In the past few days I’ve told several people that I’m reading a biography of John Maynard Keynes, and the response has been overwhelmingly one of “Huh.” Apparently he’s not nearly as well known as I expected. So here’s a little sentence or two on why he’s famous, and why everyone should know about him.
My understanding of his economic ideas (which won’t be really cemented until I finish the other two volumes of his biography and read The Economic Consequences of the Peace) is as follows: before the Depression, economists believed that supply would always equal demand, and that the same was true of labor: “all markets clear,” in the jargon. So if you’re trying to get employed, and you find that you can’t, it’s just because you’re asking for too much money. If you ask for $10 an hour, and you’re really worth $5 an hour, you just need to lower your sights a little bit.
Keynes’s realization, spurred by the Depression, was that sometimes labor cannot find a buyer at any price. Why specifically this would happen, I don’t know, but I believe it’s connected with the market’s irrationality during times of economic panic. That, in turn, is derived from individual humans’ irrationality during times of panic. This is all explained, I understand, in Keynes’s most famous work, The General Theory of Employment, Interest, And Money, which is on its way to my library and may well be, for all I know, over my head. I’ve read elsewhere (can’t remember where just now) that the Keynesian program was to bring a more-realistic psychology to economics, in order to predict these macroeconomic panics and work our way out of them. The General Theory was literally a general theory: Keynes believed that a model of Man As He Actually Is would contain Rational Man as a special case.
In response to these panics, Keynes said that government should step in and spur the economy on with public works. This helps the market regain its confidence, and that little burst of government spending does wonders for the economy. This is what Keynes is most famous for. Every time the U.S. government spends during recessions, it’s acting out a Keynesian policy. Raising and lowering interest rates, I believe, is also Keynesian. I believe the U.S. government mostly uses interest-rate changes to control inflation, but lower inflation tends to go along with higher unemployment. (Hence the apparently-famous Phillips Curve.)
Such, at least, is my less-than-junior-varsity understanding of what Keynes’s economics is (are?) about; I suspect I’ll be smarter about such things in a few months, after I’ve read more.
Speaking of labor contracts, I’ve not thought through the implications of what I’ve read elsewhere about such things: namely that whatever an employment contract might be, it is not the same thing as, say, a contract for wheat. A commodity like wheat can be completely contracted: you say you’ll sell me thus-and-so many bushels of thus-and-such a quality, and I can verify that you’re telling the truth before I give you the money; we don’t need to trust one another to make sure that the contract is satisfied. Employment contracts cannot be completely contracted, as Herbert Simon realized back in 1951: you may well say that you’ll do 40 hours of work for me every week, but unless I stand behind you for every minute of those 40 hours (or encourage your coworkers to do so, or install surveillance cameras in your office and pay people to watch over them), there’s no way to see whether you’re actually playing Freecell. As Samuel Bowles argues, incomplete employment contracting means that employers will pay systematically more for labor than its productive value; that is, employment contracts will entail positive economic rent. I believe Bowles concludes that any system requiring trust (my trust that you’ll work, your trust that Bob The Used-Car Salesman will sell you a quality automobile) will entail incomplete contracts. Incomplete contracts, in turn, will often force economic rents.
This may connect with the inability of labor markets to clear during depressions, but I’ve not really fleshed out the reasons why just yet.
And while we’re on the topic of employment contracts, one other thought: when people go to work for startups, do they tend to require higher pay in the expectation that the company may go bankrupt within a short time? That is, is there a risk-reward tradeoff in employment, just as there is in investment? It would seem sensible if there were, though it’s somewhat complicated: if the startup goes bust, I may believe that I could always get another job without much difficulty. That is, the startup may not even offer that much subjective risk. How much subjective risk it offers will be correlated with the general state of the economy: in times of high unemployment, I may trade some income for a lower-risk job. The startup would then need to offer me more money just to overcome the additional risk I’m taking on. All of this seems reasonably straightforward.
So I wonder if there’s an incomplete-contracting dimension on the seller’s (employee’s) side as well: the more I can trust my employer, the less I’ll ask for in salary. This may not be incomplete contracting at all — it may just be trust. Seems connected, though.