21 Jul 2011

Nelson Mandela and Volunteering

Shameless Self-Promotion 8 Comments

When I’m not breakin’ all the rules regarding interest theory, I take the time to criticize a call for people to volunteer more.

21 Jul 2011

Some Clarifications on Cash Balances and Saving

Economics 113 Comments

Surprise surprise, my last post didn’t end the controversy. But in the comments, I realized there were some understandable misconceptions. Let me clarify what I am saying, and then answer one of Major Freedom’s better objections.

The Clarifications: Part of the problem here is the difference between saving as a flow variable, that happens during a period, and savings as a stock concept. When we define Saving = Income – Consumption, it is clearly a flow variable (since Income is clearly a flow). However, if we say that our cash balances are part of savings, then “savings” is obviously a stock concept.

In reading some of the comments, I realized this was confusing people. So let me clarify with the same example I used in the last post:

Our period of analysis will be one month. Andrew starts out the month with $20,000 in cash balances. During the course of the month, his income is $10,000 and his consumption is $9,000. He ends the month with $21,000 in cash balances.

So for the above scenario, I would say: Andrew saved 10% of his income, or $1,000, over the course of the month. Because of that, his savings increased from $20,000 to $21,000.

Notice, I am NOT saying, “Andrew saved $21,000 during the month,” or “Andrew saved $20,000 during the month.” If you simply hold on to your cash balances, without adding to them, that act is not saving during the period. You are simply refraining from dissaving, i.e. you aren’t drawing down your capital from prior acts of saving. But of course, in order for you to accumulate the $20,000 balance in the first place, in the past Andrew must have been consuming less than his income.

To summarize, if you save during a period, then your savings will increase by the difference. (Perhaps it would be good to avoid this confusion altogether and drop “savings” as a stock concept, and refer instead to “capital.”)

Handling the Objection: People who got hip-deep in the comments at the last post, will know that I have become exasperated at times with Major Freedom (MF). However, I really liked the following argument he gave, because it took me a minute to realize what my answer would be. I think most readers will agree that my solution is independent confirmation that I am approaching this the right way, and MF (and Salerno) are not.

To set the scene, remember that I had come up with a real zinger of an argument. Salerno (and MF) want to argue that when someone holds cash balances “earmarked” for consumption, that this can’t possibly be a contribution to their stockpile of savings. So I said, what happens if Johnny earns an income of $20 on Monday, holds it as cash intending to spend it (six days later) on consumption at the movies, but then in the meantime changes his mind and invests it? Since he invested the income, he clearly had to save it. So it seems Salerno and MF are forced into saying that Johnny first consumed his income, then six days later changed his mind and un-consumed it, in order to save and invest it. To me, it was clearly more sensible to say that Johnny was saving his income all along. He held it in the form of cash balances, initially intending to consume it, but then before he actually consumed it, he changed his mind and invested it. So clearly–I thought–Johnny didn’t actually consume it ever, and clearly therefore he must have been saving it all along.

In light of this challenge, MF responded:

[L]et’s switch it around. Suppose that Johnny had the $20 earmarked for investment, but then on his way to the seller of CDs, he decides to buy $20 in movie tickets instead. Should we say “Clearly Johnny saved, because you can’t consume what you haven’t first saved.”? If so, then you are saying that consumption, in addition to investment, requires savings, which is, you must admit, not a conventional way of understanding the implications and requirements of consumption at all. I don’t think I have ever heard of any economist saying that consumption requires a prior act of saving. I have only ever heard the statement “Investment requires a prior act of saving.”

As I said earlier, I really like this one, because it stumped me for a second. But now that I have what I consider to be the correct answer, it highlights the superiority of my approach and the untenability of MF’s.

As always with these things, we have to first specify the interval of time for the analysis. If it’s wide enough to include the expenditure on consumption, then there is no problem. For example, let’s take it as a week. Then for the week (assuming he only works on Monday), Johnny’s income is $20. If he spends $20 at the movies, his consumption for the week is $20. Therefore there is no saving; Johnny’s cash balances at the end of the week are what they were at the beginning. So does my position force me to say, “Saving is always required prior to consumption?” No, not at all. In this example, Johnny consumed $20 during the week, and didn’t save at all.

