Introduction and preview

Theoretical background

The purpose of this paper is twofold. First, we discuss the nature and quantitative order of magnitude of the trade-off between real wages and employment in the small open economy Belgium. Second, we draw policy conclusions from our positive analysis, and compare income policies with alternative approaches to employment stimulation (including shorter working hours and currency depreciation).

Although our analysis is very coarse and recognises sizeable uncertainties, we hope to contribute a coherent view to the debate about the nature and likely remedies of the current state of underemployment in Belgium. Opinions differ about the respective roles of effective demand versus cost and production structures in explaining that situation. The unions' demand of a shorter working week without pay cut is strongly opposed by employers on grounds of international competitiveness.

Indecisiveness is sustained by the lack of a generally accepted theoretical framework bringing both Keynesian and neo-classical reasoning to bear on the problems of an open economy. Available econometric models suffer from similar limitations.

Our own thinking has been influenced by two recent analytical contributions which have stressed the significance of the trade-off between real wages and employment:

(i) Malinvaud's Theory of Unemployment Reconsidered (1977) brings out the possibility that demand stimulation policies may be ineffective in reducing unemployment, if supply is unresponsive to aggregate demand at the going wages and prices–a situation referred to by Malinvaud as ‘classical unemployment’.