Hutt’s Classical Theory of Unemployment

[The Theory of Idle Resources ♦ by W.H. Hutt ♦ Ludwig von Mises Institute, 2011 (1939)]

More so than any other economist, John M. Keynes decisively shifted academia’s attention from the theory of employment to that of unemployment. He replaced the classical theory of wage determination with his own, stressing the possibility of involuntary unemployment. What interested economists now was the phenomenon of ‘idle resources,’ especially the existence of ‘idle’ employment. New economics, or Keynes’ economics, was beginning to replace, or at least modify, the Classical school’s — the profession was being swept.

It was in response to these changes that W.H. Hutt wrote his 1939 monograph, The Theory of Idle Resources. While going about it in a subtle way, Hutt was clearly contesting Keynes’ critique of the Classical theory of employment. In keeping with the times, he did this by writing a comprehensive essay on the theory of unemployment. In it, he sought to categorize the proximate causes of idleness, or unemployment. These are factors which if removed would eliminate the idleness of a particular resource. Hutt’s results are mixed. While he successfully defended Classical economics from the charge of lacking a theory of involuntary unemployment,[1] Hutt failed to address a much more fundamental argument Keynes made in the second chapter of his General Theory.

Eight factors, or, more accurately, proximate causes, of idleness are recognized and explained: valueless resources, pseudo-idleness, and preferred, participating, enforced, withheld, strike, and aggressive idleness. There is no distinction between labor and other economic goods, except that some forms of idleness — viz., lack of value — are inapplicable to the former. These factors explain both voluntary and involuntary unemployment, although ultimately Hutt’s conception of the involuntary has more to do with restrictions rather than an issue inherent in the market economy.

Valueless resources are those “which at any time it would not pay any individual to employ for any purpose,” even when employment were costless.[2] Hutt’s definition is actually quite exclusive and rigorous. For instance, a machine that cannot produce to cover its depreciation is not valueless. Instead, when thinking of valueless resources it is natural resources that come to mind most easily.[3] Closely paralleling Hutt, Carl Menger made a similar distinction when defining an ‘economic good.’ For Menger, an economic good enjoys four properties — demand, its applicability as a means toward an end, an understanding of its applicability by part of the owner, and ownership —, and the failing of any one property excludes an item from the category.[4] One might get a better idea of Hutt’s ‘valueless resource’ by interpreting his definition from a Mengerian angle: resources, in the objective sense, that are not economic goods, in the subjective sense.

Pseudo-idleness, in contrast, is a voluntarily restriction of output. In the case of a machine, it may arise, for instance, if present additional output comes at a loss, but the machine is maintained idle — and not scrapped — in expectation of future demand for its products. Alternatively, a wage-worker is in pseudo-idleness if she refrains from selling her labor in expectation of being able to find a higher paying job in the future.[5] One immediately sees, as implied by Hutt’s term, that pseudo-idleness is not really idleness at all, but maintenance of availability in expectations of higher income in the future. Goods currently producing, but still maintaining availability in case of superior employment opportunities, are still pseudo-idle, although in this case it is preserving what Hutt calls a ‘double function.’[6] When concerning labor, one should be careful to not confuse pseudo-idleness with preferred idleness, Hutt’s third category. This latter form of idleness is essentially when a worker chooses leisure over employment.[7]

Between explaining these three initial categories and the remaining five, Hutt goes on a brief digression on the concept of ‘irrational preferred idleness.’ If we think about pseudo-idleness in terms of opportunity cost, where the opportunity cost of current employment may be higher than that of preserving availability, it may seem irrational in retrospect if the opportunity costs were reversed and yet the same person still chose pseudo-idleness. When one thinks of irrational idleness it is best to think of it in terms of unfulfilled expectations, where the person simply errs in judgment.[8] Similarly, in the spirit of Keynes, Hutt offers the example of a laborer preferring a higher nominal wage over a higher real wage. This leads him into a six-page criticism[9] of the notion that the Classical economists have overlooked the role of irrationalism in spurring high unemployment, where he makes the case that workers who reject a lowering of their nominal wage (and are let go) are voluntarily unemployed — a case of preferred idleness or pseudo-idleness, to be exact.

