General Theory Study Guide: Chapter 2, Sections III, IV and V

In these sections, Keynes finishes demolishing the classical understanding of unemployment that he started in section II.  By the end of section V, his theory of employment should start(START!) coming into focus.  If by the end of section V, you don't understand his argument of why there is involuntary unemployment in a money economy, I would reread sections II through V over and over until you do before moving on.

Section III

Section III starts off by repeating that workers have no mechanism to lower their own REAL wages across the economy.  This is such an important point, Keynes can be forgiven if he repeats it a couple (or even a hundred) times.  Workers can only cut their dollar-wages, but that doesn't necessarily lower their REAL wage. Understanding this is critical to Keynesian economics.  From Section III

In other words, 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, which depends, as we shall see, on a different set of forces. The effect of combination on the part of a group of workers is to protect their relative real wage. The general level of real wages depends on the other forces of the economic system.

I cannot over stress the criticality of understanding this.  Keynes is pointing out that because people make their deals in money-terms and not REAL-wage terms, there is no way for workers to increase the general level of employment by accepting wage cuts.  Even if workers start a cycle of slashing their wage demands, all that will happen is either the price of what they're making is slashed or their wages will be redistributed to other groups.  If all workers lower their dollar-wage, it redistributes wages to capital or land in the form of interest and rent.

More detail on how and why this is will be explained later and throughout the book.  For now, just understand that Keynes rejects the notion of obstinate workers as an explanation for involuntary unemployment.

Keynes also points out now why it is actually logical(remember how the Classicals thought it illogical) for workers to resist reduction in dollar-pay, but not resist loss of REAL wages from a sudden increase in the cost of living.  A rise in cost-of-living affects all industries equally and happen so often that resisting them is impractical.  Of course, Keynes, being thorough, does point out that there are exceptions when things go to the extreme(i.e. A very high increase in cost of living).

Section IV
Section IV is where Keynes takes up the task of defining involuntary unemployment.  He makes some obvious caveats about his definition and existing definitions first(you shouldn't have a problem with theses).  Then he gets to his definition.  It is a complicated definition:

Men are involuntarily unemployed if, in the event of a small rise in the price of wage-goods relatively to the money-wage, both the aggregate supply of labour willing to work for the current money-wage and the aggregate demand for it at that wage would be greater than the existing volume of employment

Fortunately, if you have a hard time deciphering this "an alternative definition, which amounts to the same thing, will be given in the next chapter".  What he's saying here is if the cost of living rises, but dollar-wages stay about the same, and more people are working after the rise than before the rise, then there was some involuntary unemployment.

Keynes in this section then reiterates that his problem with "the classicals" isn't their reasoning, it is their assumptions.  They have assumed, whether they realize it or not, that "Full Employment" already exists.

Section V
In this section Keynes comes puts and explicitly states that he does believe a reduction in REAL wages will in fact increase employment(assuming land and capital remains even).  He is not disputing this.  Only thing he is disputing is the ability for workers to cut their REAL wages.  At the end of the section he states, "The theory of wages in relation to employment... cannot be fully elucidated, however, until Chapter 19 and its Appendix have been reached."

General Theory Study Guide: Book 1, Chapter 2, Sections I and II

To start off Chapter 2 of "The General Theory of Employment, Interest, and Money", Keynes makes a keen observation of the economics profession.  That there is a tendency to talk more about how an economy distributes its wealth, and not how to produce more wealth as well as what determines the employment of the available resources.  He attributes this to be because classic political economists believe that the answer is so simple and obvious it is barely worth mentioning.   However, since Keynes is planning on refuting much of it, he'll prove that he understands the "classical" position by restating it.  In Section 1,  Keynes restates the classical position on several economic items, including: What determines wages, the "types" of unemployment, and how to reduce unemployment.  In section II, Keynes starts to refute some of these by implying that there is the possibility that there is another type of unemployment.

Section 1 is just a restatement of the "classical" view of wages and unemployment. Keynes uses Professor Pigou's writings as representative of the mainstream understanding of economics.  The reason is that Pigou was, at the time, the head of the world renown school of economics at University of Cambridge.  He studied under Alfred Marshall.  I would probably compare Pigou to Larry Summers or Greg Mankiw.  A well-known, influential economist who mostly adheres to conventional wisdom.

The classical view of wages is the typical supply vs. demand curve, like the one below, that we're all used to seeing.  The value of the worker to the company sets the demand line.  The willingness of workers to give up their time sets the supply line.