Ah but wait! MF thinks my treatment relies on my arbitrary choice of one week as the time unit. What if instead we reckon in terms of 24-hour days? Now I am forced to say that on Monday, Johnny’s income was $20, his consumption was $0, and so his saving is $20. And yes indeed, his cash balances (compared to the day before) have risen by $20. So far, so good. (Not that it matters, but suppose Johnny intends to spend the $20 a few days later buying a CD that yields 100% per month.)

But then a few days later on Sunday, Johnny is seduced by the movie poster for Transformers 3. Instead of walking down to the bank (which amazingly is open on Sunday) and buying the CD, Johnny goes into the theater and buys a ticket and popcorn for $20. On that day, I would say Johnny’s income was $0, his consumption was $20, and so he dissaved by $20–as evidenced by the fact that his cash balances drop by $20 over the course of the 24-hour period.

Holy smokes! MF has caught me in his trap, right? I am forced to admit that there was a prior act of saving, in order to finance the consumption of the movie and popcorn.

Yes, I am forced to admit that, and it’s a good thing. Because if we decide to slice up time in 24-hour increments (as opposed to one-week intervals), then Johnny earned his income before he consumed. That is, Johnny earned his income on Day 1 of the week (Monday), didn’t consume it that day, didn’t consume it the next day, and so on, until six days later, when he finally consumed it. So yes, if we are going to analyze time in such discrete units that now Johnny earns his income at one point, and doesn’t consume it until a later time–i.e. in the future–then he must have saved the income.

I submit that far from being a problem, this confirms that my framework is the proper one. If we choose the unit of time such that Johnny uses his income to buy a future good, then he necessarily must have saved the income in the intervening time periods. In contrast, MF is forced to say that Johnny somehow managed to earn an income at T1, “not-consume” it for periods T2 through T6, and yet he never saved during T2 through T6. In other words, MF’s position forces him to say that “not-consuming” is a different thing from “saving.” Do people really want to keep walking down this path with Major Freedom?

Last point: We see now how the unit of time can affect the reckoning of income, saving, and consumption. So what is the proper unit? As good subjectivists in the Austrian tradition, we should defer to the actor’s time horizon and assessment of the situation. So if I pay Johnny $20 on Monday at 3pm, and in his mind he thinks, “Oh man, I’m so thirsty, I’m gonna spend this right now by going down to the store and paying $2 for a Slurpie!”, then the proper time horizon for “the current period” has to include that purchase. After all, Johnny himself thinks the Slurpie is a present good.

Salerno thought this type of example tripped me up, but no it doesn’t: It proves the validity of my approach. For if we define the time interval to be wide enough to include not only Johnny’s earning of the income, but also his purchase of the Slurpie, then over that interval of time, Johnny didn’t save the $2 he spent on the drink.

20 Jul 2011

On Cash Balances and Saving

All Posts 54 Comments

First, I have to apologize if I have sounded condescending to those who have questioned my views on cash balances and savings. I truly thought I was relaying standard economics–including the views of Austrian economists–and that’s why I was at times impatient with the challenges. However, since one of the leaders of the modern Rothbardian movement, Joe Salerno, is equally baffled by my position, obviously things are not as straightforward as I had assumed.

I am not going to link to the blog posts leading up to our current discussion. There were a lot of things going on, involving Keynes’ theory of interest etc. It will muddy the waters here if newcomers go back and look at those posts.

To keep things as focused as possible, in the present post I will make one major claim: A person’s cash balances should always be considered part of his savings.

To start things off, here was the original thought experiment that sowed so much controversy:

15-year-old Johnny mows my lawn every week, and I pay him $20 each time. Every week, he spends $15 of it going to the movies with his friends, but he puts $5 in a piggy jar on his bureau.

After a year, he has accumulated $5×52 = $260 which he uses to buy a nice watch. Johnny says, “I’m sure glad I consumed less than my income all year, saving $5 per week. Then I used my accumulated savings to buy a watch. I deferred consumption all year in order to buy a nice good later on.”

