Real wages in the business cycle and the theory of income distribution: an unresolved conflict between theory and facts in mainstream macroeconomics
ABSTRACT
The focus of this paper is the recurring tension between mainstream macroeconomics and observed facts in connection with the difficult task of providing explanations of the business cycle consistent both with the traditional theory of income distribution and with the empirical evidence concerning the co-movements of real wages and employment over the cycle.
This is so since the latter appears to be incompatible either with the notion that the economy is moving along an (aggregate) labour demand curve, with real wages and employment moving in opposite directions, or with the notion that
employment is increasing (or decreasing) along a labour supply function owing to pro-cyclical real wage changes, given the low elasticities of labour supply estimated in the literature. The attempts to reconcile facts and theory in monetarist, real business cycle and new-keynesian macroeconomic models have led to the continuous introduction of specific and arguably ad hoc hypotheses, in contrast with the search for greater theoretical rigour claimed by the various streams of macroeconomic modelling subsequent to the neo-classical synthesis. In addition, it is shown that the specific assumptions introduced in the models, or their implications, are in turn often contradicted or, at best, not confirmed by subsequent empirical research. It Is maintained that the difficulty of keeping together in a simple and consistent framework theory and facts reflects the flaws in the theoretical foundations of mainstream theory – namely, decreasing factor demand curves -
highlighted by the capital controversy, and that the ‘puzzle’ of the co-movements of wages and employment over the cycle appears to be such only from a mainstream perspective, while the observed empirical regularities fit quite naturally into an analysis of the cycle and the general working of the economic system centred around the principle of effective demand and the explanation of income distribution based on the bargaining strength of the parties and the role of institutions.
