Greg Mankiw looks at an article by Paul Krugman on the current economic problems.
The essence of Paul’s argument is that the economy of the Great Depression was in a liquidity trap, which implies that the AD curve is vertical, which in turn implies that policies that adversely shift the AS curve do not affect equilibrium output in the short run. Thus, a policy that under normal circumstances would be bad, such as cartelizing the supply of labor, is not bad under the extraordinary circumstances of the 1930s. (See Gauti Eggertsson for a more sophisticated version of this line of argument.)
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Even staying within the AD-AS model, it seems possible to argue the opposite point of view. Imagine you are a manager of a firm considering a long-term investment project. The President has just announced a policy to encourage your workers to form a cartel. How does that influence your decision to proceed with the project? Very likely, it deters you. Investment spending, however, is part of aggregate demand (in fact, one of the most volatile components). Thus, the policy could shift the AD curve, as well as the AS curve, in a contractionary direction.
As a general matter, the state of aggregate demand depends on an amorphous variable called confidence. Anything that threatens to screw up AS in the long run most likely reduces confidence and AD in the short run. The textbook separation of AD and AS is useful for focusing discussion in the undergraduate classroom, but events in the real world are rarely so clean.
And all of this discussion ignores the issue of rent seeking. Once you tell labor organizations that they can act as a cartel and charge what are, in effect, monopoly prices and possibly even enforce such an edict with the full coercive power of the government how do you take back such a nice juicy bit of pork? The labor organization is going to love such a move and will lobby to protect such rents. At the same time corporations will lobby to remove such rents. All that lobbying is not going to help produce goods and services.
And lets keep in mind, when a cartel charges a higher price it does so by restricting output which in this case would be the number of people working. Driving up wages might be a good thing in the current economy, but you also have to think beyond the current situation and the problems you are creating for yourself down the road. Think of it like medicine to some extent. Yeah the patient in pain and needs surgery. But at the same time if you aren’t careful with the pain medication you use you could create and addict who ultimately destroys himself. And government programs, laws, and regulations have a tendency to stay around well past their desired expiration date.
And lets look at another post on Prof. Mankiw’s website,
Economists Mark Bils of the University of Rochester and Pete Klenow of Stanford say we should cut the payroll tax to stimulate the economy. They email me their rationale:
As part of a temporary fiscal stimulus, we would argue for subsidizing the payroll tax (employer and employee portions) out of general revenue over some sustained period, say calendar year 2009. It has some distinct advantages:
(1) Like previous stimulus efforts, it has the standard demand side impact (same as cutting checks). But it also stimulates employment directly by reducing the tax penalties for working and for hiring workers. Related, it works under all business cycle models (even including those obeying Ricardian Equivalence).
(2) It targets domestic production better than sending out checks (or a sales tax cut).
(3) It targets lower income households, due to the cap on social security taxes. These households may respond more in both their consumption and employment decisions.
Now, it does not target the unemployed. But, in combination with extension of unemployment benefits, those with labor force attachment are still covered. In fact, it helps limit the damaging effects of extending the duration of unemployment benefits in terms of distorting reentry and job creation decisions.
Basically this would raise the after tax wage, which is precisely what Krugman is arguing for when he talks about creating a labor cartel, but this one probably wouldn’t face the same rent seeking problems as creating a labor cartel. Why? Voters are a diverse disorganized group, whereas a labor cartel and corporations are not, as we can see when we look at how taxes.
