As I work on my book, I am trying to come up with a way
to explain the classical economic outlook. Here is one approach. Comments
welcome.
Here is an imaginary dialog between a classical
economist (C) and Keynesian economist (K).
K: See that man, Uri, sitting on the bench over there?
He is involuntarily unemployed.
C: How do you know that? Do you know his reservation
wage? That is, do you know the lowest wage that he would accept to go to work?
Do you know what his best offer has been?
K: Yes. He won’t work for less than $12 and hour, and
his best offer has been $11.50
C: So he is not really unemployed. He has withdrawn from
the labor force, because he can’t find a job that will pay him what he wants.
K: No, according to the Department of Labor, as long as
he is looking for work, he is unemployed. Besides, in his last job, he earned
$14 an hour and what he produced was worth $15 an hour. But when the economy
went into a slump, the demand at his firm fell, and he was laid off. His
problem is that there is a lack of effective demand.
C: I’m not sure what ‘effective demand’ means, but ok.
What should Uri be doing instead of sitting on the bench?
K: He could be digging a ditch for the government.
C: But he’d rather be sitting on the bench. Why should
he dig the ditch?
K: The government can pay him to dig the ditch. They can
pay him $12 an hour.
C: If his ditch-digging is worth $12 an hour, that’s
fine. The taxpayers should be happy to pay Uri to dig a ditch if it’s a
worthwhile use of his time.
K: Actually, the ditch is not worth so much. Let’s say
his ditch-digging is worth only $5 an hour. But this way, he’s working instead
of sitting on a bench, and as taxpayers we benefit from the ditch.
C: No! As taxpayers, we pay $12 and hour for
ditch-digging that is worth only $5 to us. That makes us worse off.
K: Would you rather pay unemployment benefits of $8 an
hour and get nothing?
C: No….But if we are going to redistribute income to
Uri, why not encourage him to take the offer for $11.50 and pay him just $.50
an hour as a subsidy to do that?
K: Hmmm. Not such a bad idea. But the ditch-digging puts
more spending into the economy.
C: No it doesn’t. You give $12 to Uri to spend, but that
$12 comes from those of us who pay taxes, and now we have $12 less to spend.
It’s just a transfer.
K: But we’re not going to raise taxes. We are going to
borrow the money to pay Uri to dig the ditch.
C: In that case, the borrowing is going to use up saving
that otherwise would have been used to build homes or expand businesses.
K: No. Households and businesses do not want to spend
any more. The savings would have sat idle. We need the government to spend
those savings, because no one else will.
C: Really? You seem to think that we can have an excess
of savings without driving down interest rates. I don’t see how that can
happen.
K: That’s a discussion for another day.
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