Post Keynesian Labour Market Theory: A Summary

The Post Keynesian view on labour markets is opposed to that of neoclassical economics. A summary of Post Keynesian labour market theory from Lavoie (1992) follows.

Post Keynesian economics holds that labour markets are not necessarily well behaved, that the wage rate is not an ordinary “price”, and that wages cuts can have perverse effects on economic activity contrary to neoclassical theory (Lavoie 1992: 217).

Wages are not, general speaking, set by reference to marginal product of labour, but wage rate determination is affected by notions of fairness, justice and social norms, and these factors can affect all attributes of labour from the real/nominal wage to productivity, working week, job safety, security and so on (Lavoie 1992: 218).

At the aggregate level, there is no necessary and consistent relationship between the real wage and demand for labour (Lavoie 1992: 217).

Even the neoclassical view that work necessarily carries disutility is untrue: work per se can be rewarding and bring satisfaction (Lavoie 1992: 218).

Lavoie (1992: 218) points to the dual labour market hypothesis, which is that most advanced economies have two sub-labour markets, as follows:

(1) the “core” economy labour market
Here wages and productivity are high, costs of labour training are high, and there is a greater degree of unionisation.

(2) the “peripheral” labour market
Here wages are generally low, little training is required, and turnover is high (Lavoie 1992: 218–219).

The administered pricing/mark-up pricing sector of an economy strongly corresponds to the “core” economy, though imperfectly.

A strong general characteristic of most households is that they wish to maintain their standard of living, and that they face fixed nominal contractual obligations like debt, and hence the need to maintain income levels (Lavoie 1992: 222). This, though amongst other reasons too, translates into a strong opposition to nominal wage cuts.

Even labour supply often depends on a perceived target wage rate and past standards of living (Lavoie 1992: 222–223), not necessarily on movements of the real wage rate.

The demand for labour is mostly driven by demand for output, and hence aggregate demand drives employment levels.

BIBLIOGRAPHY
Lavoie, Marc. 1992. Foundations of Post-Keynesian Economic Analysis. Edward Elgar Publishing, Aldershot, UK.

Lavoie on Mark-up Pricing in Neoclassical Theory

Marc Lavoie writes here:

“While Post Keynesians have long endorsed cost-plus pricing, mainstream economists have recently begun to make use of markup pricing. Mainstream authors … usually point out that a markup over unit variable costs is consistent with profit maximization – the markup depends on the elasticity of demand and is set to equate marginal cost and marginal revenue. This interpretation can also be found in some earlier works of Kalecki and has been endorsed by Cowling (1982). On this view markup pricing appears to be profit maximization under conditions of imperfect competition, in a trial-and-error disguise.

There are two responses to this claim. First, a number of authors have pointed out that demand elasticities computed in empirical studies are inconsistent with this profit-maximizing interpretation of markup pricing. In particular, Koutsoyiannis (1984) found that for most industries the price-elasticity of demand is below one. This implies that marginal revenue is negative, which contradicts the hypothesis of profit maximization, for marginal costs cannot be negative. Second, accounting studies and economic surveys have shown that the most frequent pricing procedure is normal-cost pricing. But normal-cost pricing, in its modern incarnation, takes unit fixed costs or unit overhead costs into account, and not just marginal or variable costs. Normal cost-pricing and target-return pricing are thus incompatible with profit-maximizing neoclassical theories, since the latter presume that overhead costs or fixed costs play no role in the determination of prices.” (Lavoie 2001: 25).

The lesson is to beware of neoclassical re-interpretations of administered pricing.

One must not confuse the neoclassical concept of marginal costs with average costs of production per unit. The two are not the same thing.

And, above all, the administered pricing behaviour of many firms is inconsistent with the idea of profit-maximisation in neoclassical theory.

BIBLIOGRAPHY
Koutsoyiannis, A. 1984. “Goals of Oligopolistic Firms: An Empirical Test of Competing Hypotheses,” Southern Economic Journal 51.2: 540–567.

Lavoie, M. 2001. “Pricing,” in Richard P. F. Holt and Steven Pressman (eds.), A New Guide to Post Keynesian Economics. Routledge, London and New York. 21–31.

Lavoie on Administered Prices

Short and concise, but insightful:

“… prices set by [sc. fixprice] firms in the short run are not market-clearing prices, and are not even intended to be so. According to Lee …, this was the most striking lesson to be drawn both from Mean’s administered prices and from the surveys conducted by Hall and Hitch (1939). The novel and radical feature of the classic article of the latter was that prices are not designed to clear markets. Prices are not such that they equate supply and demand schedules. In a context where supply is flexible, firms do not necessarily attempt to equate demand to the normal use of capacity when they set prices.” (Lavoie 1992: 95).

It is also clear that administered prices are not simply a phenomenon confined to monopolistic or oligopolistic markets, but are widespread in modern market economies and found throughout many other markets where competition exists amongst numerous small or medium-sized firms (Lavoie 1992: 95–96).

The consequences of this are the following:

(1) one of the major (alleged) mechanisms driving an economy to Walrasian full employment equilibrium collapses and the whole notion that market economies have a strong tendency to general equilibrium must be abandoned, and

(2) the Austrian (or Misesian) notion that market economies have a strong tendency to economic coordination effected by firms’ adjusting their prices towards market clearing values is fundamentally flawed and wrong.

BIBLIOGRAPHY
Hall, R. L. and C. J. Hitch. 1939. “Price Theory and Business Behaviour,” Oxford Economic Papers 2: 12–45.

Lavoie, Marc. 1992. Foundations of Post-Keynesian Economic Analysis. Edward Elgar Publishing, Aldershot.