Bryan Caplan  

Was Hoover's No-Wage-Cuts Pledge a Banana Subsidy?

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Like almost everyone else, libertarians typically argue that Herbert Hoover's policies exacerbated the Great Depression.  But there's a key difference: Normal people blame Hoover's commitment to laissez-faire, but libertarians blame Hoover's proto-New Deal policies.  Libertarian economists are particularly likely to highlight Hoover's fervent effort to maintain nominal wages in the face of sharp deflation.  See here, here, here, and here for background.

When you look into the details of Hoover's "high-wage" policies, however, you learn that it remained legal to cut wages.  Hoover talked, and many firms listened.  But this doesn't sound like a classic case of government failure.  Instead, Hoover's sermons against wage-cutting seem more like what we at GMU call a "banana subsidy" - a government policy that encourages people to take actions that are imprudent - even taking the subsidy into account.  As Tyler originally explained:  
Let's say that the government subsidized the price of bananas, you bought so many bananas, put them on your roof, and then the roof collapsed.  Is that government failure or market failure?  The price was distorted, but I still say this is mostly market failure.  No one made you put so many bananas on your roof.
After reading Lee Ohanian's, "What - or Who - Started the Great Depression," though, I've decided that Hoover's efforts to discourage wage cuts were no mere "banana subsidy."  Hoover wasn't simply preaching.  He had a two-pronged approach: (1) Threaten and pass laws to encourage unionization, and (2) Urge firms to maintain wages in order to avoid the rising threat of labor militancy.  Hoover didn't just preach; he made compliance with his preaching the lesser evil from firms' point of view.  As Ohanian explains:
In November, 1929, Hoover met with the leaders of the major industrial firms in manufacturing, utilities, and transportation at the White House.  Hoover presented his program for raising wages and work-sharing to avoid firm-labor conflict that he anticipated would arise. Hoover informed industry that they were to bear the cost of a recession by securing from them an agreement to maintain or raise nominal wage rates, and to engage in work-sharing. In return, he secured an agreement from labor to not strike and to not demand further wage increases. This program is clearly consistent with Hoover's preferences for fostering high real wages, supporting unions, and reducing the workweek...President Hoover asked industry to maintain or increase current wages, as this would help keep the industrial peace: " maintain social order and industrial peace...a fundamental view (is) that wages should be maintained for the present...that the available work should be spread by shortening the work week...the industrial representatives expressed major agreement...the same afternoon I conferred with the outstanding labor leaders and secured their adherence to the program...this required the patriotic withdrawal of some wage demands..." (Hoover [11], pp.43-44).
Ohanian goes beyond earlier accounts by presenting detailed evidence that (1) the Great Depression was the first recession where wage cuts were rare and work sharing was common; (2) leaders of labor and industry, leading academics, and major media all gave Hoover personal credit for this new-found wage rigidity; (3) the union premium at the time was unusually large, making it prudent for firms to make major concessions to avoid unionization; and finally, (4) Hoover's policies actually delivered the promised benefit of industrial peace:
In return for industry following Hoover's program, labor largely kept their pledge to Hoover to not strike, as man-days lost to work stoppages was at its all time low in 1930 (U.S. Bureau of Census, [18]). Moreover, there was little labor organization during this period. Freeman reports that union membership as a fraction of non-agricultural employment fell between 1929 and 1931.
I suspect that most macroeconomists will see Ohanian's history as window-dressing, and his subsequent calibrations as his "real" contribution.  I'd exactly reverse that judgment.  As a rule, calibrations are a question-begging leap of faith that the world resembles a tractable homework problem, and Ohanian's is no exception.  But his history genuinely advances our knowledge of the Hoover phase of the Great Depression.  Hoover's wage stabilization policy wasn't a banana subsidy.  It was more like a "voluntary" export quota, where firms consent to one bad thing in order to escape an even worse fate that government has waiting in the wings.

Comments and Sharing

COMMENTS (10 to date)
Gary writes:

What does it mean to get "industry" to agree to something? He either convinced individual firms that doing what he said was the best move no matter what all the other firms did, or he did no convincing at all.

mjh writes:

This above story reminds me the stories last year of Henry Paulson essentially forcing banks to take TARP money. Where Paulson told the CEO's to "Take the money or we'll make sure you get fired".

Rimfax writes:

mjh beat me to it. I can't help but think of the Bush terms as Hoover II (when I'm not think about it as Nixon II).

Boonton writes:

What portion of the labor force was employed in major industry in 1929? If its a minority how would jawboning by the President have prevented wage drops when the majority of workers were in farming or other industries not subject to this verbal cheerleading for high wages?

Sandwichman writes:
But his history genuinely advances our knowledge of the Hoover phase of the Great Depression.
I'm afraid Ohanian has cherry-picked his sources to such an extent as to discredit his interpretation, assumptions and conclusions. Richard Feynman identified the feature missing in what he termed "cargo cult science":
It's a kind of scientific integrity, a principle of scientific thought that corresponds to a kind of utter honesty--a kind of leaning over backwards. For example, if you're doing an experiment, you should report everything that you think might make it invalid--not only what you think is right about it: other causes that could possibly explain your results; and things you thought of that you've eliminated by some other experiment, and how they worked--to make sure the other fellow can tell they have been eliminated.