When I first wrote that, I thought everybody would have to agree with Johnny–surely he was right in classifying his behavior all year as “saving.” Yet to my surprise, some people flat-out denied this interpretation, while even Joe Salerno was not comfortable with my argument. (Note: I’m not certain, but I believe Salerno is actually a lot closer to my position than is, say, Major Freedom or Bob Wenzel. I think Salerno might agree that sometimes cash balances could be construed as part of savings, depending on the use to which the owner puts them. But he never says so, one way or the other.)

So what was it about my example of Johnny, that made Salerno hesitate? He commented:

Unspecified in Murphy’s example is exactly when little Johnny goes to the movies. Let us suppose that he regularly cuts Murphy’s lawn and receives his pay of $20 on Monday and spends $15 going to a matinee with his friends the following Sunday. Everything else remains as specified in the original example. Thus, in order to carry out this plan, Johnny must retain $15 of his weekly income in his cash balance for a full week. The question that immediately arises is whether this would also be considered saving by Murphy. Indeed little Johnny could easily say, presumably without fearing contradiction from his economist-employer, “I deferred consumption all week in order to see a good movie later on.”

Yes, little Johnny could easily say that, and he would be right to do so. Is Salerno denying this?

Let’s think this through. Suppose in addition to hiring Johnny to cut my lawn, I also hire Sally to trim the bushes. On Monday, I give each kid $20. On Tuesday, Sally spends all $20 at the mall with her friends. Johnny, in contrast, spends nothing all week, until Sunday afternoon.

At the movie theater, I see Johnny and Sally trying to buy tickets. Johnny hands over $15 to the guy, getting a ticket and some popcorn. Sally tries to walk in too, but is stopped. Oh no! She has no cash on her, because she spent it on Tuesday. She runs over to me, outraged. But I explain, “Well Sally, you already consumed your $20 back on Tuesday, remember? Johnny, in contrast, saved it until today. That’s why he is able to consume today, while you cannot. He is drawing down his savings, because back on Tuesday, he decided to forgo present consumption in exchange for future consumption five days later.”

Is Salerno challenging the above interpretation? Is there any other answer he could give Sally, besides saying that she had already consumed the $20 while Johnny had not? Next, if Salerno is in fact OK with my explanation, then what is “not-consuming” but “saving”?

Let’s go back to Salerno, to get at the root of the confusion. I think I know why he is resisting my analysis, but his fears are unnecessary. So here’s Salerno:

Now, let’s tweak the example a bit. Let us say that Johnny is always thirsty after he cuts Murphy’s lawn, because Murphy refuses to supply him with refrigerated bottled water and permits him only to drink the warm, coppery-tasting swill from his garden hose. So Johnny routinely goes to the local convenience store and orders a big Slushy for $2 one hour after he cuts Murphy’s lawn. (He therefore foregoes a large tub for a small bag of popcorn at the movies the following Sunday.) But this wouldn’t this be just as much saving according to Murphy, because Johnny holds the $2.00 in his cash balance, refraining from consumption for a full hour?

The broader point that emerges from this analysis is that Murphy is simply defining “saving” as the holding of cash balances. For consider the ineluctable fact that in a monetary economy everyone must retain a money payment in his cash balance for a shorter or longer period of time, whether he intends to purchase an immediately consumable service like a movie or restaurant meal, a consumer durable like a car or a house, or an investment asset of some kind. In other words, all income and spending (on both consumption and investment) must flow through cash balances. It follows from the very nature of money as the general medium of exchange that there is always a lapse of time between monetary receipts and expenditures. Whether it is a matter of hours, weeks or years, money income once received must always be held in cash balances before it can be spent.

As I said, now I think I see why so many people are reluctant to endorse my analysis. It seems like every dollar that is earned in income would be “savings” in my book, and clearly that can’t be right! We all know the savings rate is way less than 100%.

Yet that’s not my position at all. I am claiming that every dollar in cash, is part of someone’s savings. But that’s not the same thing as saying that all income is saved.

