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Business Council of Australia’s quack cure for recessions
Gerard Jackson
Now that the BCA (Business Council of Australia’s) has decided to waste shareholders’ money by running a useless advertising campaign to convince employees to put their trust in the benevolence of these uber-executives, it is time ponder the economic competence of this august and self-appointed elitist organisation.
It is not that long ago that the BCA produced Avoiding boom-bust: Macro-economic reform for a globalised economy. This paper was written by Tony Berg who seems to have been inspired in part by New York Times journalist and economic illiterate Thomas Friedman. This fact alone must account for some of the paper’s intellectual shortcomings.
The most striking feature of Mr Berg’s paper was its appalling ignorance of the so-called boom-bust phenomenon. In fact, I would go so far as to say that his knowledge of the subject amounts to zilch. One of his arguments was that if a proportion of labour costs were directly linked to profits this would help stabilise the economy and remove the need for mass sackings when the economy went into recession. As he put it:
More widespread profit sharing would ensure that the burden of adjustment could be shared broadly through the economy in the form of lower business profitability and small, short-term reductions in wages, rather than through plant closures, sackings, abandoned recruitment and the resulting higher unemployment.
This view, like so many economic fallacies, does contain a grain of truth, which is that wage flexibility does accelerate recovery from recessions. The rest simply demonstrates a shocking ignorance of economic history and the real nature of the so-called boom-bust cycle. America’s 1920-21 depression supplies a grim refutation of the BCA’s naive belief that flexible wage rates would go someway to eliminating booms and busts.
When the depression struck it was swift and especially painful. Unemployment leapt from 1.3 per cent in 1920 to 11.2 per in 1921. The wholesale price index stood at 248 in May 1920 –– by August 1921 it had plummeted to 141, with 100 points falling from August to August.
This point is interesting because the wholesale price index covered a far greater range of goods than the consumer price index which fell by just over 11 per cent. Moreover, the wholesale price index included business inputs. The fact that the prices of these inputs fell steeply did not seem to stem the speed at which the economy contracted.
United States Bureau of Labor statistics report that the wage index 1920 for non-agricultural wages was 229 (1914=100); this had dropped to 204 by 1922, an 11 per cent fall. Of course, it ought to go without saying that this wage average concealed variations, with declines in some industries exceeding the average. Retail prices reportedly fell by about 20 per cent, with the fall in food prices being particularly steep. It’s possible that the fall in retail prices has been understated as their prices began to fall as early as May with some New York stores cutting prices by as much as 20 per cent.
But the inescapable fact is that, despite variations between industries, real wages did not fall overall because the drop in general prices was greater. The reason why the fall in wholesale prices greatly exceeded the fall in wages can be explained by (a) immigration being shut off by the war and (b) rapid capital accumulation.
Therefore the wage situation is explained by labour having become increasingly scarce relative to the capital structure. This is why real wages did not, despite the depression, fall back to pre-war levels even though commodity prices did. The economy had begun to recover by late 1921 with labour shortages appearing in the first half of 1923 as industrial production rose to new levels.
Four things should to be noted: Though factor prices, especially wage rates, were highly flexible employment still jumped to over 11 per cent. Moreover, wage flexibility did not “ensure that the burden of adjustment [was] shared broadly through the economy” and, above all, it did not prevent the depression, though it did accelerate the recovery. That real wages did not fall clearly demonstrate that what really matters is not wage rates (total labour costs) per se but the cost of labour relative to the value of labour’s services.
It is absurd to even contemplate the thought that economic adjustments have to be “shared broadly through the economy”. Money is never neutral. This means that monetary expansion must misdirect production*. From this it follows that those lines of production upon which monetary expansion has had the greatest influence will have to make the greatest adjustments. Naturally wage rate flexibility will speed up these adjustments and thus stimulate economic recovery.
In brief: though wage flexibility is no cure for recessions its absence prolongs them and generates widespread persistent unemployment by keeping real labour costs above their market clearing values.
Considering just how bad this outfit is when it comes to economic theory, I am literally dreading its public relations approach to labour market reform. I also have a curious feeling that the endeavours of these highly paid captains of industry to sell the benefits of workplace reform to the labour force is not going to give ACTU researchers any sleepless nights.
*The vital importance of this fact is never raised in the Australian media.
Gerard Jackson is Brookes’ economics editor
BrookesNews.Com
Monday 7 November 2005