Details that could throw doubt on your interpretation must be given, if you know them. You must do the best you can--if you know anything at all wrong, or possibly wrong--to explain it.

Ohanian's treatment of the relationship between "spreading-the-work" and output is particularly egregious. He relies on a single source, Lanoie, Raymond and Shearer, "Work sharing and productivity: Evidence from firm level data." as justification for his operating assumption that reducing the number of days an employee works also reduces output per hour and can be linked to low capital input (and ultimately to reduced capital stock). That's a lot of weight to pin on a single source -- especially when the findings of that source are anomalous (in addition to being comically anachronistic).

The study in question examined the results of a "work-sharing" experiment at Bell Canada that took place in 1994, not exactly at the start of the Great Depression of the 1930s. Whether that experiment should count as evidence about the effects of reducing the number of days an employee works is confounded by the fact that in this case the number of hours per day was increased from eight to nine. Furthermore, one of the authors, Lanoie, also co-authored another paper, with Michel Huberman, which put the Bell Canada results in a broader context. Of the five Canadian work-sharing cases evaluated by Lanoie and Huberman, only the Bell Canada one had a negative effect on productivity. Two resulted in no change, one had mixed results, and the fifth case study resulted in productivity improvements.

Clearly, Ohanian has not bent over backwards to show details that might throw doubt on his interpretation. On the contrary, he has cherry-picked an oddball result to justify his questionable modeling assumption of attributing the decline in capital inputs to reduced hours per worker.

Boonton writes:

And how does this theory square with the experience of the UK during the 20's? The UK had returned to the gold standard but wanted prices to return to the pre-WWI level. As a result they drove up interest rates and unemployment hoping for wages and prices to fall. While they did fall somewhat, they would not come down to pre-WWI levels despite the explicit desire by gov't officials coupled with harsh monetary policy.

Could it be then that Hoover was less leader than follower. Perhaps the more developed an economy gets the less flexible wages get, esp. in the downward direction.

I notice that libertarian types seem to oddly put a lot of stock in gov't officials. For example, a common hypothesis is that gov't cause the housing boom and evidence presented is usually in the form of some gov't official making a speech praising banks for increasing homeownership.

But I think its more common for politicians to seek to take credit for positive things and blame their opponents for negative things. Hence they see homeownership and home prices increasing, they praise it. They see a crash and blame the guy they are running against. Does this mean lending increased because of the speech? I'm skeptical.

From the evidence presented it sounds like industry was very worried about trying to force wage cuts on workers. Perhaps because unionization in this time was still a somewhat violent affair. Hence they tried to avoid wage cuts and Hoover reinforced that with speeches and actions to take credit for 'protecting wages against the downturn'.

Sandwichman writes:

The title of the Lanoie and Huberman paper, by the way, was "Worksharing in Quebec: Five Case Studies." Another paper by Huberman (correction: Michael, not Michel), "An Economic and Business History of Worksharing: The Bell Canada and Volkswagen Experiences," might also shed light on the contention that "the Great Depression was the first recession where wage cuts were rare and work sharing was common." Wage cuts may have been common during earlier recessions but so was work sharing, according to Huberman's account.

Huberman's paper also casts doubt on whether labor viewed Hoover's promotion of work sharing in the early 1930s as a "pro-labor policy." "...many unions denounced the proposals as expedient devices to 'share the misery'... unions were claiming that worksharing arrangement were merely forced concessions." (p. 410)

Boonton writes:

Good point Sandwichman, another question that occurrs to me:

Where's the enforcement mechanism?

Back then there was no widespread income reporting to the IRS. There was barely an official unemployment rate. What exactly prevented industry leaders from promising Hoover they would "do whatever we can" to hold wages steady and then proceed to cut them?

This is esp. important if firms were 'allowed' to do layoffs but not wage cuts. It's easy for a firm to lay off the highly paid workers, keep the low paid one and then brag to Hoover that they 'stabilized wages' for their employees. Since Hoover and the Fed. gov't had nearly zero data processing ability there would be no way to verify compliance.

I think what prevented them from doing this was that they DIDN'T WANT TO CUT WAGES. Hoover was cheerleading/encouraging an economic decision that was being made independent of him.

Lord writes:

(1) the Great Depression was the first recession where wage cuts were rare and work sharing was common

Average manufacturing wages -20%, coal mining wages -25%, skilled wages -20%. You should be ashamed to mention this one.

Bill Conerly writes:

Seems like nobody remembers the "Pigou Effect." A. C. Pigou, who was Keynes's colleague at Cambridge, argued that falling wages and prices would cause a rise in real money balances, stimulating consumption, and ending a recession. The economy is self-regulating. That's why Keynes and the later Keynesians had to argue that wages and prices were not flexible.

However, instead of arguing about whether wages and prices are flexible, why shouldn't we argue about ways to encourage wage and price flexibility? Hoover explicity fought wage and price flexibility, and there are plenty of modern counterparts, including minimum wage laws. If we want to de-Hooverize the economy, we should allow downward movement of wages and prices in a recession.

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