Review of Assar Lindbeck's Macroeconomics and Unemployment (MIT Press, Cambridge, Mass. 1993), originally published in Ordfront Magasin 6, 1993.

by Per Gunnar Berglund

Why does unemployment exist? How is it determined? Why is it persistent? Voilà – three very urgent question which Assar Lindbeck is trying to answer in his new book Unemployment and Macroeconomics. Lindbeck's prominent position as public person – he has been called "one of the world's most influential economists" – as well as his vast experience of studying the subject certainly stimulates the curiosity of any and all interested in social issues. Unfortunately, the text is too difficult for the layman to access, without being difficult for the reader accustomed to economic literature.

Nowadays, many decision makers and politicians have had some formal training in economics – enough to acquire the economic terminology, but insufficient to pursue an independent analysis. They form a kind of in-between layer, above the populace but below the professional economists. They know the words of the economic language, but they do not master the proper meaning of the terms. I get the impression that this is the kind of readers Lindbeck turns to.

How, then, does Assar Lindbeck answer the aforementioned questions?

Well, unemployment exists because real wages(1) are too high, implying that the demand for labour falls short of the supply. Only a lowering of the real wages (everything else equal) can reduce the unemployment. The intellectual problem to explain the unemployment then, fully logically, becomes to explain why real wages have risen to, and tend to "get stuck" a level too high.

Lindbeck uses four categories of factors to explain this: (1) Strong labour unions exerting an upward pressure on real wages, (2) social norms against "underbidding" (unemployed offering to work at a lower wage than the employed), (3) minimum wage legislation and too generous compensation of unemployed, and (4) labour market legislation, endearing the hiring (and firing) of personnel.

The key factor is underbidding. If all obstacles to underbidding were removed, Lindbeck assures, full employment would be restored in the long run. The mechanism he adduces is the so-called real balance effect. It means that if the unemployed have the opportunity to underbid in wages, the competitive pressure will lead to a general lowering of wages. This general wage reduction will also pull prices down, almost to the same degree. Thus, when the prices sink, less money will be needed for transaction purposes. The supposedly unchanged quantity of money will then be demanded to a lesser extent, which causes the rates of interest – the charge for money disposal – to fall. This, in turn, will stimulate economic activity. Depressions are "self healing", provided no obstacles exist to underbidding – the economic system is self regulating under a laissez-faire regime.

Of course, no practical man ought to believe in this fairy-tale. Still this, and only this, is the crucial point of the neoclassical economic theory. Anybody who is familiar to these theories would know that it is more or less impossible to maintain the quantity of money in times of depression – it is diminished as a consequence of the sinking economic activity. Lowered rates of interest (which is not least to be observed in these days) do not have any significant positive effect when the economy is sliding downhill. Instability in the development of prices may lead to speculative bubbles (when the prices go up) and financial crashes (when they go down). These will in turn powerfully impact on the economic activity. Every modern economy is entirely dependent of a functioning credit market, of long-term contracts. The "flexibility" which neoclassical economists believe will save the world from the evils of unemployment, are really an instability which diminishes the predictability of the economic environment, increases the costs of contracts, diminishes capital formation and leads to permanent mass unemployment.

These questions are carefully avoided by Lindbeck. He claims (in a footnote!) that the real balance effect "eventually" will dominate over the other, negative effects of falling wages and prices. The negative effects may, however, be dominating "for many years". How many years this process of self-healing will take, Lindbeck – like all neoclassicists – has nothing to say about. We get a hint, however, when Lindbeck in another context sketches the development over the last century. He concludes that Say's law ("supply creates its own demand") is valid "in the very long run". One may wonder whether Assar Lindbeck concurs to Keynes's familiar quotation "in the long run we are all dead"? After all, we cannot reasonably expect the currently unemployed to wait to the "life hereafter" for a job?

