Structural Deficiencies in Effective Demand and
their Implications for Ireland in 2009
EC4006 Intermediate Macroeconomics | Guest Lecture 2
Stephen Kinsella | stephen.kinsella@ul.ie | www.stephenkinsella.net

Really relevant
question for Ireland
Today: will wage
reduction stimulate
employment?

Keynes’ Causal Story in The General Theory
wages -> prices -> interest rate -> Investment
(Money Supply is fixed)
Investment determines Consumption, Income (X),
Output (Y)
How?
(1) X = C+I (The Material Balance Relationship)
(2) Y = X (The Output/Income mapping)
(3) C = f(Y) (The Consumption function)

Irish Unemployment Right Now

Where did this come
from?

Rising Prices have eroded competitiveness
Source: Central Bank of Ireland, Forfas NCC Report pg. 37.

Wait: what’s ‘competitiveness?’
Price of Irish stuff < Price of everyone else’s stuff ->
Quantity Demanded for Irish stuff goes up, assuming
they are of similar quality.
From Friday: price of Irish Stuff = (Factor Cost + User
Cost)
Factor costs: Inputs to Process + Unit Labour + Unit
Capital Costs.
Idea: Drop Factor costs somehow, competition/survival
instincts will drop prices quantity demanded of Irish
stuff will rise.

“There’s a Problem With Irish Wages”
Rates vs Levels, or: Forfas NCC report vs. the Unions

“Labour cost growth rates show the change in
the cost of employing workers over time.
Ireland’s growth rates have exceeded the EU- 15
average over both periods. The average rate of
wage inflation in Ireland between 2004 and 2008
Q2 was 50 percent above the EU-15 average.”
–––Forfas, (2008):58

US $ per Hour Worked
$0
$5
$10
$15
$20
$25
$30
$35
$40
Poland
Hungary
Singapore
New Zealand
South Korea
Spain
Japan
OECD
US
France
Italy
should we look at?
What part of the chart
Ireland
EU-15
UK
Luxembourg
Source: US Bureau of Labour Statistics, September 2008
Finland
2006
Sweden
Netherlands
Germany
2000
Denmark

There is a problem with public sector wages
(source: www.ronanlyons.com)
1200
900
600
300
Public Sector Finance Motor trades Wholesale Retail Hotels and restaurants Land transport
Post, telecomms Other business Utilities Food, Beverages Textiles Paper, printing Chemicals
Rubber, Plastics Other Minerals Metals Electrical, Optical Transport Equipment Mining
0
19 Q1
19 Q2
19 Q3
19 Q4
19 Q1
19 Q2
19 Q3
20 Q4
20 Q1
20 Q2
20 Q3
20 Q4
20 Q1
20 Q2
20 Q3
20 Q4
20 Q1
20 Q2
20 Q3
20 Q4
20 Q1
20 Q2
20 Q3
20 Q4
20 Q1
20 Q2
20 Q3
20 Q4
20 Q1
20 Q2
20 Q3
20 Q4
20 Q1
20 Q2
20 Q3
20 Q4
20 Q1
20 Q2
20 Q3
20 Q4
20 Q1
20 Q2
3
Q
98
98
98
98
99
99
99
99
00
00
00
00
01
01
01
01
02
02
02
02
03
03
03
03
04
04
04
04
05
05
05
05
06
06
06
06
07
07
07
07
08
08
08
19

Back to the macro
Concentrate on changes in the real wage, w/p, or the
profit share, π.
Big question: how do changes in the real wage/profit
share affect output?
Let commodity production be determined by a markup
rule, depending on labour, L and capital, K
P = (1+∆)(wL+rK)
Now ask: how high does w have to go to inhibit ∆?

Ratio Argument
Ireland: wages are 8% of overall wage bills in high value
added sectors like Bio/Pharma
Drop w by 50%. What happens to total factor costs?
Drop by 3-4%.
So, will dropping wages w/p stimulate overall
production in high value added export industries?
NO.

What will?
Changes in the other component of factor cost: rK.
r is falling, thanks to property crash. K is not increasing
though, because no one wants to invest.
Cost of capital in Ireland has to change.
How? Increased investment in production.
This needs different expectations than we have now.
Only Govt has ability to borrow & invest on that scale

What will?
But, Govt is very poor at choosing good projects, and is
really inefficient at producing them.
Better to support local entrepreneurs in a light touch
way, allow them to start businesses which will either fail
or succeed according to the market.
BUT, EU rules against state aid.
Time to break the rules.

Back to IS-LM Mathematica Example

How does this help Ireland?

Liquidity Preference
Idea: An investor will opt for
liquidity (i.e. hold money) instead
of a bond when they expect the
interest rate on it to rise, causing
a capital loss on the bond
exceeding the running yield we
might see.

Summary
Whether wage reductions stimulate output depends on changes in effective
demand and the ratio of levels of rK: wL. Changing wL dents domestic
consumption and probably won’t increase competitiveness in short run.
It’s clear we want to change effective demand to increase X/Y.
What changes effective demand (again, determined by Factor Cost+User
Cost)
MEC (sort of) + Liq. Preferences + changes in User cost.
Support people with no money but a good idea, you change User cost.
...and more ranting about this on Friday