Blanchard & Fischer (1989) note:
“The Keynesian framework, embodied in the “neoclassical synthesis”, which dominated the field until the mid-1970s, is in theoretical crisis, searching for microfoundations; no new theory has emerged to dominate the field, and the time is one of explorations in several directions with the unity of the field apparent mainly in the set of questions being studied.” (p27).
On the Phillipscurve they note:
“The contemporaneous correlation between innovations in wage inflation and GNP is, however, positive and significant: it is this correlation that underlies the Phillips curve, which plays a central role in theories of the business cycle that allow aggregate demand disturbances to affect output.” (p19). [39]
Their discussion is critical and enlightening, but does not involve the role of the minimum wage. On p551 they discuss the high European unemployment, but then refer to the Layard & Nickell 1986 & 1987 model, concluding, a bit non-committingly:
“The Layard-Nickell model provides an example of how to relate the theories developed in this book to the data. It suggests a complex set of causes for high unemployment in which both demand and supply factors play a role and the labor market’s own dynamics explain the persistence of high unemployment with nearly stable inflation.” (p555).
Our analysis will allow a stronger conclusion. From the 1950s till the beginning of the 1990s the common view among economists and policy makers tended to be that the unemployment in the trade-off was “general” unemployment. This is not quite true for all economists, but many made this simplifying assumption. Nowadays we tend to link unemployment to lowly productive labour. For us it may be obvious, but compared to the earlier view of many it is a change of perspective that the once-thought-to-be “general” unemployment now turns up as a rather specific type. To make this change specific: we will hold that the unemployment in the trade-off has always been related to the distribution of productivity across labour.
Structure of the argument
The crucial insight is that the people who can demand pay rises need not be the people who run the risk of unemployment thereof. High productivity workers run less risk of unemployment and can more easily demand pay rises, while low productivity workers run the larger risk of unemployment. High productivity workers are more versatile and are able to shift the risk of unemployment to the lower income groups. When jobs are scarce, the high productivity workers even crowd out others from the labour market. [40]
The policy rule on taxes is: don’t tax low productivity labour. Why ? To keep it employed so that more productive labour will meet more competition and will not demand inflationary pay rises. In Europe, taxes on low productive labour are still high, causing a high minimum wage that causes unemployment. These taxes could be abolished, and without costs, since these workers are unemployed anyway. Similarly, marginal tax rates are less a problem than often said. The proposed alternative policy provides an improvement on both unemployment and inflation, exactly the kind of policy measure required for in the current situation.