Microfoundational cyborg dream
March 6, 2015
from Lars Syll
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Are macro-economists doomed to always “fight the last war”? Are they doomed to always be explaining the last problem we had, even as a completely different problem is building on the horizon?
Well, maybe. But I think the hope is that microfoundations might prevent this. If you can really figure out some timeless rules that describe the behavior of consumers, firms, financial markets, governments, etc., then you might be able to predict problems before they happen. So far, that dream has not been realized. But maybe the current round of “financial friction macro” will produce something more timeless. I hope so.
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So there we have it! This is nothing but the age-old machine dream of neoclassical economics — an epistemologically founded cyborg dream that disregards the fundamental ontological fact that economies and societies are open — not closed — systems.
If we are going to be able to show that the mechanisms or causes that we isolate and handle in our models are stable in the sense that they do not change when we “export” them to our “target systems,” they do only hold under ceteris paribus conditions and are a fortiori of limited value for understanding, explaining or predicting real economic systems. Or as the always eminently quotable Keynes wrote in Treatise on Probability(1921):
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The kind of fundamental assumption about the character of material laws, on which scientists appear commonly to act, seems to me to be [that] the system of the material universe must consist of bodies … such that each of them exercises its own separate, independent, and invariable effect, a change of the total state being compounded of a number of separate changes each of which is solely due to a separate portion of the preceding state …
Yet there might well be quite different laws for wholes of different degrees of complexity, and laws of connection between complexes which could not be stated in terms of laws connecting individual parts …
If different wholes were subject to different laws qua wholes and not simply on account of and in proportion to the differences of their parts, knowledge of a part could not lead, it would seem, even to presumptive or probable knowledge as to its association with other parts …
These considerations do not show us a way by which we can justify induction … No one supposes that a good induction can be arrived at merely by counting cases. The business of strengthening the argument chiefly consists in determining whether the alleged association is stable, when accompanying conditions are varied …
In my judgment, the practical usefulness of those modes of inference … on which the boasted knowledge of modern science depends, can only exist … if the universe of phenomena does in fact present those peculiar characteristics of atomism and limited variety which appears more and more clearly as the ultimate result to which material science is tending.
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America can be a full-employment economy once again
March 6, 2015Leave a commentGo to comments
from John Komlos
Irving Berlin was dreaming of an old-fashioned Christmas. I’m dreaming of an old-fashioned economy in which everyone has a job. I know, it was ages ago, but what are dreams for anyway?
Isn’t it strange that full employment has to be a dream, even a quarter millennium after the beginning of our stupendous surge in wealth with the Industrial Revolution? But what is full employment? Well, it’s simple enough, isn’t it? An economy in which there are enough jobs to go around for everyone. But here is where the complications begin.
There are rationalizations galore why we have to accept unemployment as an integral part of our economic system.
The practitioners of the dismal science — those in charge of the concept — don’t think of it in those terms. True to their reputation, they believe that full employment is, well, simply unattainable. There will always be a lack of jobs; people are not buying enough stuff, businesses are investing too much overseas, we are importing too much, the banks are sitting on their money, unions are destroying jobs, people do not have gas money to look for a job, people are too easily discouraged from looking for a job, government regulation and taxes discourage firms from hiring, workers do not have the right skills, and then there is always the perennial scapegoat: the minimum wage. And even when there is an opening, it takes time to find the right person for the job. There are rationalizations galore why we have to accept unemployment as an integral part of our economic system.
These rationalizations have been formalized under the umbrella concept of the “natural rate of unemployment.” This is thought of as the minimum level of unemployment attainable in the economy. It would be futile for the Fed to try to use monetary policy to get the unemployment rate below that level because it would just lead to inflation. Fiscal policy wouldn’t help either because increasing government expenditures by borrowing would increase the interest rate and thus would just be at the expense of private investment. Or so the thinking goes.
