Download The mysrery of real wage

EFFECTIVE DEMAND, EMPLOYMENT
AND THE MYSTERY OF REAL WAGE
Aimin Dang
JINAN UNIVERSITY (Guangzhou, CHINA)
This paper re-elucidates the factors determining the aggregate demand, and puts
forward a new unemployment mechanism; while unveiling the mystery of real wage which
has long puzzled the economists passingly. This paper shows that increasing the share of
salary in GDP can expand the aggregate demand, and also shows that the labor has a nature
similar to the Giffen goods,--raising salary can promote employment.
This paper has differs from previous studies as blows: a) The relation between income
and consumption is a very typical saturation nonlinearity one. For this kind of issues, this
paper forsakes the weighted average method, and introduces the sectionalized linearization,
a processing method frequently applied in other subjects. b) According to the law of
diminishing marginal utility, the limited consumption desire and the infinite money desire,
constituted human's desire on the economics. c) Introduces the method of system science,
and argues that although the whole behavior is formed by individual behaviors and the
interaction between them, however, the whole behavior also restricts the individual
behavior in reverse. d) The marginal output of most unemployed workers is far more than
their bid wage.
This paper argues that, under the restriction of effective demand, the profit
maximization behavior of enterprises is transformed into the cost minimization under fixed
output. Therefore, enterprises prefer to hire workers producing highest marginal output, till
the completion of the order. At this moment, although there are still many workers whose
marginal outputs exceed their bid wage in the market, they will not be hired.
Keywords: effective demand, unemployment, real wage, distribution
JEL Code: E12, E24, J64
[email protected]
510655
Aimin Dang
C-701 Room, Dongjin Garden, Yuancun er-heng-lu Street, Tian-he District,
Guangzhou City, Guangdong Prov, CHINA
Tel: 86-13433993322, Fax: 86-20-28851119
Total 8600 words.
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1. INTRODUCTION
This paper first re-elucidates the factors determining the aggregate demand and its
dynamic process, then further delves into the analysis of the formation mechanism of
unemployment and finally puts forward policies and suggestions, while revealing the
mystery of real wage which has long puzzled the macroeconomists passingly. This study
shows that increasing the share of salary in GDP can expand the aggregate demand, and
also shows that the labor has a nature similar to the Giffen goods, ----raising salary can
promote employment.
This paper has differs from previous studies as blows: a) The relation between
income and consumption is a very typical saturation nonlinearity one. For this kind of
issues, this paper forsakes the weighted average method, and introduces the sectionalized
linearization, a processing method frequently applied in other subjects. b) According to the
law of diminishing marginal utility, the limited consumption desire and the infinite money
desire, constituted human's desire on the economics. c) Introduces the thoughts of system
science, and argues that although the whole behavior is formed by individual behaviors and
the interaction between them, however, the whole behavior also restricts the individual
behavior in reverse. d) The marginal output of most unemployed workers is far more than
their bid wage.
This paper argues that, under the restriction of effective demand, the profit
maximization behavior of enterprises is transformed into the cost minimization under fixed
output. Therefore, enterprises prefer to hire workers producing highest marginal output, till
the completion of the order. At this moment, although there are still many workers whose
marginal outputs exceed their bid wage in the market, they will not be hired.
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The relation between the real wage and employment is an old topic long puzzling the
economists. As many classical economists, Keynes (1936) predicted that the real wage and
employment vary reversely, i.e. the countercyclical mentioned frequently later. Keynes
(1936, p.17) wrote, “In general an increase in employment will surely lead to the decline of
the real wage rate. Thus, I am not disputing this vital fact which the classical economists
have(rightly) asserted as indefeasible.” In response to the prediction of Keynes, Dunlop
(1938) and Tarshis (1939) put forward the evidence of procyclical movement of real wage.
In response, Keynes (1939) specially wrote an article expressing agreement with their
evidence. Afterwards, numerous economists conducted a large amount of research on this
prediction, and put forward many empirical evidences of procycle, including
Bodkin(1969) 、 Mitchell et al. (1985), Bils(1985), Schor(1985), Rayack(1987), etc.
However, some economists considered it to be statistically insignificant, such as Blanchard
and Fischer (1989,p.19). Therefore, in the 1990's, a relatively consistent conclusion was
that in the postwar U.S., the real wages for a representative worker are mildly procyclical
or at least acyclical ( Hoehn, 1988).
However, in recent years, a series of studies based on longitudinal microdata has
changed this conventional wisdom based on aggregate time series data. Solon et al. (1994)
argued that the procyclicality of real wages is obscured in aggregate time series because of
a composition bias: the aggregates statistics are constructed in a way that gives more
weight to low-skilled workers during expansions than during recessions. In their opinion,
the analysis of longitudinal micro-data indicates that real wages have been substantially
procyclical since the 1960s. Therefore, they concluded that near-noncyclicality of real
wages should not be accepted as a salient feature of the business cycle.
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Hoehn (1988) once conducted a numerical simulation, which showed an implausibly
high correlation between output and the real wage.
