In How to Create the Great(er) Depression, I noted that protectionism was one of the interventionist measures that helped wreck an economy. Now Amity Shlaes discusses another piece of the puzzle: artificially high wages.
In the Sunday New York Times, she clobbers Paul Krugman’s infatuation with the New Deal and his fervent hope that the Obama administration will implement a New Deal II that’ll greatly exceed New Deal I. And Krugman’s prescription is public works spending that will keep wages at an artificially high level. According to Shlaes, this is exactly the wrong medicine:
What kept the [Great Depression] picture so dark so long? Deflation for one, but also the notion that government could engineer economic recovery by favoring the public sector at the expense of the private sector. New Dealers raised taxes again and again to fund spending. The New Dealers also insisted on higher wages when businesses could ill afford them. Roosevelt, for example, signed into law first his National Recovery Administration, whose codes forced businesses to pay an above-market minimum wage, and then the Wagner Act, which gave union workers more power.
As a result of such policy, pay for workers in the later 1930s was well above trend. Mr. Ohanian’s research documents this. High wages hurt corporate profits and therefore hiring. The unemployed stayed unemployed. “If you had a job you were all right” — the phrase we all heard as children about the Depression– really does capture the period.
Why does all this matter today? Because lawmakers are considering new labor legislation containing “card check,” which would strengthen organized labor and so its wage demands. Because employees continue to pressure firms to spend on health care, without considering they may be making the company unable to hire an unemployed friend. Piling on public-sector jobs or raising wages may take away jobs in the private sector, directly or indirectly.
Keeping this in mind, let’s do a comparison of the “Great” Depression and the Depression of 1920-21. What’s usually lost in the historical noise is the fact the 1920s began with an extremely sharp recession that saw dramatic GDP loss and price deflation over a period of mere months:
The 1920-21 recession in the United States was brief relative to the Great Depression of a decade later, but it included a remarkably sharp price deflation. The decline in the GNP price deflator from 1920 to 1921 is the largest one-year percentage decline in the series in the more than 120 years covered. This is true whether the Department of Commerce [1986] estimates or the recently provided Balke and Gordon [1989] or Romer [1989] estimates are used. These estimates produce one-year deflation figures of 18 per cent, 13.0 percent, and 14.8 percent, respectively. The closest competitor is the 11.5 percent deflation recorded for 1931-32, the third year of the Great Depression.
Annual data for wholesale prices tell a similar story. Wholesale prices declined by 36.8 percent for 1920-21, the largest one-year decline on record, going back at least to the American Revolutionary War period.
The 1920-21 deflation contains another striking feature. Not only was it sharp, it was large relative to the accompanying decline in real product. The ratio of the percentage decline in the GNP deflator for 1920-21 to the percentage decline in real GNP is 2.6 using the Department of Commerce figures, 3.7 using the Balke and Gordon data, and 6.3 using the Romer data. By contrast, during 1929-30, the first year of the Great Depression, the GNP deflator declined by 2.7 percent and real GNP by 9.4 percent, for a ratio of 0.3. The ratios of the percentage decline in GNP prices to the percentage decline in real GNP for 1930-31, 1931-32, 1932-33, and 1937-38, the other Great Depressionyears in which real GNP declined, were 1.0, 0.9, 1.2, and 0.3, respectively, all well below the 1920-21 figures.
Viewed in light of the data, the “Great” Depression wasn’t all that great. But the real kicker here is wages: during the 1920-21 Depression, wages fell in synch with the rest of the economy. And the recession was indeed sharp - but short. Which is Amity Schales’ point: that any attempt to maintain wages will turn a sharp but brief pain into long, drawn-out agony that ends with a death rattle.
And all of this is a rather good advertisement against the minimum wage: the more we maintain an artificial floor on wages the more we also create unemployment and higher prices. But particularly in a recession, it’s best just to take your lumps and get it over with. If you try to avoid the punch, you’ll trip down that flight of stairs at your feet.
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