Paradox of toil
The paradox of toil is the economic hypothesis that total employment will shrink if everybody wants to work more when "the short-term nominal interest rate is zero and there are deflationary pressures and output contraction". The idea is that total employment will fall when wages, and therefore consumption, are pushed down by the simultaneous efforts of everyone to work more in situations where interest rates are against the zero bound so that rates cannot drop more to increase demand for goods.
This is a limited example of the fallacy of composition, where assuming that the increase in production that normally occurs when total labor increases applies in all situations. Put simply, when a recessionary economy is up against the zero bound, having more people seeking work - at lower wages if necessary - can actually reduce the number of jobs due to reduced demand from lower wages.
The term was intended to parallel the "paradox of thrift", a concept resurrected by John Maynard Keynes and popularized under that name by Paul Samuelson. The paradox of toil was proposed by economist Gauti Eggertsson in 2009.
Casey Mulligan argued against this effect, proposing several natural tests, among them:
- seasonal fluctuations in the job market in 2009;
- the increase in the U.S. minimum wage in 2009.
Eggertsson responded that seasonal labor supply variations, being relatively predictable, would have negligible effect on nominal short-term interest rates; and that an increase in minimum wage affected only aggregate employment, with paradox of toil saying nothing about composition.
Paul Krugman and Eggertson have since proposed that the paradox of toil and the paradox of flexibility mean that wage and price flexibility do not facilitate recovery from recessions during a liquidity trap, but actually exacerbate them.
The reasoning behind the paradox of toil, together with the paradox of flexibility, has led to speculation that there might be a "paradox of innovation" by which greater labor productivity or cheaper products reduces demand for labor, which reduces wages, and therefore reduces demand overall.
- Eggertsson, Gauti (Feb 2010). "The Paradox of Toil". NY Fed Staff Report (New York, NY: Federal Reserve Bank of New York) (433). Retrieved 2011-04-23.
- Samuelson, Paul& Nordhaus, William (2005). Economics (18th ed.). New York: McGraw-Hill. ISBN 0-07-123932-4.
- Krugman, Paul (14 Dec 2009). "A New Paradox". Conscience of a Liberal (blog). New York Times. Retrieved 2011-04-24.
- Mulligan, Casey (September 2010). "Does Labor Supply Matter During a Recession? Evidence from the Seasonal Cycle". NBER Working Paper No. 16357. National Bureau of Economic Research. Retrieved 2011-04-24.
- Mulligan, Casey (16 December 2009). "A 'Paradox of Toil?". Economix: Explaining the Science of Everyday Life. New York Times. Retrieved 2011-04-24.
- Eggertsson, Gauti (May 2010). A comment on Casey Mulligan's test of the paradox of toil (preliminary). New York, NY: Federal Reserve Bank of New York. CiteSeerX: 10.1.1.171.197.
- Eggertsson, Gauti B.; Krugman, Paul (14 February 2011), Debt, Deleveraging, and the Liquidity Trap: A Fisher-Minsky-Koo Approach
- Baxter, Michael (22 November 2010). "Why the super rich should pay more tax, and the rest should pay a lot less". Investment & Business News. IABN. Retrieved 2011-04-24.