Structural Deficiencies in Effective Demand and

Structural Deficiencies in Effective Demand and their Implications for Ireland in 2009

EC4006 Intermediate Macroeconomics | Guest Lecture 2Stephen Kinsella | [email protected] | www.stephenkinsella.net

Really relevant question for Ireland Today: will wage reduction stimulate employment?

Keynes’ Causal Story in The General Theory

wages -> prices -> interest rate -> Investment (Money Supply is fixed)

Investment determines Consumption, Income (X), Output (Y)

How?

(1) X = C+I (The Material Balance Relationship)(2) Y = X (The Output/Income mapping)(3) C = f(Y) (The Consumption function)

Irish Unemployment Right Now

Where did this come from?

Rising Prices have eroded competitiveness

Source: Central Bank of Ireland, Forfas NCC Report pg. 37.

Wait: what’s ‘competitiveness?’

Price of Irish stuff < Price of everyone else’s stuff -> Quantity Demanded for Irish stuff goes up, assuming they are of similar quality.

From Friday: price of Irish Stuff = (Factor Cost + User Cost)

Factor costs: Inputs to Process + Unit Labour + Unit Capital Costs.

Idea: Drop Factor costs somehow, competition/survival instincts will drop prices quantity demanded of Irish stuff will rise.

“There’s a Problem With Irish Wages”

Rates vs Levels, or: Forfas NCC report vs. the Unions

“Labour cost growth rates show the change in the cost of employing workers over time. Ireland’s growth rates have exceeded the EU- 15 average over both periods. The average rate of wage inflation in Ireland between 2004 and 2008 Q2 was 50 percent above the EU-15 average.”

–––Forfas, (2008):58

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Figure 3.29 Average Growth Rate in Labour Costs, by Sector, Ireland and the Eurozone, 2000 Q2 - 2008 Q238

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2000 Q2 - 2004 Q2 Ireland 2000 Q2 - 2004 Q2 Eurozone

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Since the second quarter of 2000, labour costs in all sectors of the Irish economy have increased by more than the Eurozone average. Irish wage inflation grew by more than double the Eurozone average in construction and communications between Q2 2004 and Q2 2008. Ranking: N/A

Source: Eurostat, Population and Social Conditions; Central Statistics Office, Labour Market Statistics; UK Office of National Statistics, Labour Market Statistics

Figure 3.30 Hourly Compensation Cost for Production Workers in Manufacturing (US$), 2006

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This indicator measures employee pay, employer's social insurance and other labour taxes per hour worked. Ireland is now more expensive than the OECD average and the US on this measure. However, Irish manufacturing wages are marginally below the EU-15 average and significantly below wages in Germany and Denmark. Ranking: N/A

Source: US Bureau of Labour Statistics, September 2008

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38 Public sector comparison is made to UK growth in public sector wages due to data availability. Data for Ireland refers to Q1 2008 when Q2

2008 data is unavailable.

What part of the chart should we look at?

There is a problem with public sector wages(source: www.ronanlyons.com)

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Public Sector Finance Motor trades Wholesale Retail Hotels and restaurants Land transportPost, telecomms Other business Utilities Food, Beverages Textiles Paper, printing ChemicalsRubber, Plastics Other Minerals Metals Electrical, Optical Transport Equipment Mining

Back to the macro

Concentrate on changes in the real wage, w/p, or the profit share, π.

Big question: how do changes in the real wage/profit share affect output?

Let commodity production be determined by a markup rule, depending on labour, L and capital, K

P = (1+∆)(wL+rK)

Now ask: how high does w have to go to inhibit ∆?

Ratio Argument

Ireland: wages are 8% of overall wage bills in high value added sectors like Bio/Pharma

Drop w by 50%. What happens to total factor costs? Drop by 3-4%.

So, will dropping wages w/p stimulate overall production in high value added export industries?

NO.

What will?

Changes in the other component of factor cost: rK.

r is falling, thanks to property crash. K is not increasing though, because no one wants to invest.

Cost of capital in Ireland has to change.

How? Increased investment in production.

This needs different expectations than we have now.

Only Govt has ability to borrow & invest on that scale

What will?

But, Govt is very poor at choosing good projects, and is really inefficient at producing them.

Better to support local entrepreneurs in a light touch way, allow them to start businesses which will either fail or succeed according to the market.

BUT, EU rules against state aid.

Time to break the rules.

Back to IS-LM Mathematica Example

How does this help Ireland?

Liquidity Preference

Idea: An investor will opt for liquidity (i.e. hold money) instead of a bond when they expect the interest rate on it to rise, causing a capital loss on the bond exceeding the running yield we might see.

Summary

Whether wage reductions stimulate output depends on changes in effective demand and the ratio of levels of rK: wL. Changing wL dents domestic consumption and probably won’t increase competitiveness in short run.

It’s clear we want to change effective demand to increase X/Y.

What changes effective demand (again, determined by Factor Cost+User Cost)

MEC (sort of) + Liq. Preferences + changes in User cost.

Support people with no money but a good idea, you change User cost.

...and more ranting about this on Friday