Paul Lewis On Unproven Justifications For Flexible Labor Markets

Many who do not understand economics, such as many mainstream economists working at the OECD, the IMF, the World Bank, and other powerful institutions, think less unemployment would result from more "flexible" labor markets. Flexibility is a code-word for eliminating unions, lowering the real value of minimum wages, and otherwise decreasing standards in labor markets. I have pointed out some reasons why this push for labor market flexibility is theoretically and empirically unjustified.

There is more to Paul Lewis' recent paper than this echo of my favorite argument:

"One rationalisation of F[lexible] L[abour] M[arkets] rests upon neoclassical economic theory, in particular M[arginal] P[roductivity] T[heory]. A key feature is optimisation of the quantity of each factor employed so that its price equals its marginal productivity. To fit with the trade and technology hypotheses this neoclassical model must contain a minimum of two homogeneous categories of labour - low and high skilled - and two types of 'capital' - advanced high-skill complementary and low-skill complementary equipment.¹...

...What results from these labour market conditions at a macro level is the natural rate of unemployment, or N[on]-A[ccelerating] I[nflation] R[ate] of U[nemployment] as it has come to be known. This is a long-run equilibrium, a consequence of supply and demand in the labour market, in this case largely constituted by the market for the low-skilled. It is consistent with firms having zero net profit,³ which corresponds with a 'warranted wage' for labour (Blanchard, 2006, p. 13).

¹ I consider the arguments for F[lexible] L[abour] M[arkets] rest upon the following neoclassical assumptions. (i) Capital refers to the physical means of production, which has to be homogeneous in its inherent productive features, (ii) it is quantifiable independently of its price, which allows it to be optimised in production. This characterisation of capital was shown to be nothing more than a 'neoclassical parable' as Samuelson put it, with no grounding in reality (see Blaug, 1997; Hodgson, 1997; Hunt, 2002). However, this shortcoming has not prevented its continued use as a foundation of mainstream microeconomics.

³ A condition of perfect competition in the product markets. The outcome of zero profits in equilibrium is a further example of the inability of M[arginal] P[roductivity] T[heory] to model common features of real economies." -- Paul Lewis, "(How) Do Flexible Labour Markets Really Work? The Role of Profitability in Influencing Unemployment, Cambridge Journal of Economics, V. 33 (2009): pp. 51-77