Continuing with the exploration of Hutt’s definitions, participating idleness refers to an aspect of monopolization or cartelization. Resources held idle to restrict output so that a firm, or a group of firms, can charge a higher-than-competitive price are in participating idleness. In the realm of labor, an example is work sharing programs where members agree to restrict labor,[10] distributing a limited amount of hours amongst themselves. Unions are another example. Essentially, it refers to an agreement to constrain competition for the sake of charging monopoly, or uncompetitive, prices. Two corollary categories are enforced idleness and withheld capacity. The former is similar to participating idleness, but where it may be more useful to think of it as involuntary — for example, legislation aiming to restrict work hours. Neither can resources under enforced idleness be used towards alternative ends (“disguised unemployment”). Withheld capacity, in contrast, covers voluntary restrictions of output, in the case of participating idleness. Strike and aggressive idleness are related, the former referring to a situation where resources are held idle out of demand for different conditions of exchange. A labor union strike is the most obvious example. Aggressive idleness, on the other hand, refers to the maintenance of idle capacity for the purpose of suddenly ramping up production to crush potential competition.

It is difficult to uncover error in Hutt’s precise logical analysis, but perhaps it is marginally inadequate. While The Theory of Idle Resources is not meant as a direct challenge to Keynes, as much as it is a contribution to economic theory, Hutt nevertheless spends quite a bit of time criticizing certain aspects of The General Theory. Early on, Hutt makes clear that he rejects Keynes’ employment-based variables, where labor is aggregated in terms of wage-units and these last serve as the base unit for various functions which are meant to represent the relationship between employment, output, and income. Similarly, as we have already seen, he disagrees with including those refusing lower nominal wages in the category of involuntary unemployment. While Hutt’s arguments carry weight, he fails to address Keynes’ much more important objection to the Classical theory of employment. He, perhaps, also interprets Keynes’ supply and demand functions much too literally, where it would make more sense to use them as simplified representations of the broader argument.

Specifically, Keynes conceived of a situation where, even if workers consented, a decline in nominal wages will not reduce unemployment.[11] Assume that the price of the marginal unit of output is decided by the cost of the inputs, namely wages. A fall in the nominal price of labor will fail to reduce the real wage if the price of the output falls to the same degree. Thus, when criticizing Keynes, Hutt fails to even properly consider Keynes’ actual definition of involuntary unemployment. According to Keynes, involuntary unemployment occurs when, in the event of a rise in the price of the output, there would be an increase in the supply and demand for labor at the same nominal wage.[12] Of course, it is easy to see that, in the case of falling prices, the relationship between wages, both nominal and real, and the price of the marginal unit of output is not so simple — labor is not the only factor of production. But, Keynes’ point ought to be interpreted within the context of the relationship between employment and output.

Where a fall in nominal wages does not lead to a rise in employment, the same result can be achieved by means of an increase in investment. That is, by inducing entrepreneurs to produce more output, these enterprises can employ a greater quantity of people. Keynes’ nominal–real wage theory is not widely embraced, having been replaced by the notion of price stickiness, but one can conceive of a legitimate close equivalent. Suppose that the economy suffers an industrial fluctuation, forcing a downward adjustment of prices. Firms, for whatever reason, may prefer to maintain nominal wage levels, instead downsizing the number of employees hired, expecting greater productivity from a smaller pool of better paid workers than from a larger pool of lower paid workers. While one ought to be cautious when aggregating firm behavior, there has been a recent surge in empirical evidence confirming the significance of this phenomenon.[13] There may be a situation where an individual seeking employment is not being employed at any wage, and this is essentially Keynes’ contribution to the theory of (un)employment.

In his treatment of The General Theory, Hutt misses the forest for the trees. He gets caught up in the details of Keynes’ formal approach — the specific mathematical modeling that cannot accurately model a specific instance in the real world, but is really meant as an ideal type —, does not succeed in understanding Keynes’ concern, and consequently provides only an inadequate response. Had his interpretation been a bit more forgiving, perhaps Hutt could have envisaged a situation where nominal incomes do not fall even when the worker accepts reduced wages. This could have been Hutt’s ninth proximate cause of idleness. Or, at least, Hutt might have offered a more formidable argument against it.

