Money Wages versus Real Wages

What is the actual statistical relationship between:

• changes in money-wages and
• changes in real wages?

In a particular industry, one would expect the change in real wages to be in the same direction as the change in money-wages.

But in the case of general wages, the change in real wages associated with a change in money-wages, is so far from being in the same direction. It is almost always in the opposite direction:

• when nominal-wages are rising, real wages are falling [inflation]
• when nominal-wages are falling, real wages are rising [deflation or recession]

This is because, in the short terms, falling nominal-wages and rising real wages accompany decreasing employment.

Workers are readier to accept wage-cuts when employment is falling off. Yet real wages can rise when jobs are cut when there is overemployment. The reduction of output increases the marginal return of capital equipment [when production is beyond optimum].

But this only happens when there is overemployment. The existing money-wage usually has unemployed people even during inflation. This causes real wages to fall. This means that the real prices of things is not an accurate indication of the marginal disutility of labour [workers refusing to work]. The second postulate does not hold good*.

Keynes’ Wacky Assumptions

But there is a more fundamental objection.

The second postulate flows from the idea that the real wages of workers depend on the wage bargains which workers make with the entrepreneurs. The bargains are actually made in terms of money. But the real wages acceptable to labour depend on the money-wage.

Nevertheless, it is the money-wage that determines the real wage*.

Thus, the classical theory assumes that workers can always reduce their real wage by accepting a reduction in money-wages*.

The postulate that there is a tendency for the real wage to come to equality with the marginal disutility of labour [workers refusing to work for slave wages] clearly presumes that workers can decide their real wages, but not the quantity of employment willing to work at this wage.

The traditional theory maintains that the real wage* is determined by the wage bargains between the entrepreneurs and the workers.

Let us assume free competition amongst employers and no restrictive combination amongst workers. The workers can bring their real wages into conformity with the marginal disutility of the amount of employment offered by the employers at that wage.

If this is not true, then there is no longer any reason to expect a tendency towards equality between the real wage and the marginal disutility of labour [workers refusing to work].

The classical conclusions:

• apply to the whole body of workers. It does not mean that one worker can get employment by accepting a cut in money-wages which his fellows refuse.
• should equally be applicable to a closed and to an open system
• are not dependent on
  • the characteristics of an open system or
  • the effects of a reduction of money-wages in a single country on its foreign trade.
• are not based on indirect effects due to a lower wages-bill in terms of money having certain reactions on the banking system and the state of credit.

Classical conclusions are based on the belief that in a closed system a reduction in money-wages will be accompanied by a reduction in real wages*

The general level of real wages depends on the money-wage bargains between the employers and the workers is obviously not true*.

• prices are governed by marginal prime cost in terms of money*
• money-wages largely govern marginal prime cost

Thus if money-wages change, prices would change in almost the same proportion. It would leave the real wage and unemployment the same as before. Any small gain or loss to labour being at the expense or profit of other elements of marginal cost which have been left unaltered.[6]

They diverted from this idea by the settled conviction:

• that labour can determine its own real wage
  • They think that labour can always determine what real wage corresponds to full employment, i.e. the maximum quantity of employment which is compatible with a given real wage
• that prices depend on the quantity of money

Thus, the second postulate of the classical theory has 2 objections:

1. The actual behaviour of labour

I assert that a fall in real wages due to inflation, with money-wages unaltered, does not cause the number of available job-seekers at the current reduced real wage to be less than the number actually employed prior to inflation.

If it does, then all those who are now unemployed at the current reduced real wage will stop working because of just a small inflation*. Yet this strange supposition is what Pigou’s Theory of Unemployment says[7].

2. The wage bargain directly determines the general level of real wages

There may be no method available to workers to make the general level of money-wages conform with the marginal disutility of the current volume of employment [workers refusing to work].

Workers have no way to reduce their real wage by making revised money bargains with the entrepreneurs*.

I argue that other forces determine the general level of real wages, not the workers bargaining.