Sunday, 5 April 2009

What - or who - started the great depression? (updated)

At Greg Mankiw's blog, Mankiw writes that UCLA professor of economics Lee Ohanian has sent him a paper called "What - or Who - Started the Great Depression?" I have written before on Ohanian's work on the great depression and how government actions prolonged it, see here. This new paper is not available online right now but Mankiw outlines the paper's conclusion:
The defining characteristic of the Great Depression is a substantial and chronic excess supply of labor, with employment well below normal, and real wages in key industrial sectors well above normal. A successful theory of the Depression must explain not only why the labor market failed to clear, but why monetary forces apparently had such large and protracted effects. This paper proposes such a theory, based on President Hoover’s program that offered industrial firms protection from unions in return for paying high wages. Firms deeply feared unions at this time, reflecting a growing union wage premium and a sea change in economic policy, including policies advanced and supported by Hoover, that significantly fostered unionization and enhanced their bargaining power. Consequently, there was an incentive for firms to follow Hoover’s program of paying moderately higher real wages to avoid even higher wages and lower profits that would come from unionization.

I conclude that the Depression is the consequence of government programs and policies, including those of Hoover, that increased labor’s ability to raise wages above their competitive levels. The Depression would have been much less severe in the absence of Hoover’s program. Similarly, given Hoover’s program, the Depression would have been much less severe if monetary policy had responded to keep the price level from falling, which raised real wages. This analysis also provides a theory for why low nominal spending - what some economists refer to as deficient aggregate demand - generated such a large depression in the 1930s, but not in the early 1920s, which was a period of comparable deflation and monetary contraction, but when firms cut nominal wages considerably.

Presidents Hoover and Roosevelt shared similar goals of fostering industrial collusion and increasing real wages and raising labor’s bargaining power. Hoover accomplished these goals during a period of deflation by inducing industry to maintain nominal wages, and by promoting and signing legislation that facilitated union organization and that increased wages above competitive levels, including the Davis-Bacon Act and the Norris-Lagaurdia Act. Roosevelt accomplished these goals with the NIRA and the Wagner Act, both of which raised wages well above competitive levels while increasing industrial collusion.

The 1930s would have been a better economic decade had government policy promoted competition in product and labor markets, rather than adopting policies that extended monopoly in product markets, and that set wages above competitive levels which prevented labor markets from clearing.
It will be great to see the whole paper.

Update: There is a February 2008 version of the paper available here (pdf). Don't know what has changed in the paper since that date.

1 comment:

Nigel Kearney said...

>there was an incentive for firms to follow Hoover’s program of paying moderately higher
>real wages to avoid even higher wages and lower profits that would come from

Either unionization really would have led to even higher wages or the firms made a
mistake. Surely either way that is private/market failure not just government failure.