The classic postulate allows for only two types of unemployment.  The first is "frictional" That's a fancy way of saying someone is literally "between" jobs for various reasons.  For instance, was just laid-off and is looking for another job.  The other type is 'voluntary' unemployment.  And I purposely use quotes around voluntary.  This is unemployment where a person or persons either doesn't want a job, or is holding out for more pay.

From this, Keynes lists the 4 logical ways to increase employment according to the Classic economists:(I'm paraphrasing)

A)  Better policies to make "frictional" unemployment end quicker.

B)  Make workers more willing to give up their time(to eliminate so-called "voluntary" unemployment)

C) Make workers more productive so that companies are willing to hire more at the current wage

D) All Labor becomes cheaper as compared to everything else a company(or "firm") needs to make its products

Before going to Section two let's look at the two categories of unemployment the classic economists recognize vs. those that we recognize today.  Today, economists recognize "frictional" unemployment, just like pre-Keynes's classic economists.  Today, we also recognize "structural" unemployment.  Since structural unemployment just means workers don't have the skills or knowledge to do the jobs that are available, we could categorize that as long-term frictional unemployment that the classics recognize.  That means the only point of contention between classics and today is Voluntary and "Cyclical".    "Voluntary" unemployment isn't even considered a "type" of unemployment these days.  The other category we have today, "cyclical" is what Keynes is introducing to the world.  It is appropriate that these are the types that the others don't recognize.  Because, in section II, Keynes will introduce what people will one day call "cyclical" unemployment.  However, what we call cyclical unemployment today, classical economists would call "voluntary".

Section II

In this section, Keynes is calling "Bullshit!" on the classical theory as he describes in section I.  the mainstream view of the time was that if unemployed workers would just quit being so obstinate and agree to a decrease in wages, then they could get a job and end mass unemployment.  Therefore, mainstream economists believed that massive "cyclical" unemployment was really just a type of 'voluntary unemployment'.  Keynes takes 2 issues with this.  The first issue is covered in this section and is only a minor issue.  The second issue is the "fundamental" issue and will be described in this book.

To start off explaining his first issue, Keynes again demonstrates his understanding of classic economics.  In classic economics, economists always assume that the money(or dollar) wages workers agree to are always the same as the REAL wage(i.e. adjusted for inflation) that they would work for.  Logically, if a worker would quit if an employer cut his salary by 10%, then a worker would also quit if prices of products rose 10%.  This seems logical because in both scenario's workers are getting 10% less stuff in the end.  Classical economists agree with this logic.

Keynes points out that this doesn't happen in the real world.  Workers will not resist short term REAL wage cuts that come in the form of rising prices, but do resist short term dollar cuts in wages.  As Keynes puts it, "whether logical or illogical, experience shows that this is how labor in fact behaves."  Keynes claims that the  Classical economists actually acknowledge that a short term drop in REAL wages won't lead to workers quitting - but they assume that. since it's a short term thing, it isn't a significant departure from their theory. Keynes disagrees. If dollar-wages aren't solely dependent on REAL wages then the whole classical theory of employment falls apart.

The second issue is the more fundamental issue to Keynes. Wage workers have no way to lower their own REAL wages as a group, they have only the ability to redistribute REAL wages.  Here is what I think Keynes is getting at:  An individual can always agree to lower his or her own wages to get a job.  However, that act alone will not increase employment, instead what will happen is that someone else becomes unemployed.  If labor as a group lowers it's REAL wages as a group, the number of workers won't increase, instead, the income will only be redistributed to non-labor input.  He doesn't say what that input is, but I assume he means capital and land.  Explaining how and why this all happens is the purpose of this book.

Happy B-day to 2 Misunderstood Men: Adam Smith & J.M. Keynes

It is a fun fact that both the "founder" of economics, Adam Smith, and "founder" of macro economics, John Maynard Keynes, share the same birthday.  It is a not so fun fact that both men and their theories are so misunderstood by, not just the general public, but by other economists as well.  I realize I'm a day late on wishing them a happy birthday, but I'd like to give them both a belated present:  Clearing up some common misconceptions of their work.

Adam Smith was a compassionate person who cared greatly about morality, the well-being of humanity, and the poor.  Before publishing his famous economic Treatise, The Wealth of Nations, he published The Theory of Moral Sentiments.  A book that starts out with (bold emphasis mine)

How selfish soever man may be supposed, there are evidently some principles in his nature, which interest him in the fortunes of others, and render their happiness necessary to him, though he derives nothing from it, except the pleasure of seeing it... a matter of fact too obvious to require any instances to prove it

Smith was certainly no "let the poor fend for themselves or die" Ayn Rand disciple.  Despite this, the right wing in this country attempts to portray Smith as their mascot.  Even to the point of naming right-wing institutes after him.  So let's take a look at some of his views that would get him drummed right out of the republican party, tea party, and the general conservative movement.

