Wages, Employment Not Determined By Supply And Demand

1.0 Introduction
One theme of this blog is that the introductory textbook model of the labor market is incorrect. Two recent papers make this point from the perspective of institutional economics.

2.0 The Impossibility of a Perfectly Competitive Labour Market
The abstract of the first paper under consideration states:

Using the institutional theory of transaction costs, I demonstrate that the assumptions of the competitive labour market model are internally contradictory and lead to the conclusion that on purely theoretical grounds a perfectly competitive labour market is a logical impossibility. By extension, the familiar diagram of wage determination by supply and demand is also a logical impossibility and the neoclassical labour demand curve is not a well-defined construct. The reason is that the perfectly competitive market model presumes zero transaction costs and with zero transaction costs all labour is hired as independent contractors, implying that multi-person firms, the employment relationship and labour market disappear. With positive transaction costs, on the other hand, employment contracts are incomplete and the labour supply curve to the firm is upward sloping, again causing the labour demand curve to be ill-defined. As a result, theory suggests that wage rates are always and everywhere an amalgam of an administered and bargained price. -- Bruce E. Kaufman (2007). "The Impossibility of a Perfectly Competitive Labour Market", Cambridge Journal of Economics, V. 31: 775-787

Kaufman states that, "Institutional, post-Keynesian, radical and other heterodox economists have for many years expressed scepticism about the theoretical and empirical validity of the competitive model of labour markets." He cites the following literature:

• C. Kerr (1950). "Labour Markets: Their Character and Consequences", American Economic Review, V. 40 (May): 278-291
• G. Hodgson (1988). Economics and Institutions: A Manifesto for a Modern Institutional Economics, Philadelphia: University of Pennsylvania Press.
• D. Vickers (1996). "The Market: The Tyranny of a Theoretical Construct", in Employment, Economic Growth, and the Tyranny of the Market, (ed. by P. Aretis), Brookfield: Edward Elgar
• W. Streeck (2005). "The Sociology of Labour Markets and Trade Unions", in The Handbook of Economic Sociology (ed. by N. Smelser and R. Swedberg), 2nd edition, New York: Russel Sage
• S. Fleetwood (2006). "Rethinking Labour Markets: A Critical-Realist-Socioeconomic Perspective, Capital & Class, V. 107 (Summer): 59-89

As far as I can tell, none of these papers are about the Cambridge Capital Controversy, which is the basis of my favorite critique of the introductory textbook model of labor markets.

3.0 Professor Lester and the Neoclassicals
The abstract of the second paper follows:

"This article revisits what is remembered as the 'Marginalist Controversy' in light of its immediate context and object: the substantial late 1940s increase in the federal minimum wage. Richard Lester's critique of 'marginalist theory,' and its implication that the minimum wage would be detrimental to labor was founded upon empirical studies and surveys that supported an Institutionalist conception of the business firm, the labor market, and economic policy. His disputants, Fritz Machlup and George Stigler, countered his points on the basis of what they took to be 'economic theory'. By any measure, including those of their own intellectual allies, Machlup and Stigler faired poorly. Interestingly, they are collectively remembered as having been triumphant in this debate. The essay suggests that what triumphed was not their arguments but rather the Neoclassical school of economics that Stigler represented." -- Robert E. Prasch (2007). "Professor Lester and the Neoclassicals: The 'Marginalist Controversy' and the Postwar Academic Debate Over Minimum Wage Legislation: 1945-1950", Journal of Economic Issues, V. 41, N. 3 (September): 809-826."

I had not known that the context of the debate about full cost pricing included minimum wage policies. Prasch makes the point that neoclassicals often misrepresent their position as a defense of economic theory, instead of as of a specific theory. In addition to drawing on a specific school of thought, Institutionalist economics, Lester had survey data supporting his position that the typical firm does not operate in a region of increasing marginal cost. It is this sort of data, which has been repeatedly replicated, that Milton Friedman argued, in his famous paper on positive economics, should be ignored.