The Fed has put the natural rate of unemployment, or the minimum attainable level of unemployment, at about 5.2 percent. This concept has become so engrained in the economists’ culture that even former Fed chair Ben Bernanke referred to it as “full employment.” The media adopted this euphemism — reminiscent of newspeak — which implies that 5 percent is as good as zero. Given that the unemployment rate right now hovers around 5.6 percent, by this logic, we are nearing full employment.
This attitude – that this is the best the U.S. can do – writes off some 8 million workers —roughly the population of New York City. That is invidious because it encourages policy makers to be complacent about the plight of a substantial segment of the labor force. And, of course, the confusion among the public about what full employment means is then complete. That is precisely why Noble laureate William Vickrey referred to the natural rate of unemployment as “one of the most vicious euphemisms ever coined.”
That is not all. This concept of full employment has other hidden flaws — namely that there are additional workers who are barely hanging on with the skin of their teeth but are not counted as unemployed. People who could find only half-time jobs even though they would like to work full time are considered employed for the purposes of the statistics, as Making Sen$e reported last year. So they are not counted as unemployed. Also left out are those who would like to work but have not looked recently because they thought it futile to do so — they have been turned down so often that they became depressed and could not muster the motivation or they ran out of gas money and could no longer afford to look for a job.
This group — let’s call them underemployed — is substantial: they are as numerous as the unemployed. Together the unemployed and the underemployed total an amazing 11.2 percent of the labor force or 17.5 million workers. These unfortunates add up to the whole labor force in 21 of the 50 U.S. states. This is not all. They obviously have dependents, so we are really talking about some 35 million people who are in this underprivileged group. Furthermore, the underemployment rate is much higher in many states. In 2014 it was near or above 15 percent of the labor force in Arizona, California and Nevada. Yet, according to the received wisdom, we are getting close to full employment. If that is not newspeak, I do not know what is.
Is this really the best we can do? My answer is a resounding no. We must reject the concept of the natural rate of unemployment. In 1944 the unemployment rate was 1.2 percent. That is what we should be aiming for. Sure that was wartime, you say, and we’re not likely to match that any time soon. But that just means that there was a high demand for tanks and airplanes, making work easy to find. Well, why not declare war… not in the conventional sense, of course, and not as Paul Krugman has suggested — tongue in cheek — by declaring an impending alien invasion, but by declaring other kinds of “wars”: on inferior school systems, on slums, on decaying infrastructure, on pollution, on global warming, on poverty, or on using fossil fuels. There is no shortage of such “wars” given the backlog of desperately needed investments in the economy. These projects could create enough jobs to create full employment for many years to come.
Insofar as exclusion from work threatens one’s very existence and given that most of us need to work in order to survive, the right to life implies straightaway that we must have a right to a job.
Let us diverge to assert the obvious, namely that people have a natural right to life. The Declaration of Independence even states that the right to “Life, Liberty, and the pursuit of Happiness” is “unalienable.” Moreover, the UN’s Universal Declaration of Human Rights states similarly, “Everyone has the right to work . . . and to protection against unemployment.” Insofar as exclusion from work threatens one’s very existence and given that most of us need to work in order to survive, the right to life implies straightaway that we must have a right to a job. Otherwise we cannot survive.
We first have to recognize that current labor market institutions will not deliver a true full-employment economy. If they have not done so since 1944 then “growing the economy” will never provide enough jobs. Rather, we need to think of new ways to restructure the labor market to begin to approach such a goal. We also need to acknowledge that the labor market is in need of repair. We would never have created a labor market in which the opportunity to work — like wealth and income — is so unevenly distributed across the labor force if we had designed a system from the ground up.
Currently, adjustments to the decline in demand for labor occur by reducing the number employed so that their labor time falls abruptly from 40 hours to zero. Employees work 40 hours, 20 hours or not at all. Would anyone “behind a veil of ignorance” design such a rigid system from scratch, a system with so much uncertainty and volatility–with working times ranging from zero to 70 hours per week even in normal times?
