Mises’ “Unhampered Market” Fantasy World

A statement by Mises in his explanation of labour markets and what causes demand for labour, and in the context of the Great Depression:

“Wage rates are market phenomena, just as interest rates and commodity prices are. Wage rates are determined by the productivity of labor. At the wage rates toward which the market is tending, all those seeking work find employment and all entrepreneurs find the workers they are seeking. However, the interrelated phenomena of the market from which the ‘static’ or ‘natural’ wage rates evolve are always undergoing changes that generate shifts in wage rates among the various occupational groups. There is also always a definite time lag before those seeking work and those offering work have found one another. As a result, there are always sure to be a certain number of unemployed.

Just as there are always houses standing empty and persons looking for housing on the unhampered market, just as there are always unsold wares in markets and persons eager to purchase wares they have not yet found, so there are always persons who are looking for work. However, on the unhampered market, this unemployment cannot attain vast proportions. Those capable of work will not be looking for work over a considerable period—many months or even years—without finding it.” (Mises 2006 [1931]: 164–165).

This view is hardly unique to Austrian economics of course; many streams of neoclassical theory think labour demand is wholly or mainly a function of the wage rate (and this is why they are obsessed with labour market deregulation and wage flexibility).

The trouble is: it is not true. That is to say, the main cause of demand for labour is aggregate demand for output, and wages rates are very much a secondary phenomenon. Of course, nobody denies that if wage rates get too high, it will probably reduce demand for labour, or that in some markets wage rates might be the determining factor. But in most markets wages are relatively inflexible downwards, and a high degree of wage stickiness is a persistent and omnipresent characteristic of modern advanced economies.

The empirical evidence that has accumulated over the years shows that people in general object to having their nominal wages cut, and workers are not generally, nor do they tend to be, paid their marginal labour product. In fact, very often workers simply do not know what their marginal product even is, and managers/employers find it difficult to calculate it (Bewley 1999: 82, 407). In many cases, such as when output is produced by a large number of workers with different roles, it is probably not even possible to calculate the marginal labour product of an individual worker.

But it is worse than this, because there is a great deal of evidence that even managers and capitalists often dislike pay cuts. Recent studies suggest that employers avoid pay cuts because they diminish workers’ morale, and then falling morale reduces productivity, amongst many other reasons (Bewley 1999; see a nice summary of Bewley’s work on wages here). There is even evidence that by the late 19th century downwards nominal wage rigidity was already a serious fact of life in the American manufacturing sector (Hanes 1993). This type of significant wage stickiness has clearly been around for a long time, and certainly it existed in the golden age of capitalism (1946–1973), yet in that period unemployment was historically low and it was not due to wage rates adjusting rapidly to allegedly clear labour markets.

Even when demand shocks are severe enough to cause wage and price deflation (as in the early 1930s), in an environment of high private debt, this would cause a severe debt deflationary crisis in a capitalist economy.

Mises’ “unhampered market” is a fantasy world of little relevance to an empirical economics, and the central element in it – that wage rates would be the primary determinant of demand for labour and would be flexible enough to ensure that involuntary unemployment never reaches significant levels – is hardly credible as a condition that we would see in the real world.

Further Reading
“Post Keynesian Labour Market Theory: A Summary,” August 21, 2014.

“Two Summaries of Bewley’s Why Don’t Wages Fall During a Recession?,” June 17, 2014.

“James Galbraith on the Essence of Keynes’ View of Labour Demand,” May 2, 2014.

“Keynes on Nominal Wage Flexibility,” June 7, 2014.

“The Essence of Post Keynesian Theory of Unemployment,” May 16, 2013.

“Steve Keen, Debunking Economics, Chapter 6: Wages,” February 12, 2014.

“Were Nominal Wages Flexible in 1890s and Early 1900s America?,” January 31, 2014.

BIBLIOGRAPHY
Bewley, T. F. 1999. Why Wages Don’t Fall During a Recession. Harvard University Press, Cambridge, MA.

Hanes, Christopher. 1993. “The Development of Nominal Wage Rigidity in the Late 19th Century,” The American Economic Review 83.4: 732–756.

Mises, Ludwig von. 2006 [1931]. “The Causes of the Economic Crisis,” in Percy L. Greaves (ed.). The Causes of the Economic Crisis, and Other Essays Before and After the Great Depression. Ludwig von Mises Institute, Auburn, Ala.