David R. Henderson  

Krugman's Hooverite View on Wages

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My fellow blogger Bryan has done an admirable job of laying out the problems with Paul Krugman's recent piece on wage inflexibility. I have three things to add.

First, Bryan points out that "Krugman forgets that wage rigidity is the fundamental cause of involuntary unemployment." I agree with Bryan about the harmful effects of wage rigidity. What we are seeing here in Krugman's article is that he is throwing out the Keynesian view, not just the New Keynesian view but also the earlier view of James Tobin, Franco Modigliani, and the other 1960s Keynesians that wage inflexibility is the problem. Krugman is going right back to an interpretation of Keynes that, Krugman points out, can be attributed to Keynes, but Bryan is right that this is simply bad economics.

Second, Krugman is taking Herbert Hoover's view of wages. In his article on the Great Depression, Gene Smiley writes:

In previous depressions, wage rates typically fell 9-10 percent during a one- to two-year contraction; these falling wages made it possible for more workers than otherwise to keep their jobs. However, in the Great Depression, manufacturing firms kept wage rates nearly constant into 1931, something commentators considered quite unusual. With falling prices and constant wage rates, real hourly wages rose sharply in 1930 and 1931. Though some spreading of work did occur, firms primarily laid off workers. As a result, unemployment began to soar amid plummeting production, particularly in the durable manufacturing sector, where production fell 36 percent between the end of 1929 and the end of 1930 and then fell another 36 percent between the end of 1930 and the end of 1931.
Why had wages not fallen as they had in previous contractions? One reason was that President Herbert Hoover prevented them from falling. He had been appalled by the wage rate cuts in the 1920-1921 depression and had preached a "high wage" policy throughout the 1920s. By the late 1920s, many business and labor leaders and academic economists believed that policies to keep wage rates high would maintain workers' level of purchasing, providing the "steadier" markets necessary to thwart economic contractions. When President Hoover organized conferences in December 1929 to urge business, industrial, and labor leaders to hold the line on wage rates and dividends, he found a willing audience.

Third, one of the commenters on Bryan's post said, on the basis of his criticism of Krugman's NY Times article, that he couldn't believe Bryan assigns a book by Krugman. Another commenter, johnleemk, caught the obvious problem: it makes no sense to reject good work by someone who has done bad work. Krugman was an incredible educator in economics in the 1990s. I told my students the other night (at a Masters in macro course that I teach this semester at San Jose State University) that Krugman's classic, "Ricardo's Difficult Idea," is one of the top 30 articles ever in economics. Maybe I'm exaggerating, but not by much. The point is that with Paul Krugman, as with all of life, we need to keep the wheat and discard the chaff.


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CATEGORIES: Macroeconomics



COMMENTS (17 to date)

At least Hoover has the excuse that he was following the economics of Foster & Catching -- work which not a single economist in the world had been able to refute.

Maybe the truth is Krugman isn't a Keynesian -- like Hoover he's a follower of Foster & Catchings.

Who would give me odd that Krugman would have to play NY Times column type games to come up with something wrong in the Foster & Catching account of aggregate underconsumption?

cputter writes:

Wait a minute.

Weren't we taught that Hoover was the hands off, laissez-faire guy that let the economy go to pieces?

Next you'll be telling us that FDR's New Deal didn't end the depression.

Or even that we're not getting our money's worth at public schools.

[end of sarcasm]

In my opinion you three could be much more critical of Krugman's columns. I know this is an economics blog so clearly his columns are unrelated but some of us enjoy Krugman bashing. It reminds us that not all economists think like him, which certainly gets me through the day.

SydB writes:

Mainly what I learn from these discussions is the useless and ideological nature of much economic thinking. Like a bunch of kids twisting and contorting data and models to "prove" their particular bugbear.

Mattyoung writes:

Wages relative to each other is the problem. The distribution of wages has to support to the flow of goods to workers, else the economy must restructure.

johnleemk writes:

SydB:

The tenor of academic debate amongst economists is often misleading, since the most vocal tend to be the most eyecatching. Most economists agree on a set of core principles, especially when it comes to microeconomic issues. To get an idea of what consensus there is, read Milton Friedman's Capitalism and Freedom -- in an early chapter he outlines about 20 policies few economists would disagree with. If you insist on an "unbiased" view, read a bunch of introductory economics textbooks. Virtually all of them will oppose price controls (especially rent controls) and explain comparative advantage.

Economics suffers from the same pitfalls as any other social "science," but it is not completely useless. There is substantial agreement on a number of key issues, regardless of whether you are a Keynesian or an Austrian.

