1. Law of Economics: Unions Are Not Greedy — Higher Wages Cause Higher Employment

By Jan Frederik Moos

This series of five articles offers a compact toolkit for understanding how capitalism really works. The aim is simple: to explain the core mechanics of the capitalist system clearly and realistically. What makes sense for an individual — in microeconomics — doesn’t always work for the economy as a whole — in macroeconomics. You’ll see that what benefits one person can harm society, and what seems costly for some can strengthen the whole. Everything will be explained through concrete examples; no prior economics background needed.

Before tackling issues like unemployment or inequality, we need the right foundation. Without it, we risk mistaking symptoms for causes and accepting misleading stories — about "greedy unions", the "necessity of inequality", or the "dangers of public debt". This toolkit is meant to clear that ground. If you understand the following points, you won’t fall for political tricks anymore — the stories about the “evil trade unions” or the there is no alternative mantra.

Politics has drifted from reality, and economists bear part of the blame. In economic textbook models, people are perfectly rational — they wake up calm, informed, and make flawless decisions. I don’t. Neither do you. And neither does the capitalist system. It too stumbles, adapts, and depends on guidance — the continuous art of statecraft. Without that guidance, we face rising unemployment, growing inequality, and the erosion of public goods.

One economist who never lost sight of this was Paul Davidson. He reminded us that economics is not a science of mathematical models but of institutions, choices, and history. For fifty years he kept explaining the same lesson — because it still needed to be learned. And he was right. Let’s begin with the first economic law. We’ll start with a quote from an economist whom Davidson also liked to cite.

“Firstly, the level of aggregate employment and unemployment is determined in the product market by effective demand, not in the labour market.”(Thirlwall, A. P.: 1993).

The quote sets the stage for a central insight: unemployment is a political failure, not a personal one — and the labour market’s myth needs to be unmasked. To do so, we need to examine the theory that has misled politics — the neoclassical one. A closer look reveals its severe flaws and prepares the ground for better policies that enable rising real wages and full employment.

Neoclassical economics rests on two convenient assumptions: (1) markets are self-correcting, and (2) price adjustments are the mechanism through which imbalances are eliminated. When persistent imbalances nevertheless occur — contradicting the first assumption — the model attributes them solely to politically imposed price rigidities. These are cast as obstructing the second assumption, while the market itself is never held accountable.

This leads to an important consequence: the model rules out demand shortfalls in the long run by definition. If spending falls, it assumes that flexible prices will quickly bring the economy back to balance and full employment. In other words, supply and demand are thought to move automatically towards a price that clears the market, as if the world simply waited until that price appeared.

Put simply: all markets are expected to find the "right" price, and supply and demand are believed to adjust to it—without anything else changing in the meantime, not even the so-called equilibrium price itself. Every day looks the same: the same buyers with the same needs and the same budgets, the same goods on the shelves, and only now and then does an external "shock" disturb the calm. Real life—constant change, the passage of time, shifting moods, and ongoing disturbances—is conveniently defined out of existence.

This image is transferred to the labour market, where the core components are supply (employees), demand (employers), and the market-clearing price (the real wage) (Goodwin et al. 2022: chapter 9) . The market-clearing price is determined by the interaction of supply and demand, again under the assumption of ceteris paribus. Put differently, the world has to freeze so that supply and demand can locate the "correct" price. Market clearing is characterised by full employment, which the model assumes to be the normal state of the economy. Joan Robinson, a brilliant British economist and close student of Keynes, remarked that the mainstream model is timeless. For obvious reasons, in a constantly changing world a permanently changing, fictitious market-clearing price can never be found.

Given the continuing influence of the neoclassical perspective, we will consider it in some detail; I will present the model step by step and identify its shortcomings. To illustrate the neoclassical story, imagine Farmer Brown at his village market. If he ends the day with unsold tomatoes, he lowers the price tomorrow. If his stall empties too quickly, he raises it. In this way, the price mechanism is said to guide supply and demand towards balance. Nothing changes until the market-clearing price is discovered. Every day the same customers arrive with the same needs, and Farmer Brown has the same number of tomatoes. Once the market clearing price is found, no tomatoes are wasted, no customers leave empty-handed, and equilibrium is reached. Everyone willing to buy a tomato at the given price gets one, and Farmer Brown sells the last tomato shortly before closing time.

The key implications should be noted: in neoclassical markets, only prices adjust while quantities do not (think of tomatoes), and the market is presumed always to clear. Roughly speaking: the neoclassical world knows no problems, so it is only logical to conclude that it cannot help in solving them.

