Changes in Money-Wages

The reduction in money-wages will have no lasting tendency to increase employment except by its repercussions either:

• on the propensity to consume for the society as a whole, or
• on the marginal efficiencies of capital curve, or
• on the interest rate.

There is no method of analysing the effect of a reduction in money-wages, except by following up its possible effects on these 3 factors.

The most important repercussions on these factors are the following:

1. A reduction of money-wages will somewhat reduce prices.

It will, therefore, involve some redistribution of real income:

• a) from wage-earners to other factors entering into marginal prime cost whose remuneration has not been reduced, and
  • This will reduce the propensity to consume.
• b) from entrepreneurs to rentiers to whom a certain income fixed in terms of money has been guaranteed.
  • This might reduce the propensity to consume if rentiers are the richer of the community and have the least flexible standard of life

2. If the economy is part of an international system, the reduction of money-wages locally will also reduce money-wages abroad.

This change will be favourable to investment since it will increase the balance of trade.

This assumes that the advantage is not offset by a change in tariffs, quotas, etc.

The traditional belief is that a reduction in money-wages will increase employment in the UK, more than in the US.

• This is probably because the US is a closed system compared to the UK.

3. In an international system, a reduction of money-wages increases the favourable balance of trade.

• But it is likely to worsen the terms of trade.
• Thus there will be a reduction in real incomes, except in the case of the newly employed.
  • This might increase the propensity to consume.

4. If the reduction of money-wages is expected for the future, the change will be favourable to investment.

This is because it will increase the marginal efficiency of capital.

If, on the other hand, the reduction leads to the expectation, or even to the serious possibility, of a further wage-reduction in prospect, it will have precisely the opposite effect. For it will diminish the marginal efficiency of capital and will lead to the postponement both of investment and of consumption.

5. The reduction in the wages-bill, accompanied by some reduction in prices and in money-incomes generally, will diminish the need for cash for income and business purposes;

it will therefore reduce pro tanto the schedule of liquidity-preference for the community as a whole. Cet. par. this will reduce the rate of interest and thus prove favourable to investment. In this case, however, the effect of expectation concerning the future will be of an opposite tendency to those just considered under (4).

For, if wages and prices are expected to rise again later on, the favourable reaction will be much less pronounced in the case of long-term loans than in that of short-term loans. If, moreover, the reduction in wages disturbs political confidence by causing popular discontent, the increase in Liquidity preference due to this cause may more than offset the release of cash from the active circulation.

6. Since a special reduction of money-wages is always advantageous to an individual entrepreneur or industry, a general reduction (though its actual effects are different) may also produce an optimistic tone in the minds of entrepreneurs, which may break through a vicious circle of unduly pessimistic estimates of the marginal efficiency of capital and set things moving again on a more normal basis of expectation.

On the other hand, if the workers make the same mistake as their employers about the effects of a general reduction, labour troubles may offset this favourable factor; apart from which, since there is, as a rule, no means of securing a simultaneous and equal reduction of money-wages in all industries, it is in the interest of all workers to resist a reduction in their own particular case. In fact, a movement by employers to revise money-wage bargains downward will be much more strongly resisted than a gradual and automatic lowering of real wages as a result of rising prices.

7. On the other hand, the depressing influence on entrepreneurs of their greater burden of debt may partly offset any cheerful reactions from the reduction of wages.

Indeed if the fall of wages and prices goes far, the embarrassment of those entrepreneurs who are heavily indebted may soon reach the point of insolvency, — with severely adverse effects on investment. Moreover the effect of the lower price-level on the real burden of the National Debt and hence on taxation is likely to prove very adverse to business confidence. This is not a complete catalogue of all the possible reactions of wage reductions in the complex real world.

But the above cover, I think, those which are usually the most important. If, therefore, we restrict our argument to the case of a closed system, and assume that there is nothing to be hoped, but if anything the contrary, from the repercussions of the new distribution of real incomes on the community’s propensity to spend, it follows that we must base any hopes of favourable results to employment from a reduction in money-wages mainly on an improvement in investment due either to an increased marginal efficiency of capital under (4) or a decreased rate of interest under (5).

The contingency, which is favourable to an increase in the marginal efficiency of capital, is that in which money-wages are believed to have touched bottom, so that further changes are expected to be in the upward direction. The most unfavourable contingency is that in which money-wages are slowly sagging downwards and each reduction in wages serves to diminish confidence in the prospective maintenance of wages. When we enter on a period of weakening effective demand, a sudden large reduction of money-wages to a level so low that no one believes in its indefinite continuance would be the event most favourable to a strengthening of effective demand.