Nevertheless, Hutt’s treatment of the theory of idleness is powerful, lucid, and timeless. Certainly, it is one of the most meticulous treatments of the subject by a Classical — or Neoclassical, or Austrian — economist. He sought to formulate a web of precise causation to uncover the most direct causes of unemployment. His disaggregated approach is to be commended, as by misdiagnosing the causes of idleness one might equally err in prescribing normative solutions. Whatever shortcomings present in Hutt’s criticism of Keynes, one cannot argue that Keynes’ handling of the subject was equally as defined and concerned for the minutiae — in this sense, Hutt clearly outdoes Keynes. Nevertheless, the reader should consider alternative theories. There may not be a persuasive case against Hutt, but there may certainly be causes that Hutt overlooked. This being said, those who have not read Hutt’s 1939 monograph are risking overlooking one of the most comprehensive examinations, relative to the rest of the literature.

[1] John M. Keynes, The General Theory (BN Publishing, 2008 [1936]), p. 15.

[2] W.H. Hutt, The Theory of Idle Resources (Auburn: Ludwig von Mises Institute, 2011 [1939]), p. 12.

[3] Ibid.

[4] Carl Menger, Principles of Economics (Auburn: Ludwig von Mises Institute, 2007 [1871]), p. 52.

[5] In Neoclassical theory, the laborer will abstain from employment until she finds a wage equal or above her reservation wage.

[6] Hutt (2011 [1939]), p. 27.

[7] Although, the preference does not necessarily need to be for leisure. A worker is categorized under preferred idleness, for example, if she refuses a job offer on the grounds that it is beneath her dignity (pp. 38–39).

[8] Ibid., p. 45, ftn. 1.

[9] Ibid., pp. 46–51.

[10] Note that capital goods can be used towards alternative employment, whereas labor cannot, while still being categorized as being in participating idleness.

[11] Keynes (2008 [1936]), p. 13.

[12] Ibid., p. 15.

[13] For example, Audra Bowlus, Haoming Liu, and Chris Robinson, “Business Cycle Models, Aggregation, and Real Wage Cyclicality,” Journal of Labor Economics 20, 2 (2002), pp. 308–335.

  • M.H.

    Thanks for the review.

    I read the book a few months ago. That’s an interesting book, although I am somewhat disappointed. Some austrians (especially Hunter Lewis) have said a lot of good thing about Hutt, so I was expecting too much. Again, the book is really worth reading, but perhaps a little overrated.

    Having said that, I disagree with the following statement :

    “Thus, when criticizing Keynes, Hutt fails to even properly consider Keynes’ actual definition of involuntary unemployment.”

    In my view, Hutt has completely destroyed Keynes’ notion of involuntary unemployment. I cannot remember all the interesting passages, but see for example, what he has written page 47 :

    He calls it “involuntary unemployment” but nevertheless conceives of the condition in terms of willingness to work. One might almost infer that he is trying to distinguish the wage-earners’ real will and their expressed will!

    And he says right. A person may be unemployed simply because “He judges that the search for a better opening is worth the risk of immediately foregone income” (Hutt’s own words, p 24). That is why wages need time to adjust, and why equilibrium is not achieved automatically. But Mises has also made the same point in his Human Action :

    The piling up of excessive inventories and the catallactic unemployment of workers are speculative. The owner of the stock refuses to sell at the market price because he hopes to obtain a higher price at a later date. The unemployed worker refuses to change his occupation or his residence or the content himself with lower pay because he hopes to obtain at a later date a job with higher pay in the place of his residence and in the branch of business he likes best. Both hesitate to adjust their claims to the present situation of the market because they wait for a change in the data which will alter conditions to their advantage. Their hesitation is one of the reasons why the system has not yet adjusted itself to the conditions of the market.(Human Action, 1996, p. 579)

    The various considerations which may induce a man to decide for unemployment can be classified in this way:

    1. The individual believes that he will find at a later date a remunerative job in his dwelling place and in an occupation which he likes better and for which he has been trained. He seeks to avoid the expenditure and other disadvantages involved in shifting from one occupation to another and from one geographical point to another. There may be special conditions increasing these costs. A worker who owns a homestead is more firmly linked with the place of his residence than people living in rented apartments. A married woman is less mobile than an unmarried girl. Then there are occupations which impair the worker’s ability to resume his previous job at a later date. A watchmaker who works for some time as a lumberman may lose the dexterity required for his previous job. In all these cases the individual chooses temporary unemployment because he believes that this choice pays better in the long run.

