Saturday, September 05, 2009

Hoover's Labor Policy & the Great Depression

NBER working paper by Lee E. Ohanian "What - or Who - Started the Great Depression" indicates that the Hoover administration's labor policies of fixing wages and spreading work resulted in significant labor market distortions. These government interventions prevented real wages from falling during a period of deflation.

What I found exceptionally interesting (and compelling) in Ohanian's paper is the political exchange mechanism by which he introduces the frictions.

"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 e ects. 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 signi cantly 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 profi ts that would come from unionization" (pg. 51).

Ohanian's model of the Great Depression is a public choice account of how self interested policy impacts microeconomic markets, which in turn have macroeconomic effects.

"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" (pg. 51).

Ohanian's paper is discussed in light of Rothbard's America's Great Depression by Joe Salerno (here) and mentioned in the Robert Higgs' discussion of the similar current phenomena of rising real wages. Higgs roughly estimates that from March 2007 to June 2009, "that real hourly earnings [in private industry] rose by 2.8 percent during this 28-month period of deepening recession". "The obvious question" writes Higgs, is "why, in a situation of falling demand for labor services, has the real wage risen? This outcome is not what we would expect to see in a freely functioning labor market."

Obviously, American labor markets are not freely functioning. Suppose that Ohanian's general mechanism is sound. Suppose further that we are experiencing a similar phenomena of rising real wages under conditions of falling demand for goods and services. Given the trend in labor market institutions of a decreasing percentage of the workforce in unionized industry and the increasing percentage of the workforce in occupationally licensed industry -- in what ways could we expect the political bargaining mechanisms to operate in the current context?

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