Greed, p. 107] Or the Low Pay Network report "Priced Into Poverty" which discovered that in the 18 months before they were abolished, the British Wages Councils (which set minimum wages for various industries) saw a rise of 18,200 in full-time equivalent jobs compared to a net loss of 39,300 full-time equivalent jobs in the 18 months afterwards. Given that nearly half the vacancies in former Wages Council sectors paid less than the rate which it is estimated Wages Councils would now pay, and nearly 15% paid less than the rate at abolition, there should (by the "free market" argument) have been rises in employment in these sectors as pay fell. The opposite happened. This research shows that the falls in pay associated with Wages Council abolition had not created more employment. Indeed, employment growth was more buoyant prior to abolition than subsequently. So whilst Wages Council abolition did not result in more employment, the erosion of pay rates caused by their abolition resulted in more families having to endure poverty pay. Significantly, the introduction of a national minimum wage by the first New Labour government did not have the dire impact "free market" capitalist economists and politicians predicted.

It should also be noted that an extensive analysis of the impact of minimum wage increases at the state level in America by economists David Card and Alan Kreuger found the facts contradicted the standard theory, with rises in the minimum wage having a small positive impact on both employment and wages for all workers. [Myth and Measurement: The New Economics of the Minimum Wage] While their work was attacked by business leaders and economists from think-tanks funded by them, Card and Kreuger's findings that raising the lowest wages had no effect on unemployment or decreased it proved to be robust. In particular, when replying to criticism of their work by other economists who based their work, in part, on data supplied by a business funded think-tank Card and Krueger discovered that not only was that work consistent with their original findings but that the "only data set that indicates a significant decline in employment" was by some amazing coincidence "the small set of restaurants collected by" the think tank. ["Minimum Wages and Employment: A Case Study of the Fast-Food Industry in New Jersey and Pennsylvania: Reply", pp. 1397-1420, The American Economic Review, Vol. 90, No. 5, p. 1419] For a good overview of "how the fast food industry and its conservative allies sought to discredit two distinguished economists, and how the attack backfired" when "the two experts used by the fast food industry to impeach Card and Krueger, effectively ratified them" see John Schmitt's "Behind the Numbers: Cooked to Order." [The American Prospect, May-June 1996, pp. 82-85]

(This does not mean that anarchists support the imposition of a legal minimum wage. Most anarchists do not because it takes the responsibility for wages from unions and other working class organisations, where it belongs, and places it in the hands of the state. We mention these examples in order to highlight that the "free market" capitalist argument has serious flaws with it.)

Empirical evidence does not support the argument the "free market" capitalist argument that unemployment is caused by real wages being too high. The phenomenon that real wages tend to increase during the upward swing of the business cycle (as unemployment falls) and fall during recessions (when unemployment increases) renders the standard interpretation that real wages govern employment difficult to maintain (real wages are "pro-cyclical," to use economic terminology). This evidence makes it harder for economists to justify policies based on a direct attack on real wages as the means to cure unemployment.

While this evidence may come as a shock to those who subscribe to the arguments put forward by those who think capitalist economics reflect the reality of that system, it fits well with the anarchist and other socialist analysis. For anarchists, unemployment is a means of disciplining labour and maintaining a suitable rate of profit (i.e. unemployment is a key means of ensuring that workers are exploited). As full employment is approached, labour's power increases, so reducing the rate of exploitation and so increasing labour's share of the value it produces (and so higher wages). Thus, from an anarchist point of view, the fact that wages are higher in areas of low unemployment is not a surprise, nor is the phenomenon of pro-cyclical real wages. After all, as we noted in section C.3, the ratio between wages and profits are, to a large degree, a product of bargaining power and so we would expect real wages to grow in the upswing of the business cycle, fall in the slump and be high in areas of low unemployment.

The evidence therefore suggests that the "free market" capitalist claim that unemployment is caused by unions, "too high" wages, and so on, is false. Indeed, by stopping capitalists appropriating more of the income created by workers, high wages maintain aggregate demand and contribute to higher employment (although, of course, high employment cannot be maintained indefinitely under wage slavery due to the rise in workers' power this implies). Rather, unemployment is a key aspect of the capitalist system and cannot be got rid off within it. The "free market" capitalist "blame the workers" approach fails to understand the nature and dynamic of the system (given its ideological role, this is unsurprising). So high real wages for workers increases aggregate demand and reduces unemployment from the level it would be if the wage rate was cut. This is supported by most of the research into wage dynamics during the business cycle and by the "wage curve" of numerous countries. This suggests that the demand for labour is independent of the real wages and so the price of labour (wages) is incapable of performing any market clearing function. The supply and demand for labour are determined by two different sets of factors. The relationship between wages and unemployment flows from the latter to the former rather than the reverse: the wage is influenced by the level of unemployment. Thus wages are not the product of a labour market which does not really exist but rather is the product of "institutions, customs, privilege, social relations, history, law, and above all power, with an admixture of ingenuity and luck. But of course power, and particularly market or monopoly power, changes with the general of demand, the rate of growth, and the rate of unemployment. In periods of high employment, the weak gain on the strong; in periods of high unemployment, the strong gain on the weak." [Galbraith, Created Unequal, p. 266]