    2. There are occupations the demand for which is subject to considerable seasonal variations. In some months of the year the demand is very intense, in other months it dwindles or disappears altogether. The structure of wage rates discounts these seasonal fluctuations. The branches of industry subject to them can compete on the labor market only if the wages they pay in the good season are high enough to indemnify the wage earners for the disadvantages resulting from the seasonal irregularity in demand. Then many of the workers, having saved a part of their ample earnings in the good season, remain unemployed in the bad season.

    3. The individual chooses temporary unemployment for considerations which in popular speech are called uneconomic or even irrational. He does not take jobs which are incompatible with his religious, moral, and political convictions. He shuns occupations the exercise of which would impair his social prestige. He lets himself be guided by traditional standards of what is proper for a gentleman and what is unworthy. He does not want to lose face or caste.
    … The fact that a worker discharged on account of changes occurring in the arrangement of production processes does not instantly take advantage of every opportunity to get another job but waits for a more propitious opportunity is not a consequence of the tardiness of the adjustment to the change in conditions, but is one of the factors slowing down the pace of this adjustment. It is not an automatic reaction to the changes which have occurred , independent of the will and the choices of the job-seekers concerned, but the effect of their intentional actions. It is speculative, not frictional.(Human Action, 1996, pp. 598-600)

    It should be noted, Hutt has a good discussion about this, pages 40-41 (footnote 5) :

    … Thus, if a wife leaves the wage-paid labor market when her husband succeeds in earning more, it may be to devote more time to the adequate performance of household services. If so, it would be most realistic to regard her condition not as “preferred idleness” of the leisure variety but as employed, she having exercised a new preference not involving idleness in any sense. More domestic services are purchased at the cost of the wife’s money-income foregone.

    I think I could not agree more with the following sentence : “it would be most realistic to regard her condition not as “preferred idleness” of the leisure variety but as employed”.

    Clearly, Keynes is wrong about the concept of involuntary unemployment. This concept is meaningless in the context of a free market economy. (see also Hazlitt’s TFoTNE, p 30, Rothbard’s MES p 583, and also Hoppe “The Economics and Ethics of Private Property” footnote 7 p 141-142)

    • JCatalan

      Right, but where you quote Hutt (and I discuss his case in the sixth paragraph in the review) is where I argue Hutt gets Keynes wrong. Keynes presents two big cases against the Classical theory of employment, the “wage illusion” argument and the much more fundamental point that I elucidate upon here. Hutt only responds to the first, and essentially ignores the second. The second half of this review is just about this, and I explain Keynes’ actual definition of involuntary unemployment — it has nothing to do with the money illusion, and everything to do with the belief that real wages may not fall (i.e. that real wages may behave countercyclically) even with downward changes in nominal wages. See the ninth paragraph, where I explain Keynes’ theory.

  • M.H.

    This new formula is great. I can edit my post. (my english is so bad that I must sometimes correct my sentences…)

  • M.H.

    Why not. But I think I should re-read the book, to make sure I have made no mistake.

    Anyway, you write here :

    “While one ought to be cautious when aggregating firm behavior, there has been a recent surge in empirical evidence confirming the significance of this phenomenon.[13] There may be a situation where an individual seeking employment is not being employed at any wage, and this is essentially Keynes’ contribution to the theory of (un)employment.”

    Given the abstract of the study cited in your ftnote 13, it is about the cyclicality of real wages. But I think what really matters is not real wage rates, but real wage rates after adjustment for productivity.

    • JCatalan

      I edited my comment above, but I meant pro-cyclical and not counter-cyclical. In any case, real wages are adjusted for productivity, since measurements of inflation consider changes in real output. If bust is characterized by a decline in productivity and output, real wages should also fall. As I explained in the review, Keynes didn’t think this would occur. Not because of sticky nominal wages, but because he thought that a fall in nominal wages would reduce the price of the unit of output (if price is equal to marginal cost) and therefore maintain the real wage. Keynes is wrong, but Hutt doesn’t address this aspect of Keynes’ argument. While Keynes’ theory is wrong, my alternative is more plausible and can be empirically confirmed (i.e. pro-cyclicality of real wages) — i.e. firms who prefer to a smaller pool of labor where wages are higher than a larger pool of labor where wages are lower, simply because they expect higher productivity out of the former. So, the labor market doesn’t “clear,” if we define “clear” as where wages fall to where all those willing and able to work can find employment. In this case, we need higher productivity to increase employment.

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