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America's recession: learning the wrong lesson from the Great Depression
Gerard Jackson
Americans have been assured that without swift action by the Fed and massive increases in government spending the US economy would have sank into depression. No less a person than the celebrated Warren Buffett said so, along with a number of lesser luminaries. In support of this contention advocates of the current fiscal assault on the economy are continually conjuring up the ghost of the Great Depression as evidence that increased government spending is an effective counter-recessionary tool. Unfortunately for them the evidence from the Great Depression points in the opposite direction, as the table below shows.
The first thing to note is that when federal spending was at its lowest unemployment stood at 3.2 per cent. However, when in 1936 federal spending reached its peak at 10.94 per cent unemployment was nearly 17 per cent. Only a big government cultist could look at these figures and seriously claim that they justify Obama's colossal spending and borrowing binge.
Just about every economics commentator and professional economist argues that consumption is the key to recovery. Unless consumer spending — which is normally 70 per cent of GDP — increases the economy will remain in recession. But the third column refutes this view. Throughout the 1930s personal consumption never fell below 74 per cent of GDP despite the fact that unemployment remained tragically high. In fact, when it exceed 82 per cent unemployment averaged more than 24 per cent.
The year 1948 makes for an interesting contrast. While the unemployment rate averaged just less than 4 per cent consumption was 69 per cent of GDP. If anything, it could be argued on the face of things that consumption needed to be cut back during the depression if unemployment was to be reduced.
The fifth column is the most interesting one and extremely damaging to the Keynesian view that the problem of unemployment during the 1930s was one of demand deficiency. We arrive at the productivity adjusted wage by dividing the real wage by the level of productivity. According to marginal productivity theory there is a tendency for every factor to receive the full value of its marginal product. (The value of the additional output from taking on one extra factor).
It follows from this theory that if for any reason a factor is paid in excess of the value of its product it will become unemployed. Moreover, the greater the excess payment the higher the rate of unemployment will be. This fact serves to highlight how blind Keynesians can be to anything that contradicts their dogmas.
I still recall how one of my economics lecturers tried to instil in me the idea of demand deficiency. Now he readily agreed with me that pricing a factor above the value of its marginal product would eventually render it unemployed. However, he was flummoxed, as was the class, when I said: "So when a million of them do it instead of just one the goal posts are changed and the problem now becomes one of demand deficiency". (And I still remember this incident as if it only happened this morning).
The table makes it clear that the unemployment rate moved in tandem with the productivity adjusted real wage, just as marginal productivity theory predicts. No matter how productivity is calculated during this period the results always show that productivity adjusted real wage always exceeded the level of productivity and that when it changed unemployment moved in the same direction. The chart below reveals that the Great Depression was indeed marked by real wages exceeding productivity. The grey area highlights what we should be called the job-destroying productivity gap
Source: This chart is designed so that a constant percentage increase would appear as a straight line. The values of product and wages are both expressed in dollars of constant buying power. The data for product are for the private sector, and are from the series by John W. Kendrick in his paper, National Productivity and Its Long-Term Projection (National Bureau of Economic Research, May 1951), brought up to date by the National Industrial Conference Board. For the data on wage rates, see Chapter 1, p. 11.
The problem was that because money wages were not allowed to fully adjust to deflation real wage rates were driven up by falling prices. The result was massive prolonged unemployment accompanied by an enormous amount of (what Professor Hutt astutely called) withheld capacity. Only when real wages were allowed to fall in relation to value of the marginal product could withheld capacity be released and genuine demand expanded. (William H. Hutt, The Keynesian Episode, LibertyPress, 1979).
It is to be lamented that there is nothing in the above that would faze the big government fetishists that infest the Obama administration. They are about massively enlarging the size of government no matter how much it damages American living standards. To this end they are employing every propaganda trick in the book — especially the hoary one of warning of imminent disaster if action is not immediately taken. Fortunately, millions of Americans are beginning to smell a rat. One can only hope that it is not too late.
Gerard Jackson is Brookesnews' economics editor
BrookesNews.Com
Monday 20 July 2009
consumption>
as a % of GNP
adjusted
real wage
a % of GDP
*St. Louis Fed: Survey of Current Business: 1955
