The Idle

The volume has assembled the cycle's mechanics and its sources: the multiplier that magnifies any shock into a swing, the financial mania that breeds the shock from within, the monetary contraction that delivers it from the side of money. But all of this leaves standing the deepest question, the one Say's Law had pronounced impossible — why a shortfall of spending should produce idle workers, willing workers at the going wage who can find no work, rather than merely a fall in wages and prices that puts everyone back to work. Why does the labor market not clear? The answer is the Keynesian revolution, and it is the deepest inversion in all of macroeconomics: that the economy as a whole can settle at an equilibrium of mass involuntary unemployment, because the level of output is governed by effective demand, which can fall short of what full employment would require — and that the idle worker is idle not by his choice, nor by the friction of search, but by the failure of the whole economy to demand enough to employ all who stand ready to work. John Maynard Keynes published the argument in 1936, into the wreckage of the Depression that the orthodoxy could not explain.

Recall what the orthodoxy had promised about unemployment. The labor market, like the market for any good, was supposed to clear by the movement of its price. If there were a surplus of labor — more people seeking work than there were jobs — the wage would fall, as the price of anything in surplus falls, making workers cheaper to employ until firms hired the surplus and the market came to rest at full employment. Unemployment, in that picture, could only be voluntary, the choice of a worker who preferred leisure or held out for more than the going wage, or frictional, the brief idleness of someone moving between jobs. Persistent, mass, involuntary unemployment — multitudes willing to work at the prevailing wage, or below it, and unable for years to find any work at all — was a theoretical impossibility, certain to be competed away by falling wages as surely as a glut of any good is cleared by a falling price. And then the Great Depression set a quarter of the workforce idle, desperate for work at any wage, for years on end, with no clearing in sight. The theory said the idle were choosing leisure or pausing between jobs; the breadlines and the shuttered mills said something the theory had ruled out.¹

Keynes's central move was to reverse the direction of causation between supply and demand. The classics had reasoned from supply: the economy produces all it can, at full employment, and demand obligingly adjusts to absorb the whole of it — Say's Law. Keynes reasoned from demand: the economy produces only what is demanded, and employment adjusts to produce no more than that. The total demand for goods and services — what he called effective demand — determines how much firms find it worthwhile to produce; and how much they produce determines how many workers they need to hire. Where effective demand is high, firms produce much and employ many; where it is low, they produce little and employ few, leaving the rest without work. Output and employment are set by demand, not by the supply of labor willing to be hired. And nothing guarantees that effective demand will be high enough to employ everyone, for demand rests on spending decisions — above all the volatile decision to invest — that need not, and often do not, sum to the level required for full employment. The economy makes only what its customers will buy, and its customers, together, may not buy enough to keep everyone at work.²

Here is the heart of the inversion, the thing the classical view had declared could not be: the economy can come to rest at an equilibrium below full employment, and remain there. Suppose effective demand is too low to employ everyone. Firms, able to sell only so much, produce only so much, and hire only so many; the remainder of the workforce stands idle. This is not a passing disequilibrium that market forces are poised to correct; it is an equilibrium, a genuine resting point, stable until something moves demand. The unemployed would dearly like to work, but their wish does not generate the demand that would employ them — for a jobless man would gladly buy goods, but, having no wages, he cannot; and his not buying is itself a part of the very deficiency of demand that keeps him jobless. The system is balanced, but balanced wrongly, at a level of demand that leaves willing hands idle, with no force within it pressing back toward full employment. The classics had assumed a single equilibrium, at full employment, toward which the economy always tends; Keynes showed that there is an equilibrium at every level of demand, and that the economy can settle at any of them — including those that leave great multitudes out of work, and stay settled there.³

But surely, the classic insists, wages will fall — the unemployed will offer to work for less, the wage will drop, labor will grow cheaper, and firms will hire until the surplus is gone? This is the crux, and Keynes's answer to it is the deepest part of the whole argument: a general cut in wages does not reliably cure unemployment, and may well deepen it. For a wage is not only a cost to the firm that pays it; it is the income of the worker who earns it, and the incomes of workers are the source of most of the spending that constitutes effective demand. Let wages fall across the whole economy, and yes, every firm's costs fall — but so does the income of the workers who are every firm's customers, and as their income falls, their spending falls, and demand falls with it. If demand falls as wages fall, the firm has no more reason to hire than before, and perhaps less, since now it can sell even less than it could. The labor market is not like the market for a single good, where a lower price draws in fresh buyers from outside the market to take up the surplus; it is the market of the whole economy, where the price in question — the wage — is also the income that does the buying. To lower it is not to summon demand from outside; it is to shrink the demand within. And so the one mechanism on which the orthodoxy had relied to clear the labor market — the fall in wages — fails at its task, because it cuts into demand at the very moment, and in the very measure, that it cuts into cost. The willing worker cannot price himself back into a job, for his lower price is also a lower income for all, and a lower income for all is precisely the disease.⁴