This should be obvious enough. It is difficult for workers to resist wage cuts and speeds-up when faced with the fear of mass unemployment. As such, higher rates of unemployment "reduce labour's bargaining power vis-a-vis business, and this helps explain why wages have declined and workers have not received their share of productivity growth" (between 1970 and 1993, only the top 20% of the US population increased its share of national income). [Thomas I. Palley, Plenty of Nothing, p. 55 and p. 58] Strangely, though, this obvious fact seems lost on most economists. In fact, if you took their arguments seriously then you would have to conclude that depressions and recessions are the periods during which working class people do the best! This is on two levels. First, in neo-classical economics work is considered a disutility and workers decide not to work at the market-clearing real wage because they prefer leisure to working. Leisure is assumed to be intrinsically good and the wage the means by which workers are encouraged to sacrifice it. Thus high unemployment must be a good thing as it gives many more people leisure time. Second, for those in work their real wages are higher than before, so their income has risen. Alfred Marshall, for example, argued that in depressions money wages fell but not as fast as prices. A "powerful friction" stopped this, which "establish[ed] a higher standard of living among the working classes" and a "diminish[ing of] the inequalities of wealth." When asked whether during a period of depression the employed working classes got more than they did before, he replied "[m]ore than they did before, on the average." [quoted by Keynes, Op. Cit., p. 396]

Thus, apparently, working class people do worse in booms than in slumps and, moreover, they can resist wage cuts more in the face of mass unemployment than in periods approaching full employment. That the theory which produced these conclusions could be taken remotely seriously shows the dangers of deducing an economic ideology from a few simple axioms rather than trusting in empirical evidence and common sense derived from experience. Nor should it come as too great a surprise, as "free market" capitalist economics tends to ignore (or dismiss) the importance of economic power and the social context within which individuals make their choices. As Bob Black acidly put it with regards to the 1980s, it "wasn't the workers who took these gains [of increased productivity], not in higher wages, not in safer working conditions, and not in shorter hours -- hours of work have increased . . . It must be, then, that in the 80s and after workers have 'chosen' lower wages, longer hours and greater danger on the job. Yeah, sure." ["Smokestack Lightning," pp. 43-62, Friendly Fire, p. 61]

In the real world, workers have little choice but to accept a job as they have no independent means to exist in a pure capitalist system and so no wages means no money for buying such trivialities as food and shelter. The decision to take a job is, for most workers, a non-decision -- paid work is undertaken out of economic necessity and so we are not in a position to refuse work because real wages are too low to be worth the effort (the welfare state reduces this pressure, which is why the right and bosses are trying to destroy it). With high unemployment, pay and conditions will worsen while hours and intensity of labour will increase as the fear of the sack will result in increased job insecurity and so workers will be more willing to placate their bosses by obeying and not complaining. Needless to say, empirical evidence shows that "when unemployment is high, inequality rises. And when unemployment is low, inequality tends to fall." [James K. Galbraith, Op. Cit., p. 148] This is unsurprising as the "wage curve" suggests that it is unemployment which drives wage levels, not the other way round. This is important as higher unemployment would therefore create higher inequality as workers are in no position to claim back productivity increases and so wealth would flood upwards.