In more recent years, research documents in this respect have still been published
largely, and they found much evidence for strong procyclical movement of the real wage
successively, such as Devereux (2001), Shin and Shin (2003), Hart (2006), Anger (2007),
Shin and Solon (2007). Devereux (2001) found that although Salaries exhibited little
cyclicality, but salaried workers who had income sources from bonuses, commissions, or
overtime had procyclical earnings. Shin and Solon (2007) argues that job stayers' real
average hourly earnings are substantially procyclical and that an important portion of that
procyclicality probably is due to compensation beyond base wages.
Solon et al. (1994) considered that theories designed to explain the supposed weakness
of real wage cyclicality may be unnecessary, and theories that predict substantially
procyclical real wages become more reliable. the macroeconomic models that prevail
currently, such as efficiency-wage models [See Solow (1979), Shapiro and Stiglitz (1984), George
(1982), George and Yellen (1990)], implicit contract models [See Azariadis (1975), Baily (1974),
Gordon (1974)], and insider-outsider models [See Lindbeck and Snower(1985,1986,1988，2002)],
are all used to explain the acyclical variation of the real wage, whereas almost none to
explain the procyclical movement of the real wage.
Why does the real wage move procyclically? This has puzzled the economists for long.
As an ancient Chinese saying implies, “It is up to the doer to undo the knot”, to reveal the
puzzle of the real wage, we need to set about from Keynes’ theory of effective demand.
When talking of the effective demand, the present economic textbooks always closely
relate it to MPC. In fact, it was long before that Keynes (1933) put forward the method of
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calculating the multiplier in two steps, i.e. first, considers how much of a sum of
expenditure is converted into income, and next, consider the MPC. Dang et al. (2004)
conducted a further research according to this, and pointed out that in case of greatly
disparate distribution, the multiplier is closely related to distribution , and weakly
correlated with the MPC, thus amended the calculation method of multiplier, which is of
great significance to the correct estimation of the aggregate demand .1
At present, the economies of a lot of developing countries are puzzled by domestic
demand deficiency: On one hand their GDPs grow at high speeds and the manufacturers
face a large amount of productivity surplus,2 on the other hand a great number of
workforces lose their jobs,3 and the living standards of people can’t be improved rapidly,
while the Gini coefficient remains high, and the society shows a trend of polarization. The
real output of these countries has not reached the limit of full employment of various kinds
of production factors, a lot of factors will be left unused. The amount of real output totally
depends on the aggregate demand of these countries. So the study of aggregate demand and
employment is of great importance to solving the realistic problems existing in the
economies of developing countries.
Like Keynes (1936), this paper also thinks that the equilibrium of full-employment is
only a special case, and non-full-employment is the normal state. The reality of
productivity surplus and polarization forces us to make such a judgment. As most modern
enterprises carry out their production according to the order, so overproduction can
basically be overcome and the product market can be cleared basically. However, due to the
progress of technology and the accumulation of capital, the capital output ratio has
improved by a wide margin, and capital surplus appeared; meanwhile, with population
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growth and the improvement of education level, the human capital also has increased by a
wide margin, and the factor of labor becomes excessive. In summary, the product market
can be cleared, while the factor market cannot, forming a pattern of “dual-surplus of labor
and capital” (Wang, 2002); in other words, it is productivity surplus, instead of
overproduction. The essence of productivity surplus is that factor market cannot be cleared;
therefore, we should focus our study on factor market, attaching an importance to the study
of the formation mechanism of unemployment.
2.
EFFECTIVE DESIRE AND EFFECTIVE DEMAND
2.1. Consumption
The relation between income and consumption is a very typical saturation nonlinearity
one. For this kind of issues, this paper forsakes the weighted average method, and
introduces the sectionalized linearization, a processing method frequently applied in other
subjects. 4 That is to say, in this paper, we divide people into the rich and the poor, and
assume that the MPC of the rich is inclined to 0 (saturation area), which is totally
autonomous consumption; and the MPC of the poor is inclined to 1 (linear area), who
consume fully depending on their income. This assumption is representative for those
developing countries which are seriously polarized. With this assumption and through the
following analysis, we can see that the key factor that determines the aggregate demand is
distribution, instead of MPC.
At the beginning of present economics textbooks, it is said that the desire of people is
infinite, but the resources are finite, therefore the task of economics is simplified to
producing more products with limited resources to meet people's desire to the maximum
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extent. However, it is this seemingly righteous and justifiable reason that lets economics go
on a detour. In microeconomics, we repeatedly use the law of diminishing marginal utility
to study the consumers' behavior, while in macroeconomics, we emphasize the infinite
desire of people and forget the law of diminishing marginal utility thoroughly.
It is necessary for us to study the consumption law of the rich. Though low in
population, the rich take hold of a large number of resources, machines, factory buildings,
technologies, and funds, etc. Most people are under the dominance of these few rich
persons, and the lifestyle of most people is to exchange the labor factor they own for the
capital factor of the rich. Only by realizing more factors exchange can the poor’s life be
improved. So, the further study of the consumption law of the few rich enables the poor to
exchange for as much capital as possible.
The rich are ordinary people too. However extravagant they are, their consumption
law still follows the law of diminishing marginal utility. In other words, their food,
accommodation, transportation, consumption, playing, amusement, etc., anything they can
buy with money on the market, they will surely feel content at some time.
An old saying
of China states the same truth: "Millions of hectares of good farmlands in hold, you can
only eat a limited amount of rice per day; thousands of spacious mansions in grasp, you can
only sleep on one bed at night”.
