Winter 2018 / Volume II, Number 4
Since the mid-1970s, the majority of economic power in the Western world has fallen into the hands of business and finance. At that time—facing the enormous challenges of oil price explosions, inflation, and unemployment—the governments of most countries virtually surrendered, and left it to global corporations to search for solutions. Margret Thatcher, Ronald Reagan, and Helmut Kohl, inspired by the ideas of Friedrich von Hayek, Milton Friedman, and others, embraced an ideology that prioritized reducing the influence of the state and empowering “markets.”
But how did the neoliberal revolutionaries so easily conquer the bastions long held by Keynesians until then? The explanation can be found in the unresolved and misunderstood events of the 1970s. The following chart shows that two phenomena occurred during this decade, the combination of which bolstered neoclassical-monetarist arguments. First, the wage rate rose in all major industrialized countries, because after the oil price explosions the still-powerful trade unions were able to achieve double-digit wage growth rates in conditions of full employment. Somewhat later, as the figure shows, unemployment rose in the entire Western world. What could be more obvious than to dust off the neoclassical theory about the connection between high wages and sluggish demand for work—and to use this apparently undeniable evidence to give Keynesianism the final hit?
Yet the relationship between wage levels and unemployment rates was by no means so straightforward. High oil prices and wage hikes also drove inflation to undreamed-of levels. Central bankers around the world reacted by raising interest rates. This was tantamount to adding a new demand shock to the original negative demand shock, which was caused by the oil price increase itself. This second shock triggered the collapse of investment activity all around the world, and was the immediate cause of skyrocketing unemployment. These events are typically ignored in the neoclassical narrative....MUCH MORE
But the Keynesians of that era had lost control over the interpretation of events, while the neoclassical arguments had simple and seemingly unbeatable evidence on their side. The failure of Keynesianism to deal with the new phenomenon of stagflation appeared obvious, and so the victory of its “supply-side” critics was assured.
The following decades were by no means a global success story, but the mainstream narrative nonetheless christened this period as the “Great Moderation.” This story took shape under the pretense that the decades from the 1980s to the end of the century had been very successful, because there had been neither major economic crises nor major tensions between inflation and unemployment. While the latter is true, enormous global shocks such as the Mexican peso crisis, the Asian financial crisis, Latin American debt crises, and the Russian crisis have to be ignored to make sense of the former.
Regardless, the death knell for the Great Moderation rang anyway in 2008, with the outbreak of what is now called the Great Recession. This financial shock did not become a new Great Depression only because most Western governments reacted quickly, bailing out speculators and stabilizing demand.
In the aftermath of these events, a revival of Keynesianism might have been expected, or at least the neoclassical doctrine might finally have been thrown into the dustbin of history. But far from it. Though monetarism is gone, even the obvious failure of neoclassical orthodoxy to explain the dramatic rise in unemployment (and/or the decline in labor force participation rates), coupled with the persistence of low wages, has not awakened Keynesians from their hibernation. At the same time, the Keynesians have lost their political base. In almost all countries, social democratic parties—driven by an extreme and irrational debt phobia—have completely renounced Keynesianism. Paradoxically, the inevitable result of this debt phobia has been soaring debt levels around the world, and the corporate behavior inspired by the neoliberal revolution is increasingly undermining the market economy.
The chart above indicates another important fact that is largely overlooked: the wage rate at the outbreak of the 2008 financial crisis was not high. In fact, it was very low—lower than it had been since before World War II. Despite the prevailing low wages, however, the crisis caused unemployment to rise to its highest level since World War II, shifting the balance of power in the labor market even further in favor of employers. The result was a deflationary trend in wages, as we have seen almost all over the world since 2008.Low Wages and High Unemployment Since 2008
Nevertheless, Keynesians have missed this opportunity to make up points. They have failed to show that rising unemployment in the aftermath of the financial crisis, accompanied by low wage increases and a very low wage-to-GDP ratio, disproves neoclassical ideas about the normal functioning of the labor market. Indeed neoclassical and other liberal economic theories, whether derived from monetarism or efficient financial markets, have for decades been unable to account for economic reality and can no longer offer relevant statements on economic policy.
The core neoclassical narrative on the “labor market”—that it is a market like any other—has a long history. The original dispute over the functioning of the labor market revolved around the question of whether workers’ wages are primarily determined by existing power relations or whether wage levels obey economic laws (i.e., that they are determined anonymously in a functioning market with normally shaped supply and demand curves). Economists who firmly believe that economic law will prevail, typically on the basis of the theory of marginal productivity, have held the upper hand during most of modern economic history.
Today, however, we know much more about the functioning of the labor market, especially concerning the overall economic feedback of wage levels on the demand for goods and employment. We know that supply and demand in the labor market are not independent of each other and, therefore, that assuming independent and normally shaped supply and demand functions is completely misleading. But this is systematically and consciously ignored.
In the Western industrialized countries, there is a broad consensus that wealth distribution over the past two decades has changed to the detriment of workers. For lower-income earners in particular, wages have fallen sharply in relative and sometimes even in absolute terms. The most frequently used Gini coefficient shows growing inequality in almost all countries.The Balance of Power
While it is perfectly clear that the personal distribution has changed in favor of employers and the wealthy, the shift in the so-called functional distribution—the shift in favor of capital and at the expense of labor—should not be ignored. This was to be expected; it was after all the explicit aim of neoliberal policies (often justified by neoclassical economics) to change the economic power distribution in favor of businesses and the well-off.
In the last twenty years in Germany, for example, the state has halved taxes on companies and abolished capital taxes such as the wealth tax and capital gains tax. At the same time, corporate profits have exploded as the European Union export channel created a golden opportunity for German wage dumping inside the European Monetary Union. (Similarly, in the United States, capital gains taxes were reduced just as new opportunities for labor arbitrage were created by liberalizing trade policies, while corporate income taxes were recently cut as well.)
The effects are clear: the following figures show the development of real salaries and productivity per hour in Germany and France since the beginning of the European Monetary Union. With approximately the same level of unemployment at the beginning of the century in both countries, political power in Germany was used to pressure the trade unions to allow real wages to lag behind productivity. Consequently, many wages in Germany remained below their marginal productivity, which, according to the neoclassical view, is impossible. The limit supposedly represented by marginal productivity was shown to be purely theoretical, and in practice proved to be no match for the powerful effects of state policies. This comparison demonstrates the superiority of the Keynesian view of labor markets, and illustrates the bankruptcy of the neoclassical view....
