Dear Prof. Krugman:
In your NY Times column of today you write, “But if everyone takes a pay cut, nobody gains a competitive advantage. So there’s no benefit to the economy from lower wages. Meanwhile, the fall in wages can worsen the economy’s problems on other fronts.” You overlook the fact that the major benefit of a fall in wage rates is not any competitive advantage that it might give to one firm over another, but the fact that it allows the same total payment of wages in the economic system to employ more labor and the same total expenditure for consumers’ goods to buy more consumers’ goods at the lower prices resulting from lower wage rates.
You also write, “Things get even worse if businesses and consumers expect wages to fall further in the future.” That’s true, and because it is, the implication is that when wage rates fall to the level to which they’ve been expected to fall, there will be a substantial increase in the quantity of labor demanded and in total wage payments and consumer spending.
If you are open to a serious, detailed development of ideas on deflation and unemployment that are sharply at variance with your own, I’d like to recommend for your consideration two on-line articles of mine: “Falling Prices Are Not Deflation But the Antidote to Deflation” and “Standing Keynesianism on Its Head: as Employment Increases in Response to a Fall in Wage Rates, the Rate of Profit Rises, Not Falls.”
In the latter article, you can learn of the profound contradiction that exists between Keynes’ statement of the basis of the IS-LM analysis on p. 261 of The General Theory and his statement of the basis of the declining mec doctrine on p. 136 of The General Theory. The net upshot is that a fall in wage rates does in fact result in an increase in employment, in part because it is accompanied by a rise in the “mec” rather than the fall assumed by Keynes.
George Reisman, Ph.D.
Pepperdine University Professor Emeritus of Economics
Author of Capitalism: A Treatise on Economics
Web site: www.capitalism.net