If we quantize the various goods on the market as standard “basket goods” according
to human's preference on consumption, anyone's consumption law of this “basket goods”
still obeys the law of diminishing marginal utility. No matter how much money a person
has, his consumption is sure to have a saturation amount. If this quantity is exceeded,
negative utility will occur.
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Lu (2005) has made a penetrating exposition about this issue. She argued that any
consumption needs time, while time is finite to anyone, therefore, the actual consumption
capability is finite.
To bring this understanding up to the theoretical layer, this paper introduces the
concept of “effective desire”. It is true that the “overall desire” of people is infinite, but the
desire in economic sense is restricted by market supply. People have a lot of desires, some
of which cannot be realized, such as the desire for immortality etc. Why didn't the ancient
emperors travel by air or automobile? Why didn't they watch TV or use cell-phone? It isn’t
because the emperors had no money, but that there weren’t these products on the market.
Traveling by automobile or air, watching TV or using mobile phone pertain to
“non-effective desire” to the ancient emperors. Having known what “non-effective desire”
is, you also know what “effective desire” is. “Effective desire” refers to a person's
maximum desire for the all kinds of merchandises existing on the market, but not including
the desire for money. The money is an exceptional case, the human's desire for money is
infinity, its marginal utility nearly constant invariable. The limited consumption desire and
the infinite money desire, constituted human's desire on the economics.
According to the theory of utility maximization, when it comes to consumption and
money-earning, the rich will equalize the marginal utilities of the two. If we assume that,
near this equilibrium point, the marginal utility of consumption drastically decreases and
the marginal utility of money keeps constant, then, when
fluctuation occurs to income,
for the purpose of achieving utility maximization, the rich will only adjust the quantity of
money，and always keep the quantity of consumption a constant. Because once the
consumption quantity reduces, its marginal utility will at once exceed that of money. On
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the contrary, when the consumption quantity increases, its marginal utility will be less than
that of money. That is to say, an addition of one rice in consumption will cause the
marginal utility of the rich to reach zero, even to reduce to a negative value. However,
making a dollar more doesn’t notably change its marginal utility. Therefore, for the reason
of convenience, sometimes we roughly equalize this equilibrium point with the effective
desire.
The effective desire mentioned here is approximately equal to the autonomous
demand in the consumption function. Because only rich group with very high income can
achieve autonomous consumption free from the reliance on income. As to ordinary
wage-earners, their consumption totally depends on their income, with almost no
independence.
2.2. Investment
In addition to consumption, the rich group needs to invest. The purposes of investment
can be summarized into no other than these two: one is to consume, the other is to earn
money. The investment for the satisfaction of consumption is restricted by the effective
desire, and the investment for earning money by money increment. The purpose of
investment is to earn money, but the purpose of earning money is not to invest. When
money-earning chances are present, add to the investment, otherwise, wait for chances.
Blind investment necessarily leads to the loss of all investment. Sometimes there will be
investment bubbles, but the bubbles will inevitably evaporate.
This paper argues that consumption-satisfying investments are endogenous,
determined by the quantity of consumption and in direct proportion to consumption; while
money-earning investments are exogenous, mainly determined by money increment, also
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influenced by other complex factors. This paper assumes the exogenous variable remains
constant, therefore, in this paper, wherever it comes to the static analysis, both the
consumption and investment of the rich group will be regarded as a constant.
The act of earning money plays an important role in maintaining the stability of the
macroeconomic system. If we inflict an external impact on an equilibrium economy, for
instance——government uses a deficit suddenly——then this deficit will lead to the
increases of aggregate demand, total yield, employment and even investment in a short
period of time, but soon when the rich complete earning this sum of money, the economy
will return to the original equilibrium level.
When the scale of an economic system is larger than the equilibrium scale, as
described above, the rich withdraw currency from real economy by earning money; hence
the system shrinks and returns to the equilibrium point. On the contrary, if economic scale
is smaller than the equilibrium scale, the rich group's demand cannot be met, and their
marginal utility of consumption is larger than that of earning money. Then, they will
supplement money and expand production till the equilibrium scale is reached.
2.3. Effective demand——aggregate demand
Besides consumption, the effective demands from rich group also include investment.
The investments of rich groups are mainly to cover capital depreciation. If the capital
depreciation rate, capital-output rate and factors' share are given, then the amount of
investment totally depends on the rich group's consumption. That is to say, the amount of
investment depends on the rich group's effective desire and the technical conditions of
production. As stated above,
investments for the purpose of earning money are
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exogenous, and we assume them as a constant.
The total of rich group's consumption and investment is their Saturation demand. We
can regard it as the autonomous(independent) demand, which can also be called active
demand or active order, and the demands from the wage-earners are called passive demand
or passive order.
For those countries with very serious polarization, we can estimate their domestic
aggregate demand like this. Suppose the whole rich group's Saturation demand
for the
existing merchandises on the market is A, and the distribution proportion is β for rich group
and α for workers (obviously α+β=1), then the aggregate demand of this society Qd is:
Qd 
(1)
A

Once the output goes beyond this quantity, the product market cannot be cleared.
Because in the excessive part, workers can smoothly buy the part equal to wage, while the
profit part cannot be sold, for it has exceeded the demand of utility maximization of the
rich.