Lindbeck spasmodically clings to the economic dogmas of the 1920's. Of Keynes's ideas and modern economics there is next to nothing to be found in Lindbeck's book. The lion's share of the book deals with the various causes why real wages are "too high", and why underbidding does not occur. But if the very point of departure is completely wrong, what is the use of that discussion? I know of no evidence supporting the proposition that "too high real wages" would cause unemployment. In reality, labour productivity rises when the economic activity picks up (the Verdoorn-effect), which gives room to higher real wages. This phenomenon renders impossible the neoclassical interpretation that real wages govern employment, but it is fully compatible with the opposite Keynesian standpoint – that employment governs real wages. If the Keynesian interpretation is correct, the unemployed may underbid until they are blue in the face without significantly affecting the real wages.(2) The rubbish about real balance effects (which do not exist) will be small comfort when financial markets break down and the economy moves towards a collapse. The theory presupposed by Lindbeck simply has no relevance in a world of paper currencies (fiat money) and advanced credit markets, i.e. the world we happen to live in.

Since the absence of underbidding seems to be the economist's Great Challenge in the world of Lindbeck's, I will make some causal remarks on his way of reasoning on this issue (despite its complete irrelevance). Lindbeck sports the so-called insider–outsider hypothesis as the chief explanation why underbidding does not occur in the real world. This hypothesis, which Lindbeck calls his own "original contribution" to the analysis, (mainly) consists in that costs of hiring and dismissing staff lead to a kind of "tariff wall" is erected between the insiders (the people who already are employed) and the outsiders (who are not employed). This occasions a large enough competitive disadvantage on behalf of the outsiders, as compared to the insiders, for outsiders to prefer going unemployed to lowering their wage claims to the (presumably very low) level where they outcompete the insiders. This will lock the wages on a high level, determined by the outsiders' minimum acceptable wage and the height of the "tariff wall".

In this respect, I think Lindbeck makes a good point regarding the distribution of under-employment. Today we can observe how many people stand entirely without employment, while the working tempo is being forced up for those who have a job – indeed, overtime is breaking records in the export industries in this year of grace 1993! But this has no direct bearing on the total under-employment, which Lindbeck's book is allegedly dealing with.

And what is new in this? It is long recognised that companies tend to keep competent staff over temporary downturns, which depends on the high cost of replacing lost competence (this is, by the way, a central explanation to the aforementioned Verdoorn effect). It seems to me that the only new thing about Lindbeck's presentation is his rubber-mouthing of this stale stuff.

Moreover, it may justly be doubted if a simple tariff model is the best way of dealing with this. In my view, personnel should be regarded as a capital asset. Any improvement of its competence, like any new hiring, should properly be viewed as an investment. These investments would be written down during the expected duration of employment, which depends on the company's staff turnover. No such analysis of investment decisions is to be found in Lindbeck's book, nor is there any argument about the factors determining the companies' desired stock of personnel.

It is possible that Lindbeck has pursued a more thorough argumentation of this issue in other places, but what is produced within the covers of this book must be said to border on pompous trash. This is so even if we disregard the fact that the question of underbidding lacks direct relevance to the employment problem in our kind of economy.

In the concluding chapter, Lindbeck gets into a more liberal mode of reasoning, depicting ad hoc-wise his own view of how the unemployment problem can be reduced. This is the only part of the book which is really worth reading, particularly for the international audience who are not used to the daily confrontations to Lindbeck's Advisory Almanac. To us who are, the chapter contains no great surprises – all in all, it is the usual repetition of the ticklets of the Employer's Federation: Less employment security, harsher qualifications for unemployment benefits, reduced relief employment, decentralisation of wage bargaining, trimming of the public sector, etc. What is interesting to us is the contrast of this chapter to the rest of the book. When Lindbeck addresses practical matters, he speaks with clarity and coherence, as distinct from the incoherent, muddled and sometimes even comical theoretical arguments. Using this book as the sole basis, I would guess that Assar Lindbeck's gifts mainly lie in the practical domain, and that he bites off more than he can chew in his ambitions to break new theoretical ground. What riddles me is how such a practical man still can believe in the neoclassical fairy-tale.

(1) Strictly speaking it is the so-called real product wages – the purchasing power of the gross wages including payroll taxes – which Lindbeck refers to, not the post-tax "take-home" real wages.

(2) With reservations for terms of trade effects in the open economy.