Neoclassical economists extend this allegory to the labour market. If unemployment persists, the explanation is that wages (the price of labour) are too high. Lower wages would, so the story goes, increase demand for labour, reduce labour supply, and clear the market. Unemployment, in this view, is voluntary and the result of workers pricing themselves out of jobs. In essence, the tomato market is transposed onto the labour market. A minor difference, however, is that workers are assumed to reduce their labour supply when wages fall, implying that even those dependent on employment are guided solely by a money–leisure trade-off. The weak wage growth of the past decades is evident: the wage share across OECD countries has declined since the 1980s, and yet unemployment has continued to rise. Empirical evidence shows that labour has become increasingly cheap compared to the value of its output. The model therefore fails to explain unemployment — but what is wrong with this tomato story?

This reasoning is tidy, but it is profoundly misleading. Firms do not hire workers simply because wages fall. In periods of unemployment and weak demand, what purpose would additional workers serve? What extra goods could they produce? Firms hire when they expect to sell more. Their decisions are guided by anticipated demand, not by the abstract level of real wages. Production is aligned with expected demand, and additional output requires additional workers. If wages are cut across the board, household incomes decline. With less to spend, consumer demand contracts, firms face falling sales, and many are forced to lay off workers. Policies designed to cut unemployment through wage reductions end up producing the reverse outcome. Such policies destroy confidence in the goods market, which — because of the dual role of wages as both costs and income — depends directly and positively on them.

This is not just a theoretical possibility. It was the lived reality in Greece, where wage cuts imposed during the Troika’s austerity programme deepened the crisis instead of solving it. Since a picture sometimes says more than words, let us take a closer look at it. In dark blue you can see the unemployment rate in Greece, and in light blue the development of real wages.

Figure 1: The Neoclassical Story’s Role in Greece’s Collapse

As you can see, the outcome is precisely the opposite of what the neoclassical model predicts. Politically imposed wage cuts have not stimulated employment but have instead driven down real wages while unemployment has increased. This contradiction exposes a fundamental flaw in the neoclassical assumption that lower wages automatically clear the labour market. In reality, wage reductions suppress aggregate demand and thus deepen the very unemployment they were supposed to cure. The neoclassical economists have fundamentally failed. An even more powerful illustration of the error of neoclassical theory—like the graph—appears in a book to which I had the privilege of contributing a small part. As Heiner Flassbeck has shown in his magnum opus, the most striking historical example of falling wages alongside rising unemployment is found in the Great Depression—a prolonged period in which both trends reinforced one another. He is a well-known German economics legend, but he explains how the capitalist system actually works and will never tell you anything about a tomato-market labour model.

At its core, the failure stems from a fundamental misconception. Wages are not merely a cost to firms; they are also the main source of household income. They link production to demand in a way that the neoclassical framework ignores. To treat wages like the price of tomatoes is to miss their double role in the economy. Higher wages can increase costs for individual firms, but they also sustain demand across the economy, which in turn supports production and employment.

The belief in the desirability of falling wages is therefore a simplistic microeconomic fallacy. (No wonder the labour market can be found in the standard microeconomics textbook; a somewhat more detailed discussion can be found in the appendix.) This interconnectedness explains why wage cuts backfire and why expansive wage policy is simultaneously employment policy and growth policy. Ultimately, the decisive factor in producing more goods and hiring additional workers is straightforward: it depends on demand — specifically, on whether firms expect future demand to exceed current demand, or whether new markets for their products are emerging. In other words, demand policy is employment policy, since only additional production requires additional workers — and that production, in turn, depends on the existence of a market for its goods. Anyone who wishes to take a closer look at the absurd modelling of the neoclassical framework should turn to the appendix.

Let’s talk a bit about the current political situation. The German right wing — and perhaps the right wing in your own country — promotes a pernicious narrative: unemployment benefits should be cut because "work must pay". In reality, this is little more than a sleight of hand. A far better strategy is for trade unions to demand that a greater share of national income be directed towards wages, ensuring that those in work earn more than the unemployed. But what happens when, as in Germany with the so-called Hartz laws of the early 2000s, social benefits are cut? As the red line in the graph illustrates, the wage share declines, meaning less money flows to workers and more to business profits. The welfare state, therefore, is a positive institution, and the message should always be: we want more — not they should have less.

