Transcript | 2. lecture: Lump of labour fallacy (Miroslav Beblavý) - University for modern Slovakia

Lump of labour fallacy is one of the basic myths within the economy. It is based on the false assumption, that within one economy there is a given and stable amount of work, which is necessary to be made, and which can be divided between the population in many ways in order to create more, or less working places.

One of the examples of such thinking is – if businesses limited the working hours of their employees they could hire more people and increase the overall number of employees without increasing the expenses or a negative effect on the overall productivity. Such measurement should therefore lead to a decrease in unemployment.

This phenomenon has already been described by the economist D. F. Schloss in year 1891. He explained that in such case, it is necessary to decrease the salary of employees (which is in no situation a popular step), otherwise will this measurement lead to an increase of the price of the product. Besides that – not all labour costs are dependent on the number of worked hours. Fixed expenses for the employees like mainly the rental and training of employees can be a major component of the expenses – that’s why many business can’t afford to replace one by accepting two employees part-time so they rather prefer one full-time. And so the shorter working week can lead to an increased average price for a unit of output and cause the businesses to buy less working hours.

Another, nowadays more commonly used example of this myth explained by the British Conservative Policy Forum, is the situation when it is argued that if we sacked older employees, there will be more for the younger ones. However even this example is wrong since the labour market can expand and isn’t fixed. Because the more people work, they more money they make, the more money they spend and through that increases the demand after services and goods – in other words – after work.

This argument has sadly been put through the western Europe during the 70 and 80 years. When the attempts to deal with the after effects of the oil shocks through traditional methods failed, many west governments focused on decreasing the unemployment by the withdrawal of working force from the labour market through early retirements or an easier access to invalidity. The perspective of the public policy started to change in the 90’s also thanks to the realisation, that considering the demographic crisis is the decrease in unemployment through the push-out of the productive employees out of the labour market completely counterproductive and in the long term doesn’t even lead to a higher employment, nor a lower unemployment. 

The last example, where this myth appears in a bit different way, is the example of technological revolution that is linked to the fear of firing of employees, whose work will be replaced by machines with a higher productivity and lower expenses. This will lead to less and less work. However according to David Autor and Lawrence Katza is this link between the technological innovations and this phenomenon provably wrong. While the technological innovations for example in the agriculture really decreased the number of working people in this industry, it is these technological innovations that lead to a higher productivity, higher salaries and creation of new products and services and so the transfer of employees from one industry to another. This example at the same time nicely illustrates the fallacy of composition from the first lecture – it generalises the experience of one industry to the whole economy and so it comes to an error.

In the long term will the prices and salaries be set to reflect the technological innovations, the offer and demand and working opportunities will be created where necessary. In the short term it is necessary to help the economy by a correct macroeconomic policy. When we take a look at the history or a cross section of different countries we see, that there isn’t a fixed amount of work that can be distributed in between inhabitants.

At the same time it is necessary to also mention the negative side effects of this myth. It’s not only about the force out of the older people out of the labour market in the name of making new places for the younger ones, but this myth can also be according to Paul Krugerman responsible for the following two effects. The first is the increased amount of fatalism. If the politicians and the public believe that the creation of new working places isn’t possible, they will stop to pressure the leaders with the goal to search for new solutions of the unemployment problems. The second possible side effect is the increase of protectionism. Since the reasoning according to this myth brings a policy paralysis, if the public believes that the economy isn’t capable of creating new working places it will demand to guard the remaining positions from the competition (mainly the developing countries etc.).

Overall it can be concluded (using the classic textbook of Samuelson and Nordhaus (1989))^[1], that the assumption about the fixed amount of paid work is wrong, because the economy has mechanisms, thanks to which it can adapt and create places for those, who want to work. And if it can’t, it is necessary to heal the core, because the individual division of work won’t help. This is important mainly in Slovakia, where we’re suffering from a long term relatively high unemployment. We saw in years 2004-2008 that the unemployment fundamentally decreased (from 20% down to 7%) during the time the reforms were made and the economy grew, not in times when places where divided.