Eric H writes:

David (or anyone else)--

Can you recommend any other pieces by Krugman that are similarly fruitful? A brief scan of Ricardo's Difficult Idea shows how valuable Krugman's past work is, even (or perhaps especially) to explaining comparative advantage to laymen like me. I'd like to read more of him, but don't know where to start looking.

Blackadder writes:

Eric,

I would recommend most of Krugman's Slate columns, which can be found on Krugman's old website (actually most of the stuff on this site is pretty good). In particular, I'd recommend "The Accidental Theorist," "In Praise of Cheap Labor," and "Is Capitalism too Productive?"

SydB writes:

johnleemk: I'm not complaining about economics. I've read a lot. Great stuff. It's the economic blogs pundits who I'm griping about. They're often talking past another by and large, grasping onto principles willy-nilly, a sort of sophistry. But I understand their motivation: they've got an axe to grind and a drum to beat. But I think it's mainly preaching to the choir.

Troy Camplin writes:

In his popular stuff, I find that Krugman's economics is incredibly horrible most of the time. I think I read someone at some time complaining that Krugman wasn't even using Krugman for something he said recently. It's such a terrible waste of a brilliant mind, what he's done with it.

George Selgin writes:

Some years ago my former UGA student Jason Taylor (now at Central Michigan U.) and I published a paper that explores the history of the fallacious "high wage" doctrine in some detail. Here's a link to a version on my personal page: Springer has for some reason neglected to post that issue on its online site:

http://www.terry.uga.edu/~selgin/documents/Bootstraps.pdf

David R. Henderson writes:

To George Selgin,
Thanks for that link. I started working my way through the article you cite and it looks very good.
Best,
David

El Presidente writes:

David,

You quote Bryan:

First, Bryan points out that "Krugman forgets that wage rigidity is the fundamental cause of involuntary unemployment."

Both of you seem unaware that growth and decline are each two-way streets. They can go bottom-up or top-down. Krugman never said we should have wage controls. He said that the effect of declining wages is to multiply the decline in demand, output, employment, and misery, and that stoking output to maintain wages to bolster demand can retard that multiplier. He's right. You're wrong. This has nothing to do with Hoover, and you know it. It's just a bitter pill for a committed libertarian to swallow. Mattyoung touched on the basic underlying problem. But the both of you seem to say that we can't put money in the top (bailouts and capital infusions) or the bottom (stimulus spending). So you're basically saying we should do nothing and tell people to pound sand because libertarian principles will save the day if we just wait long enough. Fairy tales.

Richard A. writes:

Krugman also writes,"We’re suffering from the paradox of thrift: saving is a virtue, but when everyone tries to sharply increase saving at the same time, the effect is a depressed economy."

This would decrease the velocity of money. But nowadays the FED would expand M to offset any decrease in V in order to maintain a smooth growing P and GDPr.

The Sheep Nazi writes:

But the both of you seem to say that we can't put money in the top (bailouts and capital infusions) or the bottom (stimulus spending).

El Presidente: not at all. At least, nobody doubts your ability to enact the legislation, this time around, since that's already done. It is certainly reasonable to doubt your ability to raise the kind of money you are going to need this time around: the recent Treasury auction may be just an isolated thing, but then again maybe not. It's very reasonable to doubt your ability to raise the kind of money you are going to need, in perpetuity. If your biggest problem were rolling over the libertarians, well, that would be a nice problem to have.

El Presidente writes:

The Sheep Nazi,

It takes less money if you put it in the right place. The bottom has a larger multiplier than the top. But, if a person says as a matter of principle that we shouldn't have anything to say about how much money goes where, they are pretty much saying that we should allow crises to run their course no matter who gets hurt or how badly; that collateral damage should not be actively limited. I had a doctor once who refused to prescribe antibiotics for a sinus infection because he wanted to, " . . . watch it and see what happens." It turned into pneumonia. And the point of this exercise was, what, exactly?

If your biggest problem were rolling over the libertarians, well, that would be a nice problem to have.

Agreed. :-)

The Sheep Nazi writes:

It takes less money if you put it in the right place.

I don't think so, not really. I expect what we shall find going forward, is that it will take whatever taxation brings in, plus whatever the USG can borrow; that the proceeds will get put in whatever place the need to buy votes and keep them bought dictates; and that this will all stop only when external creditors aren't willing to keep lending. Business as usual. I would say to you that the hazard of joining the permanent governing class is that it becomes very hard to shake the illusion that you are there to govern. The reality is, it's Mancur Olson's world, and you and I are just along for the ride in it.

El Presidente writes:

The Sheep Nazi,

I would say to you that the hazard of joining the permanent governing class is that it becomes very hard to shake the illusion that you are there to govern.

Interesting. So, enlighten me. Why am I here?

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