But this could only be accomplished by administrative decree and is scarcely practical politics under a system of free wage-bargaining. On the other hand, it would be much better that wages should be rigidly fixed and deemed incapable of material changes, than that depressions should be accompanied by a gradual downward tendency of money-wages, a further moderate wage reduction being expected to signalise each increase of, say, 1% in the amount of unemployment.

For example, the effect of an expectation that wages are going to sag by 2% in the coming year will be roughly equivalent to the effect of a rise of 2% in the amount of interest payable for the same period.

The same observations apply mutatis mutandis to the case of a boom. It follows that with the actual practices and institutions of the contemporary world it is more expedient to aim at a rigid money-wage policy than at a flexible policy responding by easy stages to changes in the amount of unemployment; — so far, that is to say, as the marginal efficiency of capital is concerned.

But is this conclusion upset when we turn to the rate of interest? It is, therefore, on the effect of a falling wage- and price-level on the demand for money that those who believe in the self-adjusting quality of the economic system must rest the weight of their argument; though I am not aware that they have done so.

If the quantity of money is itself a function of the wage- and price-level, there is indeed, nothing to hope in this direction.

But if the quantity of money is virtually fixed:

• its quantity in terms of wage-units can be indefinitely increased by a sufficient reduction in money-wages
• its quantity in proportion to incomes generally can be largely increased, the limit to this increase depending on the proportion of wage-cost to marginal prime cost and on the response of other elements of marginal prime cost to the falling wage-unit.

We can, therefore, theoretically at least, produce precisely the same effects on the rate of interest by reducing wages, whilst leaving the quantity of money unchanged, that we can produce by increasing the quantity of money whilst leaving the level of wages unchanged.

It follows that wage reductions, as a method of securing full employment, are also subject to the same limitations as the method of increasing the quantity of money. The same reasons as those mentioned above, which limit the efficacy of increases in the quantity of money as a means of increasing investment to the optimum figure, apply mutatis mutandis to wage reductions.

Just as a moderate increase in the quantity of money may exert an inadequate influence over the long-term rate of interest, whilst an immoderate increase may offset its other advantages by its disturbing effect on confidence; so a moderate reduction in money-wages may prove inadequate, whilst an immoderate reduction might shatter confidence even if it were practicable.

It is false to believe that a flexible wage policy can maintain continuous full employment.

• This is similar to the fallacy that an open-market monetary policy is can, unaided, achieve the same result.

The economic system cannot be made self-adjusting along these lines.

If labour could always take action whenever there was less than full employment, to reduce its money demands by concerted action to whatever point was required to make money so abundant relatively to the wage-unit that the rate of interest would fall to a level compatible with full employment, we should, in effect, have monetary management by the Trade Unions, aimed at full employment, instead of by the banking system.

Nevertheless, while a flexible wage policy and a flexible money policy come, analytically, to the same thing, inasmuch as they are alternative means of changing the quantity of money in terms of wage-units, in other respects there is, of course, a world of difference between them. Let me briefly recall to the reader’s mind the three outstanding considerations.

1. Except in a socialised community where wage-policy is settled by decree, there is no means of securing uniform wage reductions for every class of labour.

The result can only be brought about by a series of gradual, irregular changes, justifiable on no criterion of social justice or economic expediency, and probably completed only after wasteful and disastrous struggles, where those in the weakest bargaining position will suffer relatively to the rest. A change in the quantity of money, on the other hand, is already within the power of most governments by open-market policy or analogous measures. Having regard to human nature and our institutions, it can only be a foolish person who would prefer a flexible wage policy to a flexible money policy, unless he can point to advantages from the former which are not obtainable from the latter. Moreover, other things being equal, a method which it is comparatively easy to apply should be deemed preferable to a method which is probably so difficult as to be impracticable.

2. If money-wages are inflexible, such changes in prices as occur (i.e. apart from “administered “ or monopoly prices which are determined by other considerations besides marginal cost) will mainly correspond to the diminishing marginal productivity of the existing equipment as the output from it is increased.

