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Book Review: Out of Work

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Out of Work: Unemployment and Government in Twentieth-Century America
by Richard K. Vedder and Lowell E. Gallaway (New York/London: Holmes & Meier, 1993); 336 pages.

In 1932, the English economist Edwin Cannan delivered the presidential address to the Royal Economic Society. His topic was “The Demand for Labor.” With the Great Depression nearing its bottom, Professor Cannan discussed why many industrial economies were suffering from massive unemployment. He explained that people were wrong when they said that millions were unemployed because there was not enough demand for the services those unemployed could potentially render.

As long as there is scarcity — as long as people have desires for goods and services which have not as yet been satisfied because resources are limited in quantity — there is always more work to be done to fulfill unsatisfied wants. But there can be situations, Professor Cannan said, in which suppliers can price their goods out of the market. People may want hats but they may only be willing to pay a certain price for a particular quantity of hats. Beyond that point, rather than buy more hats at that price, they would rather spend their money on other things they now desire more highly. If sellers want to attract people to buy more hats, they must lower hat prices; otherwise, they find themselves with unsold inventories for which there is no demand. In the early 1930s, Professor Cannon argued, the “general unemployment is the result of a general asking too much.” Many workers, by not sufficiently lowering the money wage at which they were willing to be hired in the face of depressed prices for goods, had in fact priced themselves into prolonged unemployment.

The view that unemployment is caused by wage demands too high in relation to the wages employers are willing and able to pay has been out of favor for more than fifty years. Instead, Keynesian and other macroeconomists have insisted that unemployment is caused by “aggregate demand” for goods in the economy being too low for all those looking for work to be hired at the given level of wages. The Keynesian prescription was for government-led “demand stimulus” to create employment opportunities.

Richard K. Vedder and Lowell E. Gallaway, in their book Out of Work: Unemployment and Government in Twentieth-Century America, defend the pre-Keynesian view of the cause of unemployment and explain government’s role in making unemployment a significant problem in modern America. Before World War I, they explain, economists devoted little time to the problem of unemployment, not because it wasn’t important but because labor markets were sufficiently open and competitive that periods of high unemployment were rare and short-lived. When the Great Depression began in October 1929, unemployment in the United States was only 2.5 percent of the work force. But by the time the Depression bottomed out in early 1933, unemployment had reached more than 28 percent of the labor force. And in spite of the common myth that Franklin Roosevelt’s New Deal lifted America out of the Depression, unemployment never fell below 12 percent after 1933 and was still in the range of 18 to 20 percent of the labor force in 1938 and 1939.

The problem, Vedder and Gallaway argue, is that real wages — the real cost of hiring workers after adjusting for changes in productivity and in the selling prices of goods in relation to the money wages paid to workers — had actually increased during the early years of the Great Depression, making it increasingly costly for employers to keep workers on the job.

In 1930, consumer prices fell by 2.5 percent, while money wages declined by 2 percent. In 1931, consumer prices fell by 8.8 percent, while money wages only deceased by 3 percent.

And in 1932, consumer prices went down 10.3 percent, while money wages only declined by 7 percent.

Furthermore, the authors explain that labor productivity during these years either remained unchanged (1931) or actually decreased (4 percent in 1930 and 3.8 percent in 1932).

In 1933, money wages fell by 7.9 percent, while consumer prices only fell by 5.1 percent, but the decline in the real cost of hiring labor was washed out by a 2 percent decline in labor productivity.

Between 1929 and 1933, the general level of prices had gone down by 22 to 31 percent (depending upon the price index used) and productivity had decreased by 8.5 percent, but the general level of money wages had only declined by 15 percent. Real wages — the real cost of hiring labor — during this period had actually increased by 22.8 percent.

Vedder and Gallaway explain that under Herbert Hoover’s leadership, pressure was placed on industrial employers to not lower wages — under the false notion of maintaining “purchasing power.” And under the Smoot-Hawley tariff, import taxes went up from 40 to 60 percent.

The “high-wage” policy, in the face of falling consumer prices, only succeeded in pricing workers out of the labor market, generating an increasing circle of unemployment; and the high tariff walls resulted in a contraction of world trade and falling demand for labor in the American export sectors of the economy. Roosevelt’s New Deal only increased the rigidity and inflexibility in the wages for labor and prevented any significant improvement in the labor market for the remainder of the 1930s.

The authors, therefore, through careful historical analysis, substantiate the explanation for high unemployment during the Great Depression given by Ludwig von Mises in 1933:

“The duration of the present crisis is caused primarily by the fact that wage rates and certain prices have become inflexible, as a result of union wage policy and various [government] price support activities. Thus, the rigid wage rates and prices do not fully participate in the downward movement of most prices, or do so only after a protracted delay. . . . The continuing mass unemployment is a necessary consequence of the attempts to maintain wage rates above those that would prevail on the unhampered market.”

Vedder and Gallaway go on to discuss the detrimental consequences of government interference and regulation of the American labor markets throughout the post-World War II period to the present. Their analysis demonstrates beyond any doubt that the problem of unemployment has been caused by the state, not by any inherent flaws or failures in a free market.

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    Richard M. Ebeling is a professor of economics at Northwood University. He was formerly president of The Foundation for Economic Education (2003–2008), was the Ludwig von Mises Professor of Economics at Hillsdale College (1988–2003) in Hillsdale, Michigan, and served as vice president of academic affairs for The Future of Freedom Foundation (1989–2003).