Then there is the issue of the backward-bending supply curve of labour we discussed at the end of the last section. As the "labour market" is not really a market, cutting real wages will have the opposite effect on the supply of labour than its supporters claim. It is commonly found that as real wages fall, hours at work become longer and the number of workers in a family increases. This is because the labour supply curve is negatively slopped as families need to work more (i.e., provide more labour) to make ends meet. This means that a fall in real wages may increase the supply of labour as workers are forced to work longer hours or take second jobs simply to survive. The net effect of increasing supply would be to decrease real wages even more and so, potentially, start a vicious circle and make the recession deeper. Looking at the US, we find evidence that supports this analysis. As the wages for the bottom 80% of the population fell in real terms under Reagan and Bush in the 1980s, the number of people with multiple jobs increased as did the number of mothers who entered the labour market. In fact, "the only reason that family income was maintained is the massive increase in labour force participation of married women . . . Put simply, jobs paying family wages have been disappearing, and sustaining a family now requires that both adults work . . . The result has been a squeeze on the amount of time that people have for themselves . . . there is a loss of life quality associated with the decline in time for family . . . they have also been forced to work longer . . . Americans are working longer just to maintain their current position, and the quality of family life is likely declining. A time squeeze has therefore accompanied the wage squeeze." [Palley, Op. Cit., pp. 63-4] That is, the supply of labour increased as its price fell (Reagan's turn to military Keynesianism and incomplete nature of the "reforms" ensured that a deep spiral was avoided).

To understand why this is the case, it is necessary to think about how the impact of eliminating the minimum wage and trade unions would actually have. First, of course, there would be a drop in the wages of the poorest workers as the assertion is that the minimum wage increases unemployment by forcing wages up. The assertion is that the bosses would then employ more workers as a result. However, this assumes that extra workers could easily be added to the existing capital stock which may not be the case. Assuming this is the case (and it is a big assumption), what happens to the workers who have had their pay cut? Obviously, they still need to pay their bills which means they either cut back on consumption and/or seek more work (assuming that prices have not fallen, as this would leave the real wage unchanged). If the former happens, then firms may find that they face reduced demand for their products and, consequently, have no need for the extra employees predicted by the theory. If the latter happens, then the ranks of those seeking work will increase as people look for extra jobs or people outside the labour market (like mothers and children) are forced into the job market. As the supply of workers increase, wages must drop according to the logic of the "free market" position. This does not mean that a recovery is impossible, just that in the short and medium terms cutting wages will make a recession worse and be unlikely to reduce unemployment for some time.

This suggests that a "free market" capitalism, marked by a fully competitive labour market, no welfare programmes nor unemployment benefits, and extensive business power to break unions and strikes would see aggregate demand constantly rise and fall, in line with the business cycle, and unemployment and inequality would follow suit. Moreover, unemployment would be higher over most of the business cycle (and particularly at the bottom of the slump) than under a capitalism with social programmes, militant unions and legal rights to organise because the real wage would not be able to stay at levels that could support aggregate demand nor could the unemployed use their benefits to stimulate the production of consumer goods. This suggests that a fully competitive labour market, as in the 19th century, would increase the instability of the system -- an analysis which was confirmed in during the 1980s ("the relationship between measured inequality and economic stability . . . was weak but if anything it suggests that the more egalitarian countries showed a more stable pattern of growth after 1979." [Dan Corry and Andrew Glyn, "The Macroeconomics of equality, stability and growth", Paying for Inequality, Andrew Glyn and David Miliband (eds.) pp. 212-213]).

So, in summary, the available evidence suggests that high wages are associated with low levels of unemployment. While this should be the expected result from any realistic analysis of the economic power which marks capitalist economies, it does not provide much support for claims that only by cutting real wages can unemployment be reduced. The "free market" capitalist position and one based on reality have radically different conclusions as well as political implications. Ultimately, most laissez-faire economic analysis is unpersuasive both in terms of the facts and their logic. While economics may be marked by axiomatic reasoning which renders everything the markets does as optimal, the problem is precisely that it is pure axiomatic reasoning with little or no regard for the real world. Moreover, by some strange coincidence, they usually involve policy implications which generally make the rich richer by weakening the working class. Unsurprisingly, decades of empirical evidence have not shifted the faith of those who think that the simple axioms of economics take precedence over the real world nor has this faith lost its utility to the economically powerful.

C.9.3 Are "flexible" labour markets the answer to unemployment?

The usual "free market" capitalist (or neo-liberal) argument is that labour markets must become more "flexible" to solve the problem of unemployment. This is done by weakening unions, reducing (or abolishing) the welfare state, and so on. In defence of these policies, their proponents point to the low unemployment rates of the USA and UK and contrast them to the claimed economic woes of Europe (particularly France and Germany). As we will indicate in this section, this stance has more to do a touching faith that deregulating the labour market brings the economy as a whole closer to the ideal of "perfect competition" than a balanced analysis and assessment of the available evidence. Moreover, it is always important to remember, as tenured economists (talking of protective labour market institutions!) seem to forget, that deregulation can and does have high economic (and not to mention individual and social) costs too.