This aggregate demand model is a static one. In order to deepen the perception to the
problem, we explain the dynamic process below.
To simplify the question, we might as well suppose that when the macroeconomic
system “just starts”, the laborers do not have any purchasing power (might be regarded as
totally self-sufficient peasants as well).
The first stage: The rich group needs to produce “basket goods” with a quantity of A
for themselves in order to meet their own Saturation demand, and pay wage W1 at the same
time.
W1=Aα
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The second stage: The market demand is composed of two parts: first, the active
demand of the rich group, with a quantity of A still; second, the passive demand from
workers, which is the wage of the first stage W1.After finishing these orders, workers can
receive a wage with a quantity of W2.
W2=（A+ W1）α=（A+Aα）α=Aα（1+α）
The third stage: The demand on the market is still composed of two parts: first, the
Saturation demand of the rich group A; second, the wages from workers W2. After
finishing these orders, workers can receive a wage with a quantity of W3.
W3=（A+ W2）α=（A+Aα（1+α））α=Aα（1+α+α2）
……
The rest may be deduced by analogy, the wage of workers of No. n stage is Wn:
Wn=（A+ Wn-1）α=Aα（1+α+α2+…+αn-1)
This is an issue of geometric progression summation. The sum of its infinite terms is:
(2)
WT  A
1
A

1

The dynamic process tends to a stable state finally. Under the stable state, the
aggregate demand on the market is composed of two parts: one is the active demand of the
rich group A, the other is the passive demand of workers, which equals to the total wage
WT. Then we can calculate the aggregate demand Qd
(3)
Q d  A  WT  A 
A


A

We can find out that the aggregate demands of formula (3) and that of formula (1) are
consistent. The whole production process is just like the famous saying of Polish economist
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M.Kalecki, “capitalists earn what they spend; workers spend what they earn”. The profits
of the rich group equal to their consumption and investment. The more they spend, the
more profits they earn, just like “Widow's Cruse” (Keynes, 1930).
Next we give a more general aggregate demand equation which includes the budget
deficit B and net export (Ｘ－Ｍ) below:
(4)
Qd 
A  B  (X - M)


ABO

B：budget deficit
X：export
M：import
O：net export, O=X-M
The above equation is a variation on M. Kalecki's formulation of the theory of
effective demand. It indicates that the rich group, during each production period, besides
getting the consumption and investment they expect, also get the money equal to the total
of budget deficit and net export in quantity, and they do have earned money.5
For a pure consumption model without investment, we can easily get the optimum
distribution proportion under that model, which is supposed to equal to the proportion of
population. That is to say, if 80% of people make a living by providing labor factor, and
20% of people rely on the non-labor factor, to meet the effective desire of the owners of
these two kinds of factors, the share of the labor income must be 80%, and the share of the
non-labor income 20%. Obviously this is a very ideal model. If the capital depreciation and
technical research and development of the rich group are considered, the actual share of the
capital income should be higher than the ideal proportion. The more developed a country is,
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the higher its capital efficiency, and the lower the proportion it uses to cover capital
depreciation. Hence the closer its optimum distribution proportion is to the population
proportion. Theoretically, the capital income share of developing countries needs to be
higher. If the share of the capital income is too low, it will cause insufficient investment,
insufficient supply and merchandise shortage; however, if it is too high, the effective
demand will be deficient and the investment and productivity will be surplus. The present
actual condition is: The share of the wage income is too low in developing countries, which
makes them fall into the mire of effective demand deficiency far too early.
The aggregate demand model put forward here is also an economic growth
model——a demand growth model. If the developing countries want to make economic
achievement, they must work hard to expand the domestic aggregate demand. To expand
the domestic aggregate demand, they should adjust distribution to gradually reduce the
capital income share and increase the labor income share. Supply and demand are like the
two legs of macro-economy, which must advance together. Only stressing supply and
production but not stressing demand and consumption, is like walking with one leg, which
is more haste, less speed.
2.4. Model test
Example 1: According to the China Statistic Yearbook, the GDP of China in 2005
was 18.30848 trillion Yuan, and total wage was 1.979 trillion Yuan, about 10.8% of GDP,
and total output of farming, forestry, animal husbandry and fishery was 3.94509 trillion
Yuan, about 21.5% of GDP. If all the output of farming, forestry, animal husbandry and
fishery is regarded as labor income (surely overestimated), the share of all the labor income
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in GDP is about 32.3%1, and the share of non-labor factor income deduced herefrom is
about 67.7%. Suppose the independent demands (also called the active demand or
Saturation demand) of the rich group is 100, then the aggregate demand is
100÷67.7%=147.71.
The implication of this subject is like this. The rich group who account for 20% of the
population have eaten to their full after consuming 100, but the poor who account for 80%
of the population only get 47.71, which is 11.9% of that of the rich ((47.71÷80) ÷ (100÷ 20)
*100%), far from enough If increasing the output at this moment, the rich must eat more;
maybe they will burst the belly, and negative utility occurs. If products can not be
consumed completely, it will cause overproduction and the product market cannot be
cleared.
