Thursday, May 17, 2012

Labor reallocation in a depressed economy

Recently, I have been rereading Lord John Maynard Keynes' opus The General Theory of Employment, Interest and Money. Two of my previous posts, "The master teaches us about involuntary unemployment" and "Are workers employed for nominal or real wages?", have discussed labor-related issues that are covered in Book I, Chapter 2 of the General Theory.

In Chapter 2, Section III of the General Theory, Lord Keynes discusses apparently "irrational" resistance by workers of reductions in their nominal wages, but less resistance to reductions in nominal wages through inflation and suggests that "the struggle about money-wages primarily affects the distribution of the aggregate real wage between different labour-groups, and not its average amount per unit of employment ... ."  He points out that "workers ... resist reductions of money-wages, which are seldom or never of an all-round character".  On thing that had jumped out at me at the discussion in Chapter 2 of unemployment is that the master did not discuss structural unemployment, that which occurs because of a failure of supply and demand for labor within specific industries, professions, etc. to match up.

Lord Keynes' discussion on relative wages caused me  to think about the consequences of a misallocation of labor. Misallocation implies inefficiency in the market system. It occurred to me that while the unemployment rate is high, workers may be more than usually conservative about risking unemployment by actively searching for better employment (one that better matches their skills in the best remunerative position). Obviously it is quite risky to leave a job when there is no guaranteed position available, but even when a worker seeks a new position while they are still employed, there is additional risk. Such a worker puts out feelers to companies, some of whom may be interested in contacting their current employer for an assessment of their job performance, but that adds risk that their current employer could undertake an adverse action against the worker or be protective of their human capital. There are clearly negative implications to this, which will slow the labor adjustment process.

To my thinking, the answer to this problem is for the government and the monetary authorities to adopt a policy which favors consistent full employment. If the adjustment process is slowed by higher unemployment, it impedes the progress of the economy and has real and substantial costs, which should be taken into account when authorities decide upon fiscal and monetary policy.

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