Adam Smith recognized "the rich" taking advantage of the poor.  This excerpt is from From Book I, chapter 11 of the Wealth of Nations. (bold emphasis mine)

Rent, considered as the price paid for the use of land, is naturally the highest which the tenant can afford to pay in the actual circumstances of the land. In adjusting the terms of the lease, the landlord endeavours to leave him no greater share of the produce than what is sufficient to keep up the stock from which he furnishes the seed, pays the labour, and purchases and maintains the cattle and other instruments of husbandry, together with the ordinary profits of farming stock in the neighbourhood. This is evidently the smallest share with which the tenant can content himself, without being a loser, and the landlord seldom means to leave him any more.

In his day, Smith didn't use the term 'the rich' or the '1%' to describe wealthy people living off of the working class.  In his day they were called land lords and he didn't particularly care for them.  In this day and age he'd be accused of "envy" and "class warfare".  The excerpt above is just one of many that paints a negative view of landlords.

One last thing on Adam Smith.  If you were to claim Adam Smith's principles of taxation as your own, your right-wing friends and relatives would label you a socialist. It's really that first principle that would get smith labeled a socialist and thrown out of the tea party. From Book 5, Chapter 2, part 2. (bold emphasis mine)

1. The subjects of every state ought to contribute towards the support of the government, as nearly as possible, in proportion to their respective abilities; that is, in proportion to the revenue which they respectively enjoy under the protection of the state...
2. The tax which each individual is bound to pay, ought to be certain and not arbitrary...
3.  Every tax ought to be levied at the time, or in the manner, in which it is most likely to be convenient for the contributor to pay it...
4. Every tax ought to be so contrived, as both to take out and to keep out of the pockets of the people as little as possible, over and above what it brings into the public treasury of the state...

I'm not saying Smith would be a liberal or a democrat if he were alive today.  But I am saying he'd be a lot closer to one than he would be to modern conservatives.

Now let's move on to Keynes.  John Maynard Keynes was a pro-capitalist, anti-communist British economist.  His biggest contribution to economics was a coherent theory showing that when it comes to analyzing a modern economy, money matters.  Up to that point, many thought that one could apply the principles of a barter economy to a monetary economy.

The common perception is that Keynes's big contribution to economics was that "demand creates its own supply" as opposed to "Say's law" which stated "supply creates its own demand".  If that was the only thrust of his argument, people wouldn't still be talking about him.  Economists had been making that argument since the time Say made his law.  It was the underlying theory behind his conclusion that made him famous.  Keynes arrived at his  "demand creates its own supply" conclusion based on his analysis of money and it's effect.  There was a reason his major book was called "The General Theory of Employment, Interest, and Money" not "The General Theory of Employment, Interest, and demand".  There was a reason that the prequel to "The General Theory" was called "A treatise on Money" and not "A Treatise on aggregate demand".  If you still don't believe me, read this excerpt from the Preface to "The General Theory".

When I began to write my Treatise on Money I was still moving along the traditional lines of regarding the influence of money as something so to speak separate from the general theory of supply and demand. When I finished it, I had made some progress towards pushing monetary theory back to becoming a theory of output as a whole.
[snip]
This book, on the other hand, has evolved into what is primarily a study of the forces which determine changes in the scale of output and employment as a whole; and, whilst it is found that money enters into the economic scheme in an essential and peculiar manner, technical monetary detail falls into the background. A monetary economy, we shall find, is essentially one in which changing views about the future are capable of influencing the quantity of employment and not merely its direction.

There is something else about Keynes.  He shows that, because of money, the state must play a role in the economy to maintain full employment.  This has spawned two common misconceptions:  One is that conservatives demonize Keynes as the second-coming of Karl Marx.  The other is that in a recession, the government should spend money all willy-nilly until the recession is over.

For the first misconception, Keynes seemed ready for the attack.  In the last chapter of "The General Theory" he states several times he is no socialist and does not advocate it.

But beyond this, no obvious case is made out for a system of State Socialism which would embrace most of the economic life of the community.
[snip]
To put the point concretely, I see no reason to suppose that the existing system seriously misemploys the factors of production which are in use.  There are, of course, errors of foresight; but these would not be avoided by centralizing decisions.
[snip]
But there will still remain a wide field of the exercise of private initiative and responsibility.  Within this field the traditional advantages of individualism will still hold good.