Example 2: According to the data provided by US Bureau of Economic Analysis in
“Table 1.12 National Income by Type of Income”,
2
the national income of US in 2005
was $10.8876 trillion, and the labor income was $7.0296 trillion, therefore the labor
income share of US in 2005 was 64.6%, and the share of the non-labor factor income was
35.4%. Suppose the independent demand of the rich group is 100, then the aggregate
demand is 100÷35.4% =282.49. Therefore we know that when the rich group reach the
saturation, the masses of the poor have also reached 45.6% ((182.49÷80) ÷ (100÷ 20)
*100%). Considering rich groups must cover capital depreciation, then the difference of
consumptions between the poor and the rich is basically not so large, and their respective
effective desires are basically achieved.
Just as the calculation result above, the demand deficiency that the U.S.A. faces is not
1
2
The corresponding data are: 53.9% in 1978, 53.9% in 1989, 42% in 1997, 33.3% in 2004
Please refer to US official website: http://www.bea.gov/national/nipaweb/index.asp
15
as serious as that of China. Its development is more balanced and the polarization is not so
conspicuous. Perhaps these two specific instances have revealed all the secrets of the poor
and the rich countries.
According to the data of US Bureau of Economic Analysis, even in the 1930s, the
share of wage in national income of US was above 50%, which kept over 60% after 1940s.
By comparison, according to the data in China Statistic Yearbook, the share of wage of
China in GDP declined to 10.8% in 2005 compared with 17% in 1980, and the total of
wage of workers and the aggregate output of farming, forestry, animal husbandry and
fishery in GDP declined to 32.3 % in 2005 compared with 53.9% in 1989.
According to the data provided by Checchi and penalosa(2005), the labor share in some
OECD countries in 2003 is as follows: 65% in Japan, 64% in Sweden, 62% in British, 61%
in Canada, 61% in Italy, 60% in Germany, 58% in France and 52% in Norway.
Research finds that in all the rich countries, the shares of their wages in GDP are
higher. On the contrary, in those poor countries, shares of the wages in GDP are obviously
on the low side, and on decline with the increase of capital accumulation. Though this
paper cannot provide the data of the labor income shares of other developing countries, we
can also know about the real situation of their income distribution through their
increasingly rising Gini-Coefficients.
3. THE MECHANISM OF MODERN UNEMPLOYMENT
3.1. The micro-mechanism of modern unemployment
Although the whole behavior is formed by individual behaviors and the interaction
between them, however, the whole behavior also restricts the individual behavior in reverse.
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McKelvey(1999) puts forward the concept of endogenous environment.
A common feature of modern enterprises is producing according to orders. From
macroscopic perspective, under the restriction of limited total effective demand each
enterprise only can get a small share of the effective demand formed during the last stage,
which becomes the enterprise’s order of this stage. After completing this order, the workers
get the corresponding wages. These wages along with the saturation demand of the rich
group, form the effective demand of the next stage.
Under the restriction of limited order, the enterprise's profit maximization behavior is
transformed into the cost input minimization under fixed output. The lower the cost, the
more profit got from the order.
We suppose the production function of an enterprise is:
(5)
F=f（L，K）
Then, suppose the price of labor factor is W, the price of capital factor is r, and the
marginal output of factors is ML and MK respectively, then it is easy to conclude that the
factor combination of cost input minimization of the enterprise should be in accordance
with the following condition:
(6)
ML MK

W
r
This condition is to make the marginal output of each unit of labor equal to the
marginal output of each unit of capital. This seemingly somewhat harmonious conclusion
hides extreme disharmony beneath. For individual enterprises, any production factor is
their cost; therefore they must to the largest extent lower its price. For macro perspective,
all enterprises must strive to lower the wages of workers, and sharply counterpose wage
against profit. Therefore, this paper agrees with Schor(1985), who thinks the wage is
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exogenous, determined by custom, technology and the game strength between the
employee and employer.
Now, we arrange all the workers in a close market in descending order of their
(ML÷W), to form a “job-waiting queue”. To achieve cost minimization, the enterprises will
scramble for those in the top of the “job-waiting queue”. The number of employees an
enterprise hires depends on two factors: one is the size of the order; the other is the extent
of the output of workers. If an enterprise fails to complete the order in spite of hiring all the
workers whose marginal outputs are more than their bid wage, those at the bottom of the
“job-waiting queue” whose marginal outputs are less than their bid wage will be
unemployed. This is classical unemployment. However, there is another possibility: if the
enterprise has accomplished the limited order before it hires all the workers at the top of the
“job-waiting queue” whose marginal outputs are more than their bid wage, then, modern
unemployment (involuntary unemployment) occurs.
Under modern unemployment, the marginal output of most unemployed workers is far
more than their bid wage, which is an extremely typical feature, and the situation of less
than their bid wage is extremely rare. This is an ironclad fact, and this kind of conclusion is
easy to draw as long as you plunge into the social life a little and do a little survey. Modern
unemployment and classical unemployment originate from two kinds of completely
different unemployment mechanisms. Let’s make a comparison：A big cage contains a
smaller one within, and a bird is encaged in the smaller cage. Obviously, what now restricts
the activity of the bird is the small cage rather than the big one. Under classical
unemployment, production corresponds to the small cage, and demand corresponds to the
big one. But today, with the development of productivity, the former small cage expands to
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be even bigger than the big one. Therefore, the modern unemployment is subject to the
insufficiency of effective demand, market, sales and effective desire of the rich group.