Now the question the volume was built around can be answered. Why can a willing worker, at the going wage, fail to find a job? Because the number of jobs is fixed not by how many wish to work, nor by how low a wage they will accept, but by how much firms can sell — by effective demand; and effective demand can be, and often is, too low to require the labor of all who would work. The worker is idle not because he prefers leisure, for he is desperate to work; not because he is briefly between jobs, for he has searched in vain for years; not because his wage is too high, for to cut it would shrink demand and destroy more jobs than it created. He is idle because the economy as a whole is not generating enough demand to need what his labor would produce. His unemployment is involuntary in the strict and bitter sense: he would gladly work at the going wage, or beneath it, and still there is no work for him, because the jobs depend on a demand that is not there. This is the central scandal of the cycle that the author named — and the scandal of it is exactly that it is no one's choice and no market's clearing, but a failure of the whole that no single person can mend and that the price mechanism, far from curing, can only worsen.⁵

If the disease is deficient demand, the cure is to restore demand — and here the multiplier returns. Someone must spend more, to create the income that creates the spending that breaks the downward spiral. But in a slump no private party will: households, frightened, hold back and save, each prudently, and in the aggregate ruinously, by the paradox of thrift; firms, seeing no customers, will not invest, however cheap the credit. Each is behaving sensibly, and the sum of all their sensible caution is a level of demand too low to employ them all. The one actor that can spend when no one else will is the government, which can borrow and spend against the tide — hiring directly, funding public works, or putting income into people's hands — to supply the demand the private economy is failing to supply, that spending then multiplying through the system to lift output and employment back toward full. This is the Keynesian prescription: that in a slump the state should deliberately spend more than it taxes, running a deficit on purpose, to fill the gap in demand the market has left. It is not a repudiation of the market but a rescue of it — a means of returning the economy to the full employment it cannot, by itself, regain. How far the state can do this, how quickly, and whether by spending or by money, the volume's other plates weigh; that it is the answer the diagnosis demands, this plate establishes.⁶

Stand back and see what has been overturned. The price families, and the classical tradition behind them, had taught that markets clear — that a surplus drives its own price down until the surplus is gone, and that an economy of such clearing markets is guided, as if by an invisible hand, toward the full employment of all its resources. Keynes's revolution was to show that this, true of any single market within the economy, fails for the economy taken as a whole. The economy is not one great market that clears; it is a circular flow, in which every party's spending is some other party's income, so that the very price that is supposed to clear the labor market — the wage — is also the income that demands the goods, and cannot fall without shrinking the demand it was meant to restore. The fallacy of composition, which the multiplier first exposed, reaches here its deepest and most consequential form: the whole does not behave as the part does, and an economy composed entirely of rational, market-clearing individuals can nonetheless come to rest with willing hands idle, and possess within itself no force to set them working. This is why macroeconomics had to be born as a science apart — because the economy in the aggregate obeys laws that the single market does not, and the gravest of those laws is that the whole can fail, as the parts cannot, to employ all who would work, and can remain so failed, with nothing inside it to put matters right.⁷

The cycle, then, is the second of the aggregates and the dark companion of the first. Growth is the long upward trend, the economy swelling across generations as ideas compound; the cycle is the fluctuation around that trend, the recurring lurch between boom and idleness, the failure of demand that strands willing workers for reasons having nothing to do with the trend's slow rise. The two are bound together: a slump is a fall below the growth path, and a deep enough slump can scar the path itself, as a later plate observes, so that the tremor alters the trend. And the cycle passes on, to the family's remaining motions, the questions it cannot answer alone. If a slump is too little demand and a boom too much, what becomes of the value of money as demand swings — the inflation that fevers the boom, the deflation that haunts the slump? That is the level. And when the slump idles the worker while the owner of capital weathers it on different terms, how does the burden of the bust, and the spoils of the boom, divide between those who labor and those who own? That is the share. The aggregates are the great motions of the whole economy: growth its trend, the cycle its tremor, and beneath the tremor the deepest truth the classical mind could not accept — that an economy left to itself can settle into the sheer waste of willing hands idle, and that the scandal of the slump is not nature's doing but the avoidable failure of the whole to demand the work that all stand ready to give.⁸

The classical economists had built an economy that could not fail: supply made its own demand, markets cleared, and willing workers always found work, for a falling wage would summon employment as a falling price summons buyers. Keynes built the economy that can. Output is set by effective demand, which can fall short; the economy can rest at an equilibrium with mass involuntary unemployment; and the falling wage that was supposed to cure it instead shrinks the demand that is everyone's income, and so fails, because the labor market is not a market like the others but the circulatory system of the whole. The willing worker is idle, then, not by choice and not by friction, but because the economy together is not demanding enough to need his work — a failure no individual can remedy and the price mechanism cannot fix, but which a government willing to spend can. Say denied the general glut; Keynes affirmed it, and named its human face: the involuntary idleness of those who would gladly work. That is the central scandal of the cycle, and it is the one the aggregates exist to confront. The next motions are the level and the share.