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Once the role of the “free entry and exit” assumption so characteristic of orthodox labor economics is understood, it becomes apparent that it is anything but an innocent “simplifying assumption.” Rather it is a substantive assumption, in the sense that much of what passes for “knowledge” about the operation, efficiency, and fairness of contemporary labor markets is based upon it. Without full employment, relative bargaining power becomes a crucial determinant of the market process. It follows that policies derived from an ill-considered presumption of full employment must be rethought and even reconsidered if the facts do not support that assumption. At the most abstract level there is a simple and direct lesson in all of the above. In an economy without full employment it is relative bargaining power, not “skills” or “productivity,” that determines the wage structure. Moreover, supply and demand models that implicitly assume full employment necessarily obscure this fundamental reality and for that reason can lead us to erroneous conclusions and flawed policies.

Robert E. Prasch



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