From the perspective of enterprise, it will strive to lower the wages of workers to
achieve cost minimization. From micro perspective, lowered wage cost not only can bring
bigger profit in this stage, but occupy an advantageous position when carving up the
aggregate demand, and strive for more orders in the next stage. However, from macro
perspective, such behavior of the enterprise will lead to the shrinking of the aggregate
demand, and the decrease of total orders and fall into “prisoner's dilemma”.
From the perspective of workers, to get a job, they will be reluctant to have their own
bid prices lowered, so that they can stand on the front of the “job-waiting queue”. However,
from macro perspective, such collective behavior will lead to the overall decrease of
workers’ the wages, and the shrinking of aggregate demand, and the decrease of overall
employment chances, and fall into “prisoner's dilemma”, too.
This is a slightly complicated “prisoner's dilemma” in which multiple sides participate.
The general knowledge of game theory tells us that, if their payoffs matrix can be changed
by external force, then the Pareto improvement can be achieved. For example, the bid wage
of the workers can be raised by an appropriate amount by making use of the strength of the
labor union. Thus, the profit of the enterprises in this stage will decrease to some extent,
but it’s still profitable, and will be forced to hire workers. Meanwhile, the added wages
paid in this stage will be transformed into the order of the next stage, and then, the
enterprise will receive a bigger order at the next stage. Facing the bigger order, the
enterprise can accomplish this order by simply hiring a few more workers; for there are still
workers whose outputs are more than their bid wages in the labor market. Because more
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workers are hired at this stage, the order of the next stage will be bigger, cycling like this,
the profit will be identical to the original one when equilibrium is reached, and the rich still
can achieve their saturation demand. The profit of the enterprise does not decrease, but the
wages of the workers increase, and the employment increase, therefore, this is a Pareto
improvement.
The government can also make the enterprises realize cooperative game by
establishing the minimum wage system. Everyone volunteers to abide by the bottom line
for the minimum wage to game within the framework of the game rule. Therefore, from
macro perspective, such restriction is harmless to them as a whole, and may fully exert the
productivity of the enterprise and make contribution to social welfare.
The principle for hiring workers is like this, so is that for hiring other factors. The
enterprises will prefer to choose the cheapest resources and other factors, till the
accomplishment of the order. Many resources and alternative solutions of production are
left unused，it is not that they lack social value, but not cheap enough instead.
3.2. The macro-model of modern unemployment
To study macroeconomics issues, we might as well ignore the differences between the
workers, assume all labor are homogeneous. Under this assumption, the enterprise hires
workers stochastically, and it will be chaotic to determine who can find a job and who can’t
microcosmically, but this does not influence our macroscopic analysis.
Suppose each worker hired can complete order P（i.e. the output of an individual
worker）, this order brings profit R to enterprise, and brings wage W to the worker. Then, in
order to complete the aggregate order it is equal to the aggregate demand formula (3) in
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quantity, the enterprise must hire N workers. Therefore, it is easy to deduce the following
relational expression:
A
(7)
N
Qd
A
A
A
A




 
P
P P R
R PW
P
P
N: Number of hired workers
A：Saturation demand of rich group, including consumption and investment
P: Completed order of individual workers, P =R+W
R: Profit from order P
W: Wage from order P
β: share of profit, β=R÷P
If we assume that A, P, W are three independent variables, so we can differentiate
formula (7) with respect to W as follows
(8)
N
A

0
W (P  W ) 2
The above equation indicates that the higher the Wage, the more workers the enterprises
must hire, and the more the gross output, and the real wage reveal strict procyclicality.
Here, we suppose A, P and W are three independent variables. Readers may ask: can
this kind of assumption be tenable? Now we make some analysis as follows.
First of all, let’s study the order quantity P which a single worker can complete. The
author thinks that if the capital used, technical condition of production, working time and
the labor intensity of an individual worker remain unchanged, the output of an individual
worker is a constant. Though when wages increase, the workers' enthusiasm will get higher,
under the circumstance of strict supervision workers will do job more actively. So, increase
21
of the wage does not remarkably improve an individual worker’s output P, the correlation
between wage and individual worker' output is weak, the output P can be regarded as a
constant and is irrelevant with wage W.
Secondly, let’s study the rich group's saturation demand A. We acknowledged in the
preceding study that the rich group's consumption depends on their effective desire, and the
rich group's investment totally depends on consumption under a specific technical level. So
we can ascertain the rich group's demand has reached a saturation value.
Two of the three variables are constants, so the assumption that regards them as
independent variables is tenable. We can boost employment and expand output by adjusting
the exogenous variable of wage.
According to formula (7), (8), the increase of the real wage will cause the increases of
effective demand, output and employment, the real wage reveals strict pro-cyclicality,
which is highly consistent with the evidence provided by the many literatures mentioned
Section Ⅰ, with no need to further elucidate.
