Keynes vs. Classical Economists: A Dialogue on Employment

Setting: A economic roundtable, where John Maynard Keynes engages with representatives of classical economic thought.

Classical Economist: Let us begin with what we consider irrefutable. There are two postulates at the core of our theory of employment:

1. The wage equals the marginal product of labour.

2. The utility of that wage — when a given volume of labour is employed — equals the marginal disutility of employment.

These postulates lead to one logical conclusion: the labour market always clears. Unemployment must be either frictional or voluntary.

Keynes: I’m afraid that’s far too optimistic, gentlemen. Your framework denies the existence of involuntary unemployment and that is precisely where your system collapses. The postulates may work in abstract, but they fail to explain the mass unemployment of the 1930s.

Classical Economist: But surely if wages are too high, the market will self-correct. Lowering money wages should reduce real wages, making labour cheaper, and encouraging firms to hire. That restores full employment.

Keynes: Ah, but you assume that workers bargain over real wages. They don’t. Workers care about money wages — the actual pounds and shillings they bring home. Your second postulate—that the disutility of work is tied to real wages—collapses when we acknowledge this behavioural fact.

In truth, workers resist cuts in money wages, even if prices are falling. But they are generally tolerant of inflation eating into their real wages, especially if it results in more jobs. They aren’t being irrational; they’re protecting relative position, their status compared to others.

Classical Economist: That may be socially true, but it violates logic. The market requires flexibility.

Keynes: And yet flexibility in money wages may backfire. Suppose workers agree to lower their money wage from £10/hour to £8/hour. You assume this reduces real wages. But at the same time, prices fall too, possibly more than wages. Result? Real wages actually increase. Employers face higher costs per unit of output, and still don’t hire.

Classical Economist: But the marginal productivity of labour ensures that wages will adjust to maintain equilibrium.

Keynes: In theory, yes. But in practice, output falls, marginal productivity rises, and fewer workers are needed. The real wage remains high. Employment doesn’t rise just because workers accepted lower money wages. You assume price levels are stable or predictable, but they’re not.

Let’s not forget: firms hire workers not because they’re cheap, but because they expect demand for what those workers produce.

Classical Economist: But Say’s Law ensures that every act of production creates demand. Income from producing goods gets spent—either on consumption or investment. There cannot be a general glut.

Keynes: That’s an optical illusion. Saving is not automatically translated into investment. The decision to save and the decision to invest are made by different actors, influenced by different motives. There is no natural force that guarantees all income will be spent.

Sometimes, savings sit idle. Liquidity preference rises. Effective demand falls. Output contracts. Unemployment spreads.

Classical Economist: Then what would you suggest? How should employment rise?

Keynes: You suggest four methods, and I’ll address them:

1. Reduce frictional unemployment – Yes, better organisation can help, but its impact is limited.

2. Reduce the disutility of labour – Making work more pleasant to shrink voluntary unemployment is noble, but again, small effect.

3. Raise productivity in wage-good industries – This can increase real wages without inflation. Agreed.

4. Shift demand away from wage goods – An odd solution that relies on changing consumer structure.

But none of these explain or solve systemic involuntary unemployment. When people want to work at current wages, and firms want to hire at those same wages, but still unemployment persists, your framework fails.

Classical Economist: Then what is your alternative?

Keynes: My theory hinges on effective demand — the total demand for goods and services at a given level of output and employment. Employment rises when aggregate demand rises. If demand is low, no matter how low wages fall, firms will not hire.

Thus, involuntary unemployment exists when both supply and demand for labour exceed the current level of employment — but demand for goods is insufficient, so employment doesn’t rise.

Classical Economist: Then you reject our theory altogether?

Keynes: No. I conditionally accept your first postulate — in the short run, as employment increases, marginal product of labour falls, and real wages fall. That’s sound microeconomics. But I reject the second postulate, and I reject your assumption that the economy is always at or near full employment.

In fact, I argue that your entire theory is a theory of distribution, not employment. It answers the question: “Who gets what, once full employment exists?” But it says nothing about how to get there in the first place.

Keynes: Your economic theory is like Euclidean geometry in a non-Euclidean world. When parallel lines seem to meet, you scold the lines — not your axioms. But I suggest: throw out the parallel postulate. Embrace a new geometry. An economy shaped by uncertainty, psychology, and demand.

(Keynes walks out)