The underlying argument for flexible labour markets is the notion that unemployment is cased by wages being too high and due to market imperfections wages are sticky downwards. While both claims, as we have seen above, are dubious both factually and logically this has not stopped this position becoming the reigning orthodoxy in elite circles. By market imperfections it is meant trade unions, laws which protect labour, unemployment benefit and other forms of social welfare provision (and definitely not big business, patent and copyright laws, or any other pro-business state interventions). All these ensure that wages for those employed are inflexible downwards and the living standards of those unemployed are too high to induce them to seek work. This means that orthodox economics is based on (to use John Kenneth Galbraith's justly famous quip) the assumption that the rich do not work because they are paid too little, while the poor do not work because they are paid too much.

We should first point out that attacks on social welfare have a long pedigree and have been conducted with much the same rationale -- it made people lazy and gave them flexibility when seeking work. For example, the British Poor Law Report of the 1830s "built its case against relief on the damage done by poor relief to personal morality and labour discipline (much the same thing in the eyes of the commissioners)." [David McNally, Against the Market, p. 101] The report itself stated that "the greatest evil" of the system was "the spirit of laziness and insubordination that it creates." [quoted by McNally, Op. Cit., p. 101]

While the rhetoric used to justify attacks on welfare has changed somewhat since then, the logic and rationale have not. They have as their root the need to eliminate anything which provided working class people any means for independence from the labour market. It has always aimed to ensure that the fear of the sack remains a powerful tool in the bosses arsenal and to ensure that their authority is not undermined. Ironically, therefore, its underlying aims are to decrease the options available to working class people, i.e. to reduce our flexibility within the labour market by limiting our options to finding a job fast or face dire poverty (or worse).

Secondly, there is a unspoken paradox to this whole process. If we look at the stated, public, rationale behind "flexibility" we find a strange fact. While the labour market is to be made more "flexible" and in line with ideal of "perfect competition", on the capitalist side no attempt is being made to bring it into line with that model. Let us not forget that perfect competition (the theoretical condition in which all resources, including labour, will be efficiently utilised) states that there must be a large number of buyers and sellers. This is the case on the sellers side of the "flexible" labour market, but this is not the case on the buyers (where, as indicated in section C.4, oligopoly reigns). Most who favour labour market "flexibility" are also those most against the breaking up of big business and oligopolistic markets or are against attempts to stop mergers between dominant companies in and across markets. Yet the model requires both sides to be made up of numerous small firms without market influence or power. So why expect making one side more "flexible" will have a positive effect on the whole?

There is no logical reason for this to be the case and as we noted in section C.1.4, neo-classical economics agrees -- in an economy with both unions and big business, removing the former while retaining the latter will not bring it closer to the ideal of perfect competition. With the resulting shift in power on the labour market things will get worse as income is distributed from labour to capital. Which is, we must stress, precisely what has happened since the 1980s and the much lauded "reforms" of the labour market. It is a bit like expecting peace to occur between two warring factions by disarming one side and arguing that because the number of guns have been halved peacefulness has doubled! Of course, the only "peace" that would result would be the peace of the graveyard or a conquered people -- subservience can pass for peace, if you do not look too close. In the end, calls for the "flexibility" of labour indicate the truism that, under capitalism, labour exists to meet the requirements of capital (or living labour exists to meet the needs of dead labour, a truly insane way to organise a society).

Then there is the key question of comparing reality with the rhetoric. As economist Andrew Glyn points out, the neo-liberal orthodoxy on this issue "has been strenuously promoted despite weak evidence for the magnitude of its benefits and in almost total neglect of its costs." In fact, "there is no evidence that the countries which carried out more reforms secured significant falls in unemployment." This is perhaps unsurprising as "there is plenty of support for such deregulation from business even without strong evidence that unemployment would be reduced." As far as welfare goes, the relationship between unemployment and benefits is, if anything, in the 'wrong' direction (higher benefits do along with lower unemployment). Of course there are a host of other influences on unemployment but "if benefits were very important we might expect some degree of correlation in the 'right' (positive) direction . . . such a lack of simple relation with unemployment applies to other likely suspects such as employment protection and union membership." [Capitalism Unleashed, p. 48, p. 121, p. 48 and p. 47]

Nor is it mentioned that the history of labour market flexibility is somewhat at odds with the theory. It is useful to remember that American unemployment was far worse than Europe's during the 1950s, 60s and 70s. In fact, it did not get better than the European average until the second half of the 1980s. [David R. Howell, "Introduction", pp. 3-34, Fighting Unemployment, David R. Howell (ed.), pp. 10-11] To summarise:

