Driving Down Nominal Wages

A recent article in the Toronto Star suggested that it is the intent of the current Conservative government in Canada to drive down workers’ wages so as to inflate the profits of corporations. If true, this is a misguided way to try to manage an economy.

Keynes, in the General Theory, tells us quite rightly what is the thinking that underpins a desire to depress nominal wages: “a reduction in money wages will, cet. par. stimulate demand by diminishing the price of the finished product, and will therefore increase output and employment up to the point where the reduction which labour has agreed to accept in its money-wages is just offset by the diminishing marginal efficiency of labour as output (from a given equipment) is increased. (General Theory, p. 257)

Keynes goes on to tear this argument apart and show that it is fallacious.In particular, he points out that a reduction in nominal wages will only increase profits under two conditions: one, that society’s marginal propensity to consume is equal to unity, and two, there is no gap between the increment of income and the increment of consumption.

Decreasing nominal wages is not likely to increase output and employment unless it can be shown to impact the propensity to consume for society as a whole, or impact the marginal efficiency of capital (the yield earned on employing an additional unit of capital), or the rate of interest. Since interest rates are already at the lower bound, advocates of driving down nominal wages must show that their approach will affect the first two variables in order to have the effect they claim.

While wage flexibility is desirable in certain situations (i.e., where an industry is in decline, or rapidly expanding), in the general Theory, Keynes advocated maintaining a stable overall general level of nominal wages. Following this policy helps to maintain price stability and avoid volatile fluctuations in price levels.

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