Developments Outside the Mainstream
There are several streams of thought among critical, non-mainstream economists. A widely shared view, however, is the rejection of the supply and demand curve apparatus in factor markets, which is the foundation of the long-run tendency to full employment and the associated notion of distribution determined by full employment marginal products.
The latter analytical framework has often been questioned on the grounds of its inability to describe and explain real-world phenomena. Such an inability, however, is connected to fundamental flaws in the theoretical construction that have emerged thanks to the results obtained by Sraffa (1960), Garegnani (1966, 1970) and Pasinetti (1966). These show that when heterogeneous capital goods exist, in an economic system with free competition and profit maximizing firms, a fall in wages will not necessarily lead to adopting techniques exhibiting a higher proportion of labour relative to the value of capital and/or a higher proportion of labour per unit of output: the cost-minimizing technique after the fall in the real wage may, on the contrary, turn out to exhibit a lower proportion of labour relative to capital and per unit of output. By the same token, it cannot be expected that the relative price of commodities produced with more labour intensive techniques will fall, thus inducing substitution in consumption and hence, indirectly, between factors of production.These results therefore question the very foundations of factor demand curves (that is, for labour and capital and hence investments) and with them of the entire edifice of neoclassical theory.
From the point of view of the theory of employment, these criticisms lead to the rehabilitation of the principle of effective demand as the only sound theory of output and employment, and remove from the scene the endogenous mechanisms restoring full employment (or the equilibrium unemployment rate) put forward both by the pre-Keynesian versions of neoclassical theory and by subsequent mainstream macroeconomic models.
The absence of a tendency towards full employment or equilibrium unemployment needs no longer to rest on any real or nominal rigidity in wages and prices. Downward flexibility of money prices and wages, even conceding that (as in the neoclassical synthesis) it would lead to a fall in the interest rate, would not by that route be able to stimulate investments, since a sound theoretical foundation of the inverse relation between interest and aggregate investment cannot be provided (Petri 2004: ch. 7), nor can it be supported by empirical evidence (Chirinko 1993). Nor would a fall in the real wage lead to higher employment by way of substitution mechanisms. On the contrary, by negatively affecting the propensity to consume, it may cause a fall in effective demand and employment. Keynes’s statement about the desirability of money wage rigidity as a stability anchor for the economy is therefore vindicated and, in the light of the above criticisms, can now be extended also to real wages.The traditional neoclassical foundations were still present in the General Theory and caused tensions between the intended generality and long-run nature of its main conclusions and the need for short-run assumptions (such as given expectations as to the normal level of the interest rate) in order to state them. The removal of the neoclassical elements provides the theory with theoretical robustness and generality. The principle of effective demand explains not only aggregate fluctuations of employment, but also its long-run level. The meaning of long run in this context requires some clarification, and is actually a twofold meaning. The first is that when a persistent change in effective demand (for example, in public spending) leads to a change in macroeconomic equilibrium output and employment, there is no endogenous mechanism in a market economy, which will restore the previous level of output. The second is that if there is no mechanism ensuring full utilization of capacity in any given period, it becomes natural to think that capacity creation over time through investment will reflect the degree of capacity utilization.
That is, the main determinant of aggregate investments is the trend of effective demand. This implies that while in any given period effective demand determines aggregate output through the degree of utilization of existing capacity, in the long run it will determine potential output through capacity creation (Garegnani 1992). A parallel line of reasoning can be applied to the labour force: while in any given period effective demand will determine the unemployment rate, over longer periods of time it will tend to affect the size of the labour force available for wage labour. How this may come about had already been indicated by Marx when describing the creation of a reserve army of the unemployed as part of the accumulation processes. Consistently with that approach it may be recalled that, among other things, changes in the available labour force may be brought about in advanced economies also by migration flows and by changes in the activity rates of some sections of the population, particularly women, in response to persistent changes in employment opportunities. In less developed economies, effective demand and employment in the wage sector of the economy will affect the proportion of the population in low-income, pre-capitalist and informal activities and migration. Thus, evidence of a relative constancy of unemployment rates over very long periods of time may indicate endogeneity of labour supply in the very long run, rather than the adjustment of labour demand to the available labour supply, as would be predicted by mainstream analyses.A rejection of the neoclassical foundations also requires an alternative approach to the theory of distribution. The traditional classical approach, which sees wages as resulting, within limits determined by the historically prevailing living standards and the institutional setting, from the relative bargaining power of the parties, naturally suggests itself as suitable for developments and integration with the theory of employment already outlined.
Other streams in critical economic analysis tend to regard wages as residually determined by the mark-up charged by firms over costs. This in turn is explained by financial requirements and/or growth objectives by firms or the structure of the market for final products (for a critical assessment of these, see Pivetti 1992: 108-19; Steedman1992). Some economists, following an initial suggestion by Sraffa, have highlighted the role of the interest rate in determining the return on capital required by firms and hence, by that route, the rate of profits (Pivetti 1992). This however should not be accepted mechanically, since distribution would ultimately depend also on the behaviour of money wages and prices, and thus be the outcome of actions undertaken by various parties and institutions, including the central bank (Stirati 2001).
These theories are consistent with, and can account for empirical evidence often found to be puzzling by mainstream macroeconomists, such as the wide fluctuations of employment accompanied by moderately pro-cyclical movements of real wages (Stirati 2015); or the downward sloping Phillips curve, which could very straightforwardly be interpreted as representing the influence of the unemployment rate on wage bargaining (Rothschild
1993), rather than reflect excess aggregate demand as in mainstream analyses; or the inability of labour market “rigidities” and institutions to account for the diversity of unemployment experiences (Baker et al. 2005, among others).
The approach to employment theory outlined above has very profound implications for economic policy, which are in many respects completely opposite to those that can be derived from mainstream models. According to this approach, long-term growth of output and employment can only be the result of growing aggregate demand, particularly of its autonomous and non-capacity-creating components, among which public spending has a very important role. On the other hand, labour market “reforms” aimed at greater flexibility have no direct impact on employment levels, and will be counterproductive if they have adverse effects on real wages and consequently on the propensity to consume.
Antonella Stirati