"it appears to be only relatively recently that the maintained greater flexibility of US labour markets has apparently led to a superior performance in terms of lower unemployment, despite the fact this flexibility is no new phenomenon. Comparing, for example, the United States with the United Kingdom, in the 1960s the United States averaged 4.8 per cent, with the United Kingdom at 1.9 per cent; in the 1970s the United States rate rose to 6.1 per cent, with the United Kingdom rising to 4.3 per cent, and it was only in the 1980s that the ranking was reversed with the United States at 7.2 per cent and the United Kingdom at 10 per cent. . . Notice that this reversal of rankings in the 1980s took place despite all the best efforts of Mrs Thatcher to create labour market flexibility. . . [I]f labour market flexibility is important in explaining the level of unemployment. . . why does the level of unemployment remain so persistently high in a country, Britain, where active measures have been taken to create flexibility?" [Keith Cowling and Roger Sugden, Beyond Capitalism, p. 9]

If we look at the fraction of the labour force without a job in America, we find that in 1969 it was 3.4% (7.3% including the underemployed) and rose to 6.1% in 1987 (16.8% including the underemployed). Using more recent data, we find that, on average, the unemployment rate was 6.2% in 1990-97 compared to 5.0% in the period 1950-65. In other words, labour market "flexibility" has not reduced unemployment levels, in fact "flexible" labour markets have been associated with higher levels of unemployment. Of course, we are comparing different time periods. A lot changed between the 1960s and the 1990s and so comparing these periods cannot be the whole answer. However, it does seem strange that the period with stronger unions, higher minimum wages and more generous welfare state should be associated with lower unemployment than the subsequent "flexible" period. It is possible that the rise in flexibility and the increase in unemployment may be unrelated. If we look at different countries over the same time period we can see if "flexibility" actually reduces unemployment. As one British economist notes, this may not be the case:

"Open unemployment is, of course, lower in the US. But once we allow for all forms of non-employment [such as underemployment, jobless workers who are not officially registered as such and so on], there is little difference between Europe and the US: between 1988 and 1994, 11 per cent of men aged 25-55 were not in work in France, compared with 13 per cent in the UK, 14 per cent in the US and 15 per cent in Germany." [Richard Layard, quoted by John Gray, False Dawn, p. 113]

Also when evaluating the unemployment records of a country, other factors than the "official" rate given by the government must taken into account. Firstly, different governments have different definitions of what counts as unemployment. As an example, the USA has a more restrictive definition of who is unemployed than Germany. For example, in 2005 Germany's unemployment rate was officially 11.2%. However, using the US definition it was only around 9% (7% in what was formerly West Germany). The offical figure was higher as it included people, such as those involuntarily working part-time, as being unemployed who are counted as being employed in the USA. America, in the same year, had an unemployment rate of around 5%. So comparing unadjusted unemployment figures will give a radically different picture of the problem than using standardised ones. Sadly far too often business reporting in newspapers fail to do this.

In addition, all estimates of America's unemployment record must take into account its incarceration rates. The prison population is not counted as part of the labour force and so is excluded when calculating unemployment figures. This is particularly significant as those in prison are disproportionately from demographic groups with very high unemployment rates and so it is likely that a substantial portion of these people would be unemployed if they were not in jail. If America and the UK did not have the huge surge in prison population since the 1980s neo-liberal reforms, the unemployment rate in both countries would be significantly higher. In the late 1990s, for example, more than a million extra people would be seeking work if the US penal policies resembled those of any other Western nation. [John Gray, Op. Cit., p. 113] England and Wales, unsurprisingly, tops the prison league table for Western Europe. In 2005, 145 per 100,000 of their population was incarcerated. In comparison, France had a rate of 88 while Germany had one of 97. This would, obviously, reduce the numbers of those seeking work on the labour market and, consequently, reduce the unemployment statistics.

While the UK is praised for its "flexible" labour market in the 2000s, many forget the price which was paid to achieve it and even more fail to realise that the figures hide a somewhat different reality. It is therefore essential to remember Britain's actual economic performance during Thatcher's rule rather than the "economically correct" narrative we have inherited from the media and economic "experts." When Thatcher came to office in 1979 she did so promising to end the mass unemployment experienced under Labour (which had doubled between 1974 and 1979). Unemployment then tripled in her first term, rising to over 3 million in 1982 (for the first time since the 1930s, representing 1 in 8 people). This was due in large part to the application of Monetarist dogma making the recession far worse than i