The model discussed above is built for a closed economic environment, but if an open
economic environment is taken into consideration, the circumstance differs. If we consider
the budget deficit B and net export (X-M) as active demands，we can get the following
aggregate employment formula
N
(9)
A  B  (X - M) A  B  O

R
PW
B：budget deficit
X：export
M：import
O：net export，O=X-M
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If the wage in this area increases, while those of surrounding areas don’t, the
enterprises will transfer the orders to the surrounding areas so as to achieve cost
minimization. Under such circumstance, the correlation between real wage W and net
export O is negative. We can differentiate Formula (9) with respect to W as follow：
(10)
N A  B  O
1 O


2
W
P  W W
(P  W )
Because the second term is negative in Formula (10), the positive correlation between
real wage and employment will be weakened. However, the capital transfer caused by wage
increase must occur after the increase of wage. Therefore, Formula (10) is unlikely to be
negative. That is to say, under no circumstance will countercyclical occur.
3.3. Some common issues
In the face of robust empirical evidence, it seems unnecessary to defend the above
theory. But to clarify some puzzles, it is necessary.
Under the circumstance that the marginal output of the workers is greater than their
bid wage, one more worker hired by the enterprise, one more marginal product (real thing),
which is yet not necessarily the marginal profit (money) that the enterprise wants. Only
after the enterprise sells out this marginal product, will it become marginal profit. Whether
this marginal product can be sold fully depends on the saturation of the aggregate demand
in the market.
Some may think, after the wage is raised, and the output expanded, but the total
profit does not increase, as a result, the profit rate decreases. In fact, this is the so-called
“small profits but quick turnover”. The key is not low profit rate, but lower risk. The rate of
bank deposit is low, but there’s no risk. Therefore, many people choose it. After the
increase of wage, the market is expanded, and business risk relatively decreases.
23
Some may insist that when worker's wage is raised, the rich group's demand will be
reduced accordingly. Because there is a large amount of usable idle labor and capital, when
worker's wage increases, the rich can maintain their extravagant life by simply hiring more
workers, and it is unnecessary for them to be thrifty. Even reversely, when worker's wage is
raised, the demand increases, the market situation turns better, social conflicts appeased,
and the rich group will probably increase their demand.
Some may think that wage rise will cause the transfer of international capital to places
of lower wage. In fact, capital transfer also costs, some of which is untransferable. The
capital transfer arising from wage increase of a country also contributes to other poor
countries and regions indirectly. If the whole world is seen as a closed economy, then the
wage increase of any country or region will have a promotion effect on the whole global
employment and output. For the issue of capital transfer, we must strengthen international
cooperation, and object to “low-wage competitions” between countries, to avoid falling
into “prisoner's dilemma”.
Some think that it is unfair for those who are willing to accept employment of lower
wage to reject them by the minimum wage system In fact, this is the so-called “free market
to decide labor price” argument. Studies show that if the labor market is not protected by
the law, a good employment level is unable to be kept steady. If we offer no protection and
allow those who are willing to accept lower wage level to be employed, some of the
employees with higher wage levels will be driven away. As a result, the passive demand in
the aggregate demand is reduced unconsciously. The reduction of aggregate demand will
inevitably bring about the reduction of total employment opportunity, and then cause more
persons to lose their jobs. Once more people are unemployed, the competition of labor
24
market gets fiercer, and more persons would accept jobs with lower wage, thus forming a
vicious cycle. Eventually, the wage drops to a level that is just enough to make a living, and
always maintains at this low-level being hard to improve.
As to those people who are unable to get employment at above- minimum wage level,
the government should give an appropriate living guarantee to them, instead of encouraging
them to compete with a low price. Such an encouragement will necessarily cause the labor
market to collapse (drastic drop of wages and practitioners).
Some may think that after the wage is raised, the rich group will replace labor with
capital. The author thinks that in a short period, enterprises are unable to replace labor with
capital. If a large number of replacements are incurred by wage increase, it will cause
investment increase in at least a short time, and this will inevitably cause the increase of
demand for labor.
Some may think that the increase of wage will lead to price rise and the reduction of
aggregate demand. In fact, if the price rise is caused completely by the wage rise, the
aggregate demand will inevitably increase. The two models of aggregate demands and
aggregate employment both support this conclusion. We can give one more example to
explain this issue
Example 3: Suppose the total annual pay of a couple is 50,000 Yuan, and the wage
cost accounts for 11% of the total price of goods. If the price of an ordinary commercial
apartment is 500,000 Yuan, then they need 10 years to afford it without eating or drinking.
According to the data above, we can calculate that the wage cost of this apartment is
55,000 Yuan .If the present wage levels are doubled generally; the wage of this couple will
be raised to 100,000 Yuan annually. The wage cost of the same house will rise to 110,000
25
Yuan. If we add the increased wage cost to the housing rate, it will be 555,000 Yuan. In
this case, this couple needs only about five and a half years to buy the house.
Of course, for those living on deposit (such as the retirees), the government can
guarantee that their purchasing power is not influenced through monetary policy.
This example gives a very useful calculation formula:
(11)
Real wage=nominal wage ÷ price
=nominal wage ÷ (nominal wage + profit)
We can conclude from the above formula that, though the increase of the nominal
wage leads to price rise, but the real wage increases instead of decreasing. This is a very
useful analysis method, which may be called “factor analysis method”.
4. TREATMENT OF MODERN UNEMPLOYMENT
Based on the relational expression (7) of employment quantity given above, we can
start from the following ways to solve the unemployment problems.