It would be much more palatable to have the adjustment occur in the number of hours worked so that instead of dismissing workers, the available work would be divided among those wanting to work. Hence, an institution that distributes work more evenly would be a reasonable solution to this quandary.
Thus, our aim should be to restructure the labor market in such a way that it would distribute the available work more evenly and thereby generate full employment. There are several ways to achieve this. For instance, we could reduce the standard full-time working day to seven hours. Note that, in this regard, for a long-time after the Industrial Revolution, even a 10-hour workday was a dream and most Americans worked 12 or more hours a day six days a week. The eight-hour day did not become the standard in the U.S. until the 1930s and workers literally had to fight for it because the employers were resisting it vehemently. Just think how much greater unemployment would be if people still regularly worked 10-hour days.
Given the substantial increase in productivity per hour since the 1930s it is about time that we reduce the number of hours worked per day to seven. That, by itself, would immediately open up more work opportunities for the underemployed and effectively eliminate underemployment. The extra salaries could come out of corporate profits that sum $1.9 trillion per annum and have increased by an incredible 50 percent since 2007 (before the financial crisis). No other component of Gross National Product increased by as much. If the private sector will not provide sufficient jobs then we have to restructure the institutions of the labor market in order to achieve these goals for the sake of equity.
Other policy steps could complement the above reduction in the work day. A government agency similar to the depression-era Work Progress Administration could become the employer of last resort similar to the government’s role as lender of last resort for the financial system. The new institution, whose role would be comparable to the Federal Reserve’s role in finance, could guarantee similar stability to the labor market. It would contribute to an inclusive economy in which absolutely no one is deprived of the opportunity to work.
Of course, we could also provide jobs by reducing, or even eliminating our $500-billion-a-year trade deficit as Warren Buffett advocated in Fortune magazine in 2003. It is crazy to stimulate the economy of the rest of the world at a time when our own economy desperately needs the stimulation. Getting our foreign trade in order alone would create millions of jobs and, in combination with the other two policies above, would create a full-employment economy. Such an economy would increase leisure time and reduce the psychological burden of unemployment, thereby increasing quality of life for millions of Americans. It would be a much fairer method of distributing the pain of a decline in the demand for labor (associated with globalization and technological change) than the prevailing system.
In sum, the natural rate of unemployment is a bogus concept. According to the UCLA economist Roger Farmer, “it is an idea that is past its sell-by date.” We must no longer be complacent about 17.5 million people being unable to find full-time employment. How inefficient! That is like the population of New York, Chicago, Los Angeles and Houston sitting around idly watching us work. It is up to us to stop dreaming and start acting to overcome the obstacles created by a “jobless recovery.” We can create a truly full-employment economy and eliminate the pain associated with being excluded from the labor market.
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Links. It’s the political economy, stupid.
March 5, 2015
1) Alex Tabarrok discovers the limits of profit seeking behaviour and the marketization of the government. Join the club.
2) His findings are related to this Voxeu post by Victor Kümmritz about Global Value Chains (i.e. the international division of labour and production processes). It’s not just about ‘equal trade’ between companies, but about a brutal power struggle between countries, too. In the gentler wording of Kümmritz:
These new findings lead to two conclusions for policymakers.
- Firstly, integrating into GVCs is a sound strategy. Interacting with global production networks can improve productivity and lead to spillovers for the domestic economy, as successfully shown by a large set of middle-income countries (e.g. Czech Republic, South Korea).
- Secondly, the materialisation of these gains is not guaranteed [e.g. the Baltic states, Greece M.K.]. New entrants need to ensure that they have a good institutional environment that incentivises foreign firms to source inputs locally and to outsource a growing share of their production.
3) Megan McArdle discovers the ‘historical school’ and is right to state that (my interpretation) marvelous techniques like vaccination benefited the rich as well as the poor and poverty and prosperity is not just about money. Look for somewhat related ideas also here. Developments in the Eurozone however remind us that absolute measures of poverty have been increasing – the number of poor increased (again: not a relative monetary measure of poverty!). This happened even in the UK, which its job rich recovery.