Finally, if your only understanding of Keynes is, "use government stimulus to get out of recessions", you haven't fully understood him.  Keynes made clear that in a monetary economy, there is chronic under-consumption and under-utilization of resources.  Even during expansions there is a need for "social investment" (though not necessarily as much).  If the government can always guarantee full employment levels of spending, the private sector will respond by making their own investments and thereby cut the amount government needs to make.  There's much more to Keynes than just his conclusion of demand management.  But they'll have to wait as this post is too long already.  They'll have to wait until next year.

How much will it cost to fence up the border?

Last Wednesday, Felona asked "How much will it cost to fence up the border?"  That's a great question.  First of all, there aren't any perfect answers.  Until it is actually "fenced up" we can only estimate, but I will give you the best estimates I can find.  Before diving into the numbers, I must say I was shocked at the price tag.  I guess when I hear the word "fence" I think of the chain link fence in my backyard, or the wood picket fence my grandparents had.  But the "Border fence" is actually more like a prison wall, or even multiple prison walls like the walls in the designs below.

A concept design of a Border wall(s)

Actual Image of a Border Wall(s)

So, the question remains, how much will these walls cost?  Let's try one part.  Boeing was payed 67 million dollars to create a 28 mile "virtual fence".  Based on the fact that the U.S. Mexico border is 1993.4 miles(pdf), it comes down to a math problem.  67 million/28 miles * 1993.4 miles = nearly 4.8 billion dollars to build.  Unfortunately, it doesn't end there.  Due to delays, glitches, and other cost overruns, The fence actually ended up costing  almost a billion dollars to span just 53 miles.  Plug that into your calculator and you get 37.6 billion dollars.  A lot higher than earlier reports of only 6 or 7 billion.

Of course, other, less costly style border walls have gone up.  But even those will be upgraded with additional fencing and equipment.  The problem is that a single fence is not good enough.  A single fence can be scaled, dug under, etc...  It requires something elaborate to actually stop people.  So I think it's fair to estimate the cost of a Boeing style wall:  Double walls, specially built with barbed wire or slants at the top to make it difficult to climb over, separated by cameras and other sensors to alert border agents.

To check my numbers, I found this congressional research service report from a couple of years ago about the status of the border wall.  It threw out a lot of estimates on per mile costs of the fence:

The Congressional Budget Office (CBO) has estimated that border fencing would cost $3 million a mile to construct and that maintenance would total roughly 15% of the overall project costs per year.103 However, the CBO does not elaborate on what is included in those estimates. DHS predicts that the San Diego fence will have a total cost of $127 million for its 14-mile length when it is completed—roughly $9 million a mile. Construction of the first 9.5 miles of fencing cost $31 million, or roughly $3 million a mile, while construction of the last 4.5 miles of fencing is projected to cost $96 million, or roughly $21 million a mile.104 However these costs may be somewhat misleading due to the following factors: construction of the fence was delayed for an extended period of time; the remaining construction involves filling a relatively large gulch which may be more complex than the average stretch of border; and DHS is proposing to use private contractors to expedite the construction process which may increase the labor costs and thus may increase the overall project costs. According to the Government Accountability Office (GAO), the border fencing constructed by the end of FY2007 (using mostly the Corps of Engineers and the National Guard to construct the fencing) cost about $2.8 million a mile.  The fencing constructed
in FY2008, using mostly private constructors, cost about $5.1 million a mile.105

All those estimates are between 3 and 9 million dollars per mile(I left out the 21 million dollar per mile estimate since, as the report described was an unusual geography).  That's between 6 and 18 billion dollars to complete.

Of course, that is just the cost to complete the fence.  That doesn't cover maintenance of the border fence.  There is a very real possibility of people knocking down portions of the wall or nature just washing away 40 feet of it at a time.  In the same report at the one above, the army corp of engineers estimated the maintenance costs to be between 16.4 and 70 million dollars per mile over a 25 year period.  That comes out to 650 thousand and 14 million per year per mile.  Or put another way, between 1.3 billion and 5.6 billion per year just to maintain and repair the wall after it is completed.

Not a direct cost, but the Sierra Club and others have noted the damage to wildlife that a border fence would pose.  It is unclear to me how much that would cost business or government to either solve or to endure it.

In conclusion, I have to say while building and maintaining a border wall along the U.S.-Mexico border is very expensive, it is not completely impractical.  Even taken the highest estimates to build and maintain, we are talking about between 1 and 2% of the average Federal Budget to build the fence and less than 1% per year to keep up.  I'm happy to offer some the real, concrete numbers. I'll let others argue about whether it is worth the costs.  I think my position has been made clear in the past.  Thanks for the great question, Felona!