Trap Awaits Those Who Would Cut Wages

In 1936, John Maynard Keynes, probably the most accomplished economist of this century, explained how and why capitalist economies become ensnared in high unemployment “equilibrium” traps.

One part of his analysis dealt with wage reduction policies. At the time--the 1930s--Keynes was fighting the British treasury’s view that lower wages would induce an expansion in the demand for labor.

The treasury view held that as a consequence of lower prices on goods, a firm’s demand for labor would increase as it received more orders for its products. If all firms in that industry reduced prices through lower wages, this might stimulate a higher demand for labor through a price-induced expansion in demand.

Keynes pointed out, however, that lower wage policy in a firm or industry was not an appropriate wage policy for the economy as a whole. Reducing the wages of all workers would impoverish the economy. The only reason such a policy works at the level of one firm is that aggregate consumer spending power is maintained by the stable higher wages of other firms.

Although this is well known, there seem to be many contemporary instances where Keynes’ views are ignored, even rejected, in a rush to gain temporary price advantage for cities, regions, firms, industries and whole economies. Consider:

In Pittsburgh, it is commonly argued that the drastic decline of local manufacturing was due to high union wages. There is much debate over the relative contribution of high union wages versus other factors such as the dumping of foreign products, low levels of investment in domestic plants, management ineptitude, and so on.

Whatever the role of high union wages in industrial decline, since 1979 more than 80,000 jobs have been lost in local manufacturing, and there appears to be no end in sight. At the same time, employment in Pittsburgh actually has grown during the past few years so that in 1987 there are more new jobs than before. The “new” jobs have come from the service sector.

Given these patterns, the lessons drawn by local policy-makers seem to be: high union wages caused the decline of manufacturing, low union wages caused the growth of service employment. Thus, if local manufacturing jobs are to be preserved, union workers must take substantial wage and benefit cuts.

What is lost in this “analysis” is the fact that the volume and diversity of Pittsburgh’s service jobs is due to high union wages. Without union wages and benefits, the local economy would be a mere shadow of its current structure. The average Pittsburgh service job pays much less than half the average union manufacturing job. Furthermore, lay-off benefits of union workers, so important to the local economy in recent years, often pay as much as jobs in fast food stores. To imagine a local economic development program that has as one of its policies the reduction of union wages and benefits is appalling.

It might be argued that there is no alternative, that those with manufacturing jobs will lose them unless they take substantial wage and benefit cuts. This may be the case. Nevertheless, it is highly unlikely that such a policy would benefit the local economy. “Saving” local jobs by lowering manufacturing wages would have profound negative consequences for those immediately affected, and the local economy at large.

This example can be extended to the national and international economy. There is much debate over the future prospects of U.S. industries such as steel, autos, chemicals, textiles, electronics--indeed all manufacturing sectors. The problems of these industries are many, but often involve price competition from foreign manufacturers.

This “problem” has elicited a number of possible solutions from the U.S. government. One is for these industries to reduce wages while improving productivity. The idea is that domestic firms should be able to compete with imports by virtue of their higher relative economic efficiency. But no one knows by how much wages have to be reduced to be competitive. Some commentators believe that the ultimate competitive efficiency wage is the lowest Third World wage plus the cost of shipping steel from across the world.

For the U.S. economy as a whole, however, there is another implication. If manufacturing wages are drastically reduced, the domestic market for service products will also drastically shrink.

For the world economy, there is an even more sobering implication. During the past decade the U.S. economy has become the market place for many countries as their own markets have stagnated and declined. Collapse of high-wage manufacturing jobs would starve the American service economy and could lead the rest of the world into economic depression.

Perhaps that is an extreme scenario. Even so, it is made quite plausible by a new generation of policy-makers who have forgotten Keynes’ lessons.