Update: it’s in fact more ‘evolutionary economics’ than ‘historical school economics’ as there is something in her piece which admits that people themselve change, in tandem with their circumstances, and are part of these circumstances. Vaccination is of course an excellent example of this. If you’re vaccinated against measles you’ve changed, becoming a kind of super human. Really. But it changes my circumstances, too, as you can’t be contagious anymore. She will however have to deal with the increase of the official estimates of ‘absolute’ poverty (‘material deprivation’).
4) Alejandro Justiniano, Giorgio Primiceri and Andrea Tambalotti state that the housing and credit booms were credit supply driven.
5) The ECB has a neat graphing tool (but I did not yet manage to copy paste the graphs)
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Where’s the Structure?
March 5, 2015
from Peter Radford
In its long search for the illusion of equilibrium economics has had to barter away one aspect of reality after another. Driven by its desire to unearth laws that explain the presence of that illusion economists have long ago lost contact with the grittiness of actual economies. They prefer the pristine and simplified sanctuary of their models no matter how reduced the image of an economy those models portray.
Oddly I do not criticize them for this. No, I think I understand the logic of the process that produced the result. I applaud the effort. I salute the intellectual energy that has been absorbed into the project.
It’s the outcome I abhor. Economists are simply caught in a valley which, unfortunately for them, sits in the shadows of reality rather than sitting on a peak casting light on it.
I was thinking thus because I was trying to relate how economics, most of it anyway, ignores uncertainty. As you know this ignorance vexes me more than somewhat, because I see uncertainty as central to human existence. Without some element of uncertainty there would be no need to learn — we would know everything already. It is the absence of knowledge that incites us to search, to innovate, and to arm ourselves against the unknown. It is the very essence of life: problem solving is the distinguishing characteristic of life. It is how we tell that something is alive. The intentional imposition of order on disorder is the central property of all things we consider to be living.
But to impose order we need to take risks. We need to risk that the order we impose has utility in the face of future unknowns. We need to risk that the patterns we think we detect around us are repetitive and can therefore be anticipated. We need to risk that the unknowns are not so significant that they can doom our survival. And so on.
So we need to mitigate and manage that risk.
And one way — perhaps the biggest way — we do that is to introduce structure into our lives.
Structure is manifest around us. Our institutions, cultures, norms, and relationships are all structural buttresses to support life. Each of these explodes, in turn, into a myriad smaller, yet significant, sub-structures.
In a more prosaic domain: the way we conduct business and economic transactions is an activity sitting within a web of structure for exactly the same reason. And, as our economy has grown more complex because of the relentless move from self-sufficiency towards a collective mutual dependency — Smith’s greatest insight is that we create wealth best by dividing tasks into ever smaller bundles so that each can be sold or bought and thus be a source of income — we need to offset the uncertainty created by the mutual dependency by adding ever more structure.
Business cannot take place in the absence of structure. Assets, resources, and skills have to be accumulated that have specific ends in mind. Without structure to ensure the durability if that specificity no one would accumulate them. Relationships need to be formed and relied upon to allow us to buy or sell things we no longer produce ourselves. Structures provide that assurance.
Money is one such structure. We take it for granted, but it is a structure. It is a component of the overall architecture that we call an economy.
So too are the laws governing transacting.
So too are the plans we make in business to define our activities.
So too are the very businesses themselves — they are defined in law, social norms, culture, and other structures in order to perform their roles.
All economic structure can be stylized as an attempt to carve out in time and space a safe zone within which the onslaught of uncertainty is reduced to a manageable proportion. It can never be eliminated. We simply try to fend it off. We can never succeed permanently though, which is why businesses fail despite their best plans.
And, naturally since the economy is a dynamic phenomenon, our safe zones themselves provide uncertainty — they divert the natural world and cause unintended consequences which are a source of future disorder we then have to cope with. The expansion of our knowledge simply adds to our ignorance — we know, increasingly, how little we know.