To see why, first we have to remember that saving, like income, is a flow variable. So you need to define it for a certain period of time. When an accountant prepares an income (aka “Profit & Loss”) statement, it is for a period, such as “3rd quarter of 2010.” (In contrast, the balance sheet is a stock concept, defined at a particular moment in time. E.g. what did the balance sheet look like, last Tuesday at the close of the business day?)

Let’s say Andrew starts out the month with $20,000 in his cash balances. On the 15th day, he gives a speech and earns $10,000. (Andrew used to be a popular TV host, and now in his semi-retirement just does one-off speaking engagements about once per month.) During the course of the month, he spends $9,000 on rent, groceries, gas, and other consumption items.

So how do I account for all this? I would say that over the course of the month, Andrew’s income was $10,000, and his consumption was $9,000. Therefore Andrew saved $1,000. His savings rate is 10%, not 100%.

Now what form does Andrew’s savings take? If he ends the month with $20,000 in cash, and a newly-purchased bond with a market value of $1,000, then it’s clear he invested this new savings into the bond. On the other hand, if he ends the month carrying cash balances of $21,000, then he still saved, and (I would say) he invested the savings in the form of cash.

Here’s where people are getting tripped up: What happens if we shrink the time period? Nothing changes, except the numbers. The principles are still the same.

For example, suppose Andrew’s first outflow of cash occurs on the 1st of the month, when he goes out to dinner with his lady friend and spends $500. His cash balance drops from $20,000 to $19,500. If we are reckoning in terms of days, not months, then yes, on that 1st day, I would say Andrew lived beyond his means. He dissaved by $500. His income that day was zero, and he consumed $500 worth of goods and services.

In contrast, on the 15th day of the month, suppose Andrew spends $100 on food and other consumption goods. During that 24-hour period, I would say his income was $10,000, while his consumption was $100. So yes he saved $9,900 that day, which is reflected by the jump in his cash balances of an equal amount, from their level the night before.

Of course, during the rest of the month, he dissaves, whittling down the cash balances.

I submit there is nothing odd about these statements, and I invite Salerno or other critics to give me an alternate way of handling it. Yes, it’s sounds a bit weird to talk of dissaving 29 days of the month, and a massive amount of saving on the one day. And that’s precisely why we would normally reckon in terms of months, or even years, when talking about someone’s saving behavior.

(Note that I chose someone who gives speeches, because if a person works at a regular job and just gets paid a paycheck, the accounting is more confusing. Technically the person is earning an income every day he goes to work, and then that accrued asset is given in the form of cash on payday.)

Another point to mention is that not all forms of cash intake are “income” in an accounting or economic sense. For example, if Andrew sells shares of stock for $25,000, making his cash balances go from $20,000 up to $45,000, he hasn’t saved. Rather, he has transformed his savings from one form to another. So the $25,000 in new cash balances are a part of his savings, but he didn’t need to save (in the current period) to acquire them. He had already saved in the past, and invested in the stock.

Salerno then says:

Let us change Murphy’s example one more time to illustrate the point from another angle. Suppose that Murphy is the franchise owner of the local multiplex theater and also a silent partner in a local jewelry store. Assume further that he makes a deal to pay Johnny a voucher for a matinee ticket and concession items worth $15 plus a $5 credit to Johnny’s layaway account for a watch at his jewelry store. In this scenario Johnny receives and holds no cash balances, precisely because money enters the transaction only as a numeraire or accounting device and not as a true medium of exchange; in effect, Johnny’s income and expenditures are simultaneous, i.e., he purchases the movie voucher and layaway account credit instantaneously upon receiving his money. Nonetheless Johnny achieves exactly the same ends on the market—a movie every Sunday and a watch at the end of the year—as he does when he is compensated in money.

Ironically, this seems to play right into my hands; I was thinking of a similar argument to show why I must be right.

Let’s simplify it even further. On January 10th, Johnny spends all day in backbreaking work, painting my barn, cleaning the stables, blah blah blah. I pay him with a voucher that says, “The bearer of this voucher can redeem it for a new watch on December 10th.”