Thus the greatest practicable fairness will be maintained between labour and the factors whose remuneration is contractually fixed in terms of money, in particular the rentier class and persons with fixed salaries on the permanent establishment of a firm, an institution or the State. If important classes are to have their remuneration fixed in terms of money in any case, social justice and social expediency are best served if the remunerations of all factors are somewhat inflexible in terms of money. Having regard to the large groups of incomes which are comparatively inflexible in terms of money, it can only be an unjust person who would prefer a flexible wage policy to a flexible money policy, unless he can point to advantages from the former which are not obtainable from the latter.

3. The method of increasing the quantity of money in terms of wage-units by decreasing the wage-unit increases proportionately the burden of debt; whereas the method of producing the same result by increasing the quantity of money whilst leaving the wage unit unchanged has the opposite effect. Having regard to the excessive burden of many types of debt, it can only be an inexperienced person who would prefer the former.

4. If a sagging rate of interest has to be brought about by a sagging wage-level, there is, for the reasons given above, a double drag on the marginal efficiency of capital and a double reason for putting off investment and thus postponing recovery.

It follows that if labour were to respond to conditions of gradually diminishing employment by offering its services at a gradually diminishing money-wage, this would not, as a rule, have the effect of reducing real wages and might even have the effect of increasing them, through its adverse influence on the volume of output.

The chief result of this policy would be to cause a great instability of prices, so violent perhaps as to make business calculations futile in an economic society functioning after the manner of that in which we live.

To suppose that a flexible wage policy is a right and proper adjunct of a system which on the whole is one of laissez-faire, is the opposite of the truth. It is only in a highly authoritarian society, where sudden, substantial, all-round changes could be decreed that a flexible wage-policy could function with success. One can imagine it in operation in Italy, Germany or Russia, but not in France, the United States or Great Britain.

If, as in Australia, an attempt were made to fix real wages by legislation., then there would be a certain level of employment corresponding to that level of real wages; and the actual level of employment would, in a closed system, oscillate violently between that level and no employment at all, according as the rate of investment was or was not below the rate compatible with that level; whilst prices would be in unstable equilibrium when investment was at the critical level, racing to zero whenever investment was below it, and to infinity whenever it was above it. The element of stability would have to be found, if at all, in the factors controlling the quantity of money being so determined that there always existed some level of money-wages at which the quantity of money would be such as to establish a relation between the rate of interest and the marginal efficiency of capital which would maintain investment at the critical level. In this event employment would be constant (at the level appropriate to the legal real wage) with money-wages and prices fluctuating rapidly in the degree just necessary to maintain this rate of investment at the appropriate figure.

In Australia’s case, the escape was found, partly of course in the inevitable inefficacy of the legislation to achieve its object, and partly in Australia not being a closed system, so that the level of money-wages was itself a determinant of the level of foreign investment and hence of total investment, whilst the terms of trade were an important influence on real wages.

In the light of these considerations I am now of the opinion that the maintenance of a stable general level of money-wages is, on a balance of considerations, the most advisable policy for a closed system; whilst the same conclusion will hold good for an open system, provided that equilibrium with the rest of the world can be secured by means of fluctuating exchanges. There are advantages in some degree of flexibility in the wages of particular industries so as to expedite transfers from those which are relatively declining to those which are relatively expanding.

But the money-wage level as a whole should be maintained as stable as possible, at any rate in the short period. This policy will result in a fair degree of stability in the price-level;-greater stability, at least, than with a flexible wage policy.

Apart from “administered” or monopoly prices, the price-level will only change in the short period in response to the extent that changes in the volume of employment affect marginal prime costs; whilst in the long period they will only change in response to changes in the cost of production due to new technique and new or increased equipment.

If there are large fluctuations in employment, substantial fluctuations in the price-level will accompany them.

But the fluctuations will be less, as I have said above, than with a flexible wage policy.

Thus, with a rigid wage policy the stability of prices will be bound up in the short period with the avoidance of fluctuations in employment.

In the long period, on the other hand, we are still left with the choice between a policy of allowing prices to fall slowly with the progress of technique and equipment whilst keeping wages stable, or of allowing wages to rise slowly whilst keeping prices stable.

On the whole my preference is for the latter alternative, on account of the fact that it is easier with an expectation of higher wages in future to keep the actual level of employment within a given range of full employment than with an expectation of lower wages in future, and on account also of the social advantages of gradually diminishing the burden of debt, the greater ease of adjustment from decaying to growing industries, and the psychological encouragement likely to be felt from a moderate tendency for money-wages to increase.

But no essential point of principle is involved, an it would lead me beyond the scope of my present purpose to develop in detail the arguments on either side.