This general perspective is why I abhor most economics. One of the most important aspects of reality economists have tossed overboard in their pursuit of perfection is the existence of structure. They ignore time and space. Or, rather, they abuse it. They compress it into nothing and thus absolve themselves of the task of explaining structure. They treat transactions with a disdain unbecoming to a science with transacting at its heart. They assume a weightless, frictionless, and certain coincidence of supply and demand that takes place outside of time and space. They ignore all the evidence of the need for structure because structure requires them to step back from their ideal and step within the complications of reality. And those complications, with uncertainty underlying them, are the root cause of structure.
Order itself, of course, implies structure. And, in this case, structure is the transmitter of information. It is the origin of information. It is the end of information. Without structure there is no information for there is no way of telling one thing apart from another.
Yet economists pluck order from nowhere. It just appears. There are no processes, no spaces, no time elapses, no sources of potential disruption. It just appears. The information within the economy is assumed into place. It is dropped in situ all at once. It does not evolve, mutate, alter in any way. It just appears as if by magic. The props necessary for this magic are nowhere accounted for. And if, or when, they are encountered they too are assumed to be in place ready to play their role with their history or origin unquestioned. With reality so determinedly set aside most economics has no need of structure. There is no need of support to hold the edifice together because, well, it just is.
So most economics cannot ever explain why an economy came to be. It cannot provide a history. It cannot account for change. It cannot explain difference. Economies, in the mainstream account, just appear. Most economics posits economies as being born miraculously without gestation, created as if by a divine hand, all magic and no substance.
Then, subsequent to this magical appearance, economists settle down to explain the economy’s operation. But without, let me repeat, having any account of how it arose in the first place. The entire theoretical approach is a tautology.
All because they want to ignore structure and the reasons for structure. Which, in turn, they ignore because they assume away uncertainty.
Isn’t it odd how one decision — to ignore uncertainty — made long ago has so distorted the discipline? And how utterly irrelevant much of its theorizing is as a consequence.
Bring back structure, and we restore economics to reality.
Steve Keen’s New Book
Developing an economics for the post-crisis world
Steve Keen
Published 2 March 2015 by WEA Books – price: $10
The veracity of mainstream economics has been called into question in the years since the economic crisis began. But the questioning of economics precedes the crisis, and not by merely years but arguably ever since 1898, when Thorstein Veblen published his brilliant paper “Why is Economics not an Evolutionary Science?” But Veblen’s critique fell on the deaf ears of the mainstream, and was unknown to the public. Only in the fringes of academic economists did Veblen’s words, and the spirit of rebellion he encouraged, live on.
Economics came under challenge again in the 1930s, and this time Keynes led the charge against an orthodoxy that, six years after the Great Depression began, had no idea what caused it, or how to overcome it. But Keynes’s challenge was largely deflected by Hicks’s reinterpretation of Keynes, and the taxonomic economics that Veblen hoped to defeat was rebuilt after the challenge of the Great Depression and the World War had ended.
In 2007, the global economy experienced its greatest crisis since the Great Depression, and once again, mainstream economics failed to anticipate the crisis, and even after it has apparently passed – in the Anglo-Saxon world at least – once again, can provide no explanation of why it happened in the first place. What is different this time around is that there is a publicly accessible outlet for critical voices, and it has been around – in various guises – for 15 years. What was first known as PAECON (the Protest against Autistic ECONomics) and is now known as the Real World Economics Review was established by Edward Fullbrook in 2000 in response to protests by French students against the unworldly theorems they were forced to learn in the French economics curriculum. When the financial crisis hit in late 2007, the Real World Economics Review was already there, ready to provide an outlet for critical economists, and intent on getting their views to the public.
This short book provides the articles that I have published in RWER over the last fifteen years – starting with the first in July 2001. The topics covered include methodology, microeconomics, and the monetary approach to macroeconomics that I have been developing – along with many other non-mainstream economists – over the last 20 years.