OK, now Johnny clearly earned an income that day, and I would say he clearly saved it. He quite literally exchanged his labor for a future good (the claim to a future watch). So this is clearly saving. Now if Salerno agrees that in many respects, this is equivalent to me paying Johnny in cash, and then him waiting a year to buy the watch…?

* * *

Let me close with some questions for those who still resist classifying all cash balances as part of people’s savings:

(1) Cash is a financial asset, and thus part of someone’s capital. So how could it not be part of savings?

(2) Do you agree that the cash owned by a business is part of its savings?

(3) Go back to the case of Johnny, who earns $20 on Monday cutting a lawn. Johnny plans on spending the full $20 at the movies on Sunday. While he’s holding the money in his (now higher) cash balances, I think Salerno wants to say that that $20 isn’t really savings, because Johnny has earmarked it for consumption. But then on the way to the theater Sunday afternoon, Johnny runs into a guy who convinces Johnny to put the money into a CD yielding 100% per month.

So how does Salerno handle this? Clearly, Johnny ended up investing the $20 he earned on Monday. So clearly that income must have been saved; you can’t invest what you haven’t first saved. Yet the decision to invest it occurred on Sunday. Therefore, it seems Salerno has to say that Johnny didn’t save his income from Tuesday to Sunday, at which point he saved it.

How can that be? Johnny obviously didn’t consume the income in the intervening days. So if he didn’t consume it, and he eventually saved it…I want to say he was saving it all along. What would Salerno say?

20 Jul 2011

More Thoughts on Large-Scale Unemployment

Economics 40 Comments

Bryan Caplan and others have been trying to explain why wages aren’t falling, in spite of high unemployment. I applaud their efforts, since this is an important task to avoid a Keynesian solution.

However, I haven’t found these theories too convincing. (Here are my own musings on “sticky wages.”) For example, I’m pretty sure Bryan was dabbling in the idea that employers would hurt morale if they cut everybody’s wages 10%, rather than maintaining wages and letting people go. (I don’t have the link, and maybe I’m wrong and Bryan was criticizing this theory. But I know he, and I think Alex Tabarrok, were blogging about this stuff within the last year or so.)

Yet even if this is true, it hardly is decisive. Is still raises the question: Why don’t entrepreneurs open completely new locations, staffed by formerly unemployed workers who are willing to work for 90% of what their peers are making in a sister operation?

You might say, “Why would a firm go out of its way to expand operations, in the midst of a recession?” Fine, but right now there are still places that are opening their doors every month. The frequency is obviously lower than during 2005, but it is still happening. So why aren’t these new places offering starting salaries well below the “normal” amount?

My arguments here are the standard thing libertarian economists say, when the market is accused of discrimination against women or minorities. We usually say, “Well shucks, if for some reason a bunch of racist employers are paying less than what some employees are worth, worst-case a black entrepreneur would open up shop and hire fellow blacks at a slight pay raise. Since he would be making more profit per employee than his racist rivals, he would outcompete them…”

My main point isn’t so much that libertarian economists are wrong for thinking “morale” explains sticky wages, but rather that we should be consistent across arguments. If we think these sorts of things can keep wages above the market-clearing level for years at a time, then we should be open to the possibility that these types of things can keep market wages well below their “equilibrium” level for years at a time too.

20 Jul 2011

Are Government and Private Debt Different?

Economics, Krugman, MMT 44 Comments

This idea has been zooming around the geeconosphere. Krugman et al. keep telling us, with eyes rolling, that the Republicans (and even that poor ol’ hoodwinked Obama) are nuts when they say things like, “In tough times when families are tightening their belts, the government should do the same.”

Now this always troubled me, for the same reason that the MMT analysis seemed wrong: It makes a qualitative distinction between “public” and private, when there is nothing intrinsic to the analysis relying on that distinction.

For example, could Krugman et al. say with equal validity, “In times when men are tightening their belts, the only way to avoid depression is for women to run up the credit cards”? Or could they start a campaign, urging Google and Microsoft to go billions into debt? More generally, are Krugman et al. really saying, “If only everybody around the world would stop trying to pay down their debts, we’d be fine”?