Figure 2: Wage Share and the Impact of Social Benefit Cuts

The conclusion is clear: wages must grow in line with the productive capacity of the economy (defined as possible output under full employment) if sufficient demand is to be maintained. This requires a sound wage policy, a strong social system and responsible unions capable of striking a balance between restraint and ambition. A prime example is the behaviour of German unions during the pandemic and post-pandemic period. If wages keep pace with productivity, households can afford the annual increase in output. The relationship between real wages and consumption is to be understood with a childlike naivety. Some empirical evidence (Figure 3) relating to Greece can be found in the appendix: a graph comparing private consumption and real wages.

What still prevents sufficient demand for full employment is the savings behaviour of households and firms. The topic of the second blog entry—the second law—will therefore be how large the government deficit must be to guarantee permanent full employment. Final remarks: Wage policy cannot on its own resolve all demand problems, but it provides the optimal solution within the economy—supplemented by the necessary fiscal deficit.

For a deeper understanding of the shortcomings of the neoclassical labour market, Paul Davidson’s work is essential, complemented by an important contribution from Heiner Flassbeck and Friederike Spiecker, available only in German. The position represented here is rooted in post-Keynesian economics; foundational works on post-Keynesian economics can be found in the writings of John King and Steve Keen, and you might begin with Marc Lavoie’s freely available book.

If you are interested in working with me as an editor, interview guest or guest lecturer, or if you have any questions, please feel free to get in touch: mmtmitjan@gmx.de

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Appendix:

Figure 3: Real Wages and Private Consumption in Greece

Figure 4: Wage Share in Germany, USA, China, and Japan (1980–2010)

Why Does Employment Rise in the Neoclassical Model?

According to neoclassical theory, unemployment can be solved through the substitution effect that results from lower real wages. The production function consists of the factors capital and labour, which can be combined in different ways. The argument runs as follows: when the real wage falls, labour becomes cheaper relative to capital. Firms are therefore expected to substitute labour for capital, hiring more workers while using less capital. This substitution is said to generate a new equilibrium with higher employment — a mechanism that underpins the downward-sloping labour demand curve typically shown in textbooks. As long as production is described by a well-behaved neoclassical production function Y=F(K,L), the substitution of capital for labour leads to a new equilibrium characterised by a higher level of employment.

In this way, the neoclassical model presents unemployment as a self-correcting phenomenon: if wages are flexible, the market will restore full employment by adjusting the real wage downward. This logic underpins the downward-sloping labour demand curve shown in Figure 1.2(a). The vertical axis (w/p) represents the real wage, while the horizontal axis (L/K) shows the labour–capital ratio. The curve labelled LD illustrates how the quantity of labour demanded declines as the real wage rises. The vertical line LS represents the labour supply. The point where the two curves intersect marks the neoclassical equilibrium, which is defined as the point where no one is additionally willing to work at the given real wage — meaning that unemployment does not exist.

Figure 5: Different Labour-Demand Curves

Empirical evidence, however, has long demonstrated that this theory bears little resemblance to reality. In practice, there is no observable trade-off between wages and employment, and such a conflict does not even enter into the reasoning of entrepreneurs. First, firms always produce with the most advanced technology available in order to remain competitive. A shift back to more labour-intensive techniques when real wages fall is neither technically feasible nor economically rational. Second, a wage cut immediately reduces aggregate demand. When households have less income, they consume less, which directly lowers sales expectations. Once again, it becomes clear that the model is timeless and assumes a logical relationship that can never exist in time, since cuts in real wages weaken the economy to such an extent that a trade-off is never actually considered. Thus, the idea that lower wages could stimulate higher employment is not even considered at the level of practical decision-making, because demand collapses before any substitution between labour and capital could occur.

However, Pierangelo Garegnani, a student of Piero Sraffa, demonstrated that this neoclassical assumption — already contradicted by empirical evidence and rooted in a timeless abstraction — does not even hold up theoretically. Garegnani presented numerical examples showing that a fall in the real wage may, in fact, lead to a reduction in labour demand — and it is precisely this possibility that undermines the notion of a stable equilibrium. Figures 1.2(b) and 1.2(c) illustrate diffrent possibilitys. (The Cambridge capital controversy showed that changes in the profit and real wage rates alter relative prices and the valuation of capital goods, implying that the capital–labour ratio can rise with higher profit rates—contradicting the neoclassical “principle of substitution” and undermining the neoclassical explanation of the labour market.)

In short, the neoclassical model lacks genuine explanatory power, as mathematically alternative cases can also arise, while empirical evidence strongly indicates that the relationship runs in the opposite direction — higher wages tend to stimulate demand, output, and employment.