An economics fit for purpose in a finite world
March 4, 2015
from Herman Daly
Causation is both bottom-up and top-down: material cause from the bottom, and final cause from the top, as Aristotle might say. Economics, or as I prefer, “political economy,” is in between, and serves to balance desirability (the lure of right purpose) with possibility (the constraints of finitude). We need an economics fit for purpose in a finite and entropic world.
As a way to envision such an inclusive economics, consider the “ends-means pyramid” shown below.
At the base of the pyramid are our ultimate means, low entropy matter-energy–that which we require to satisfy our purposes–which we cannot make, but only use up. We use these ultimate means, guided by technology, to produce intermediate means (artifacts, commodities, services, etc.) that directly satisfy our needs. These intermediate means are allocated by political economy to serve our intermediate ends (health, comfort, education, etc.), which are ranked ethically in a hierarchy by how strongly they contribute to our best perception of the Ultimate End. We can see the Ultimate End only dimly and vaguely, but in order to ethically rank our intermediate ends we must compare them to some ultimate criterion. We cannot avoid philosophical and theological inquiry into the Ultimate End just because it is difficult. To prioritize logically requires that something must go in first place.
The ends-means pyramid or spectrum relates the basic physical precondition for usefulness (low entropy matter-energy) through technology, political economy, and ethics, to the service of the Ultimate End, dimly perceived but logically necessary. The goal is to unite the material of this world with our best vision of the good. Neoclassical economics, in neglecting the Ultimate End and ethics, has been too materialistic; in also neglecting ultimate means and technology, it has not been materialistic enough.
The middle position of economics is significant. Economics in its modern form deals with the allocation of given means to satisfy given ends. It takes the technological problem of converting ultimate means into intermediate means as solved. Likewise it takes the ethical problem of ranking intermediate ends with reference to a vision of the Ultimate End as also solved. So all economics has to do is efficiently allocate given means among a given hierarchy of ends. That is important, but not the whole problem. Scarcity dictates that not all intermediate ends can be attained, so a ranking is necessary for efficiency–to avoid wasting resources by satisfying lower ranked ends while leaving the higher ranked unsatisfied.
Ultimate political economy (stewardship) is the total problem of using ultimate means to best serve the Ultimate End, no longer taking technology and ethics as given, but as steps in the total problem to be solved. The total problem is too big to be tackled without breaking it down into its pieces. But without a vision of the total problem, the pieces do not add up or fit together.
The dark base of the pyramid is meant to represent the fact that we have relatively solid knowledge of our ultimate means, various sources of low entropy matter-energy. The light apex of the pyramid represents the fact that our knowledge of the Ultimate End is much less clear. The single apex will annoy pluralists who think that there are many “ultimate ends.” Grammatically and logically, however, “ultimate” requires the singular. Yet there is certainly room for plural perceptions of the nature of the singular Ultimate End, and much need for tolerance and patience in reasoning together about it. However, such reasoning together is short-circuited by a facile pluralism that avoids ethical ranking of ends by declaring them to be “equally ultimate.”
It is often the concrete bottom-up struggle to rank particular ends that gives us a clue or insight into what the Ultimate End must be to justify our proposed ranking.
As a starting point in that reasoning together, I suggest the proposition that the Ultimate End, whatever else it may be, cannot be growth in GDP! A better starting point for reasoning together is John Ruskin’s aphorism that “there is no wealth but life.” How might that insight be restated as an economic policy goal? For initiating discussion, I suggest: “maximizing the cumulative number of lives ever to be lived over time at a level of per capita wealth sufficient for a good life.” This leaves open the traditional ethical question of what is a good life, while conditioning its answer to the realities of economics and ecology. At a minimum, it seems a more convincing approximation to the Ultimate End than today’s impossible goal of “ever more things for ever more people forever.”
What is neoclassical economics?
from Lars Syll
For your edification, I offer this link to an elegant explanation of why neoclassical economics presents itself as purely scientific and denies any ideological commitments, and strangles pluralism.