(On this last point, the reason I ask is this: If some people in the private sector really do want to pay down their debts, while other people in the private sector don’t want their debt to increase correspondingly–and this is the ostensible problem, according to Krugman–then how does it “solve” this problem by having governments take on offsetting debt? To the extent that the people in the private sector realize they are responsible for paying the interest on the “public” debt, won’t they try to save even harder? I’m not invoking a full-blown Chicago-style Ricardian Equivalence argument, but I’ve never seen any of the “public debt is different from private debt” people even address this complication, which seems rather serious to me.)

Anyway, such were my musings up until now. Yet along comes Daniel Kuehn to shock me:

Yesterday afternoon I was doing something I usually avoid – listening to a lot of the Congressional debate on C-Span. Both sides were depressing because both were demanding deficit reduction…

One of the things that just about every Republican said was that “Washington needs to do what families do and not spend more than they take in”. It’s powerful rhetoric that is electoral gold. Getting tough on the deficit is good for politicians – analogizing it to family values is even better.

What’s bothersome is that no one challenged this view, which among economists is almost universally considered to be fallacious. Even those economists who don’t think deficit spending is good macroeconomic policy do not claim that government has to, on average, run a balanced budget. The people demanding austerity ultimately have a better stump speech than the people who understand public deficits and debt, and this is a problem.

So my question to readers is – what is a good, succinct way for politicians to communicate that (1.) public debt is different from private debt, (2.) it is not fiscally responsible to cut public debt during downturns, and (3.) we can run deficits from now until the Sun burns out and everything would be just fine, so long as their magnitude is manageable over long periods.

As I say, this shocked me. In the Ron Paul moneybomb interview I gave yesterday, I was trying to play fair with Keynesianism. When the host suggested that the theory was responsible for our massive government debt, I gently clarified that in textbook theory Keynesians want to run a balanced budget over the course of the business cycle. Yes, you’re supposed to run big deficits during recessions, but you’re supposed to pay them off during booms. But now I stand corrected by Daniel; I guess nice guys really do finish last.

And how do we deal with the part I’ve put in bold? Yes, we can indeed run deficits forever, so long as we cap total debt at a certain fraction of GDP. (If that sounds impossible to you, I do the math in this article.)

Yet again I ask: How is this different from a corporation? At what point will GE be forced to start reducing the total market value of its outstanding bonds?

Last thing: I heartily encourage Daniel & Friends to write a stump speech for Democrats, in which they make clear to voters that we should raise the debt ceiling now, because we plan on running deficits until the sun explodes. Really guys, I mean that with sincerity: Blast that message out there.

20 Jul 2011

Market Prices Mean Something, When an Economist Agrees With Them

Economics, Federal Reserve, Gold, Krugman 14 Comments

This is pretty funny. In the great debate over Bernanke, guys like Scott Sumner and Paul Krugman keep pointing at the bond market to show that guys like me are nuts for worrying about (price) inflation.

My strongest comeback is to point at commodities, and in particular the price of gold. After all, surely S&K aren’t going to argue that gold is up simply because of the increased demand for dental fillings in emerging markets.

So how do I deal with the undeniably low yields on US debt? Well, maybe the fact that the Fed has absorbed so much of it is one big factor. (Speaking of which: Does Krugman really think that bond yields would hardly move, even if the Fed not only stopped accumulating, but actually dumped its entire portfolio over the next month? I’m not asking that sarcastically.)

My other response is to say, “Gosh I don’t study these things as much as the professional bond traders, but I nonetheless think sovereign debt is in a bubble. A few years from now, I think we’ll look back at the collapse in bond prices and realize ‘the market’ was as deluded as during the housing bubble.”

Not entirely satisfactory responses, I’ll grant you, and I am actively refining my views on these things since the massive grocery store price inflation has not yet materialized as I was confident it would by now.

