This was posted today on the Societies for the History of Economics (SHOE) website:
Can someone explain Hayek’s (1978) logic:
“I have just published an article in the London Times on the effect of trade unions generally. It contains a short paragraph just pointing out that one of the effects of high wages leading to unemployment is that it forces capitalists to use their capital in a form where they will employ little labor. I now see from the reaction that it’s still a completely new argument to most of the people. [laughter]”
In further explanation of his puzzlement, he pointed out that this makes no sense using marginal productivity theory since everything else will re-adjust to create full employment so what was Hayek trying to say. I therefore gave my explanation which followed behind another explanation given by James Ahiakpor, the only other modern day relentlessly anti-Keynesian economist I know of, but this is from me:
In Australia where I was involved in our National Wage Cases on behalf of employers, there was an argument we continually had to deal with which came from the bench and not the unions. It was that raising wages would be good for the economy since it would force businesses to become more capital intensive. The assumption here was that the higher productivity forced on employers would lead to increases in the economy’s ability to finance the higher real wage being imposed.
Marginal productivity theory is part of micro and will tell you what an individual firm will do in the face of higher real labour costs. It does not, however, tell you what will happen across the economy. Forcing real wages higher than the underlying productivity of the economy will support will drive some people out of work. This seems to me so obvious that both then and now it leaves me nonplussed to see it even mentioned, but then I, like James, think about these questions using classical forms of analysis. Unfortunately, like Hayek said, it still seems to be a completely new argument to most people.
The only difference between myself and James is that I would send you to Mill rather than Ricardo.