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10 December 2012

Why Economists Shouldn't be Listened To

It's not that Paul Krugman has taken time off, it's just that I tried, I really did, to get off that ship.  But here he goes again.

Please read this.  And don't get thrown.  It is not "wonkish" unless wonkish means deliberately obfuscating some pretty simple concepts.

Krugman presents the following graph:


He writes the following: "Now, in a perfectly competitive economy (don’t worry, we’ll talk about what happens "if not"* in a minute), we would expect the labor force to achieve full employment by accepting whatever real wage is consistent with said full employment. And what is that real wage? It’s the marginal product of labor at that point — which, graphically, is the slope of the aggregate production function where it crosses the vertical blue line." (* quotes added for clarity and emphasis added by me)

This is, so far as any economic theory can be, correct.  Krugman then goes on to make the point that under certain circumstances, technological improvements can lead to lower real wages.  This, too, is correct.  The workers may not share fully in the productivity gains.  So the next logical question is "so what?"  So long as the wage matches the marginal product of one's labor, then we're good.  Unless some people think it better to pay people for work they are not doing so long as those wages for unproductive labor are being paid by someone else, but who would be so damn fool as to think that's a good idea?

But before I come across as callous about people being paid less money for less work (yes, I understand fully the problems and pressure a family can face if, through no fault of one's own, if wages are lower in real terms in succeeding years), let me address what Professor Krugman skips over with an all-too-casual afterthought.  He writes: 

Start with the notion of an aggregate production function, which relates economy-wide output to economy-wide inputs of capital and labor. Yes, that sort of aggregation does violence to the complexity of reality. So?

Furthermore, for current purposes, hold the quantity of capital fixed and show how output varies with the quantity of labor.

In the first part he explicitly acknowledges that the aggregate models has no real bearing in reality.  Will that stop him?  Of course not.

In the second part, he “hold[s] the quantity of capital fixed” in order to show how his spurious function using a bogus model will affect real wages.  The problem is that in any real economy, the quantity of capital is not fixed.  And in a thriving free-market system (which ours isn’t, but if he can live in a fantasy world, why can’t I) far more capital is created than destroyed and everyone is better off.  Further, technological improvements affect positively all of the factors of production, if not there would be no increase in efficiency and thus it would not be considered a “technological improvement.”  Does a technological improvement increase all factors of production evenly?  No, of course not.  But productivity is increased.  And this benefits the economy as a whole, however marginally.  And that is reality.

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