In brief: Arnsperger and Varoufakis define “neoclassical” economics in terms of three “meta-axioms.”
First, neoclassicism assumes “methodological individualism,” i.e. that economists must ultimately posit individuals’ behaviors as the root cause of broad economic phenomena.
Second, it assumes “methodological instrumentalism,” i.e. that these actors are somehow or other acting instrumentally in pursuit of goals, are “irreversibly ends-driven.”
Third, it assumes “methodological equilibration,” i.e. rather than asking whether or under what conditions shall a state of affairs continue unchanged, it seeks to show that if equilibrium occurs, then it will endure.
The big twist of Ansperger and Varoufakis’ argument is that by keeping these assumptions well-hidden and unquestioned, neoclassicism simultaneously guts its own ability to effectively explain and predict real-world economic phenomena AND expands its own discursive authority.
The real genius of this article is in demonstrating how this paradoxical circumstance occurs. They carefully and explicitly reject the view that economics professors are cynically and purposively responsible as a “conspiracy theory.” Instead, they pursue a “functionalist” explanation (which seems like maybe the defining characteristic of science itself: showing how cause and effect, independent of any overarching purpose, lead from situation A to situation B), which boils down to funding sources.
Basically, they claim that economists who pursue technical elaborations, “who simply ‘get on with the job,’” get funding while those who raise important but non-actionable questions about assumptions, method, and framework do not. “No one wants to keep quiet on the meta-axioms. They are just too busy building magnificent edifices on top of them, and being magnificently rewarded for it” …
So the three meta-axioms of neoclassical economics define the language and concepts which can/must be invoked by any economist who wishes to be taken seriously. By presenting as self-evident and obvious, they effectively make themselves invisible while also precluding alternative approaches.
[h/t Mark Buchanan]
For my own take on this issue, see, e.g., here and here.
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The ‘bad luck’ theory of unemployment
from Lars Syll
As is well-known, New Classical economists have never accepted Keynes’s distinction between voluntary and involuntary unemployment. According to New Classical übereconomist Robert Lucas, an unemployed worker can always instantaneously find some job. No matter how miserable the work options are, “one can always choose to accept them,” according to Lucas.
This is, of course, only what you would expect of New Classical economists.
But sadly enough this extraterrestrial view of unemployment is actually shared by ‘New Keynesians,’ whose microfounded dynamic stochastic general equilibrium models cannot even incorporate such a basic fact of reality as involuntary unemployment!
Of course, working with microfunded representative agent models, this should come as no surprise. If one representative agent is employed, all representative agents are. The kind of unemployment that occurs is voluntary, since it is only adjustments of the hours of work that these optimizing agents make to maximize their utility.
In the basic DSGE models used by most ‘New Keynesians’, the labour market is always cleared – responding to a changing interest rate, expected life time incomes, or real wages, the representative agent maximizes the utility function by varying her labour supply, money holding and consumption over time. Most importantly – if the real wage somehow deviates from its “equilibrium value,” the representative agent adjust her labour supply, so that when the real wage is higher than its “equilibrium value,” labour supply is increased, and when the real wage is below its “equilibrium value,” labour supply is decreased.
In this model world, unemployment is always an optimal choice to changes in the labour market conditions. Hence, unemployment is totally voluntary. To be unemployed is something one optimally chooses to be.
If substantive questions about the real world are being posed, it is the formalistic-mathematical representations utilized to analyze them that have to match reality, not the other way around.
To Keynes this was self-evident. But obviously not so to New Classical and ‘New Keynesian’ economists.
The notion that unemployment is voluntary is, in the context of the current self-inflicted wound in Europe, downright offensive. Real workers must pay bills and feed families from jobs that have fixed hours and fixed wage rates. The idea that workers ‘trade off’ labor against leisure by figuring out the real wage rate and then slacking off or going on an indefinite unpaid leave is the type of thinking that leads us to see the Great Depression as a giant, unexpected, and astonishingly long unpaid vacation for millions of people: original, yes; helpful, no.