But in terms of grasping at straws, Krugman’s explanation for gold prices strikes me as downright silly. Whereas I can try to explain bond prices due to Ben Bernanke and his trillion-dollar-plus printing press, Krugman blames…Glenn Beck, with his radio and TV shows:

Kash, at the Street Light, has a very good post on the price of gold and its relationship or lack thereof to inflation fears. He points out that the market for gold is surprisingly small, so that it would take only a relatively small number of extra buyers to push the price way up, even when other, more direct measures of expected inflation remain low….

Surprisingly, though, Kash doesn’t say explicitly that this parallel is not at all hypothetical. Glenn Beck was financially intertwined with Goldline, and therefore had a financial stake in pushing fears of hyperinflation. And he had many, many viewers. So there was a direct channel through which conservative Americans were being pushed into buying gold.

Market prices almost always tell you something useful. But sometimes what they tell you is that there’s a marketing scam in progress.

19 Jul 2011

Potpourri

Climate Change, Economics, Potpourri, Ron Paul, Shameless Self-Promotion 32 Comments

* Another great Anthony Gregory article, this time ripping Republicans. My favorite line: “To say Republicans spend money like drunken sailors insults sailors and greatly exaggerates the effect of alcohol on financial judgment.”

* A great Mises Daily (not from me) showing a silly use of mathematical economics to “prove” the efficacy of a carbon tax.

* Today I was part of the Iowa Ron Paul moneybomb radio marathon. (Note I haven’t donated nor do I vote. A performative contradiction? Discuss.)

* There must be a rational explanation for this

* I used to teach with this guy at Hillsdale. (He’s an Austrian economist.)

* Speaking of Hillsdale, when I was a student there I took at least 6 classes from Richard Ebeling. Here’s a recent blog post, and remember he will be one of our fantastic speakers this Friday at the Night of Clarity. If you’re within driving distance of Nashville, you can still register.

* Salerno writes his last blog post… (I already know what to say in response, I’m just picking the best Grass Roots song to lead. This one is my personal favorite, so it will get first consideration.)

* And remember kids, tomorrow starts the 2nd class in the tour of Man, Economy, and State. Full details here.

18 Jul 2011

Wage Movements During Two Depressions

Economics, Shameless Self-Promotion 46 Comments

In the thread discussing today’s Mises Daily, we are getting into a standard fight over the idea that Herbert Hoover might have had something to do with unemployment (and not because he was a dogmatic laissez-faire kind of guy). Blackadder made the point well:

Clearly you have very different outcomes from the 1921 and 1929 recessions, and asking what the difference was that caused the different outcomes is an important question. However, saying that the difference is explain by the fact that Hoover held a conference with business leaders and urged them to not cut wages doesn’t hold water. In any other context libertarians would find the idea that government jawboning could have such a huge effect laughable. The only reason libertarians take the idea seriously w/r/t Hoover, I submit, is that they need some explanation for how government prevented recovery from 1929-32, and this is the best they can come up with.

OK, so things are a lot better for me than Blackadder is painting it. For what it’s worth, I too was skeptical about saying that Herbert Hoover held up wages through mere jawboning. But what pushed me over the edge was finding this type of information (quoting from my book on the Depression):

[A]fter the stock market crash Hoover quickly convened a series of White House conferences with leading financiers and businessmen…He won their agreement to aim for the maintenance of wages, positions, and investment spending. If this proved impossible, the business leaders would cut wages more slowly than product prices…The business leaders not only agreed–Henry Ford even promised to raise wages–but also appointed their representatives to a special advisory committee that would coordinate the government-industry response to the crisis. [Murphy p. 39]

OK so that’s part of my explanation; this wasn’t mere jawboning on the radio, Hoover had names. If he wanted to reward you for going along, or punish you for not, he knew who you were. I have seen some theories as to what the carrots and sticks may have been, but nothing that totally convinced me. Nonetheless, the idea that the president could lean on major businesses doesn’t seem completely ludicrous on its face, as Blackadder suggests.

In any event, Blackadder is misleading when he implies that we are merely starting from the observation that the economy stalled a lot longer in the 1930s than in the early 1920s. No, we know specifically that wages behaved very differently. Quoting Vedder and Galloway (from my book):

While the initial increase in unemployment can