First, increase workers' wage W, and reduce the rates to add to the quantity. Wage
increase will cause increase of passive demand, thus the aggregate demand and the total
employment volume will also increase. For this reason, trade unions are formed and strike
movements break out in western developed countries to enable the workers to negotiate
with enterprises as a whole, thus providing everybody with a uniform wage which to an
extent alleviates employment pressure and insufficient demand. The income share of the
wage is higher in the distribution of the national output, which guarantees the prosperity of
their country.
For the numerous developing countries, if they want to expand domestic demand and
achieve economic development, they have to constantly adjust the distribution proportion
26
of factors, to constantly improve the income share of wage. In the upcoming 10 years,
China should focus on raising the income share of wage; to raise the share of wage income
from 10.8% in 2005 to about 40%.
This will greatly improve the people's living standard,
expand domestic demand, and lay a solid foundation for building a harmonious and
commonly rich society.
Second. Reduce each worker's output P. This can be achieved through limiting
working time strictly (such as 40 hours every week), reducing work intensity and
increasing labor protection, etc. For example, the unemployment is reduced significantly in
France after it carries out the 35-hour work week. The experiences of developed countries
in this respect are worth adopting.
Third, Faced with the international capital transfer, we must implement international
cooperation and coordination, do not attract investment by low wage, do not carry out low
wage competition, do not shift one's trouble onto others, to avoid falling into “prisoner's
dilemma”.
In fact, when having deeper understanding on the mechanism of the unemployment,
we can find out more better and effective solutions to treat it, which is not detailed in this
paper.
5. CONCLUSION
The present macroeconomic is to exaggerated human's consumption desire
excessively, and deviated from the microeconomics foundation seriously, so that it is
unable to profoundly understand the vital significance of the effective demand, and unable
to holding the profit maximization behavior of the enterprise.
27
Orders are finite, and productivity is sufficient. Under the restriction of effective
demand, enterprises produce strictly according to the order, thus, the profit maximization
behavior of enterprise is transformed into the cost input minimization under fixed output.
Under this circumstance, although there are many workers whose marginal outputs are
greater than their bid wage not hired in the market, the order of the enterprise has been
accomplished, as a result, they will certainly be unemployed.
In a closed economic environment, increasing wage can boost employment and
increase output, and the real wage reveals strict procyclicality. By comparison, in an open
economic environment, increasing real wage may cause capital transfer, thus may weaken
the procyclicality of the real wage.
Although that an enterprise increases wages or employees will certainly cause the
increase aggregate demand accordingly, however ， this newly added demand will
necessarily be divided by thousands of enterprises, which renders us unable to perceive this
increase; on the contrary, we only see the decline of this enterprise.
However, if we adopt
some compulsory measures and policies to enforce the enterprise to increase wages, the
increases of total demand and total employment will be conspicuous and perceivable
(mathematically, equivalent to zero multiplying infinite). Generally speaking, we are
deluded by the bad phenomenon mentioned above and cannot see the “splendid scenery”
beneath.
As early as more than two thousand years ago, ancient Greek philosopher Aristotle
put forward the famous argument “the whole is more than the sum of its parts”, and modern
system science pushes further the research of “whole and part”, finding that “the whole is
less than the sum of its parts”( Xu,2000, p21) sometimes. That is to say, the conclusion of
28
downfall caused by pay raise of a single enterprise can not be directly copied to the overall
enterprises. Currently, the theoretical dilemmas on the employment issues is fully due to
our excessive dependence on the superficial experience based on the microscopic level, and
completely stagnate on the conclusion about “one factory and one business”, thus hindering
us from understanding and grasping the essence of the unemployment issue from the
macroscopic level.
In EMERGENCE, Holland（1998）reveals the processes that start from a few rules and
produce puzzling systems. The model presented in this paper is simple (almost equal to
axiom), but it is exactly the rule that macroeconomics and microeconomics must follow to
run. A good many dazzling economic and social phenomena are almost correlated with
these few simple rules. With respect to the participants of the game, it is indispensable to
understand these simple game rules.
Notes:
1. Suppose the share of labor income in national income is α, and that of non-labor
factor is β, and the MPC of wage-earners is b, then the investment multiplier is  
1
.
1  b
Dang et al. (2004) pointed out, because the MPC of wage-earners b is high, which reaches
nearly 1, while their income share α is far smaller than 1, therefore, the investment
multiplier can be simplified as  
1
1
1

 .
1  b 1   
2. According to 21st Century Business Herald, the fields in which productivity surplus
exists in China currently include 10 major sectors: steel, concrete, electrolytic aluminum,
calcium carbide, coke, hydroelectricity, coal, textile, auto, and alloy iron.
3. In respect of the unemployment situation in China, Mr. Xu Kuangdi, chairman of
CPPCC and president of China Engineering Academy, said in March 2007: “(the official
29
statistic of) unemployment rate is 4.6%, excluding jobless graduates, who haven’t
registered, as well as surplus rural labor. We conducted a survey, in fact, the total
unemployment rate reaches nearly 8%, including those who are laid off and those who are
awaiting jobs in large and medium-sized cities.” And the composition of unemployment
persons shows a tendency of spreading towards junior population and high-knowledge
population. In China, there are about 0.1 billion rural labor forces under the condition of
unemployment.
4. For example, in the theory of automatic control, this method is often used to handle
nonlinearity issues.
5. At this moment, a steady and non-equilibrium “money dissipative system” which is
larger than the equilibrium level will appear.
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