May 4, 2009

Krugman: Wage cuts could lead to unemployment

The temptation to cut wages in a downturn might save jobs at an individual company, but when everyone starts doing it unemployment is likely to rise, economist Paul Krugman argues in the New York Times. Further, he says shrinking incomes act as an anchor on an already slow moving economy, since our bills won't drop to keep up with our lower wages.

Krugman writes:
Here’s how the paradox works. Suppose that workers at the XYZ Corporation accept a pay cut. That lets XYZ management cut prices, making its products more competitive. Sales rise, and more workers can keep their jobs. So you might think that wage cuts raise employment — which they do at the level of the individual employer.

But if everyone takes a pay cut, nobody gains a competitive advantage. So there’s no benefit to the economy from lower wages. Meanwhile, the fall in wages can worsen the economy’s problems on other fronts.

My question, does this argument hold true for individual sectors in the economy... say, newspapers? If every major newspaper publisher cuts wages, does that negate the benefit to individual companies?


Richard said...

This is an odd analysis coming from Krugman who has advocated Keynesian stimulus as a corrective policy in this recession. Keynes's logic is predicated in part on "sticky wages" (, and now Krugman offers evidence that wages, in the U.S. at least, might not be very sticky. In fact, the neo-classical critique of Keynes rests on the view that wages will adjust within a reasonable period, clearing the labor market. In his essay on the heuristic value of the IS-LM model, Krugman appears to acknowledge this point (see ): "To make the transition [to Keynes's analysis] we must introduce some kind of price-stickiness, so that incipient deflation is at least partly translated into output decline . . . I regard the evidence for such stickiness as overwhelming . . ." We ought to celebrate evidence to the contrary, that in our contemporary economy, stickiness is overrated and the classicists may now be right, even if in the 30s they were wrong. But of course, if one regards Keynesian stimulus as an artifice to drum up support for a disguised desire to expand government command over society's resources, than acknowledging this implication must be avoided. Krugman's latest column shows that he believes the best defense against this obvious flaw in the Keynesian argument is an offense, turning healthy market adjustment into yet another imagined symptom of dysfunction.

Adam "Bud" Smith said...

Say what?

Anonymous said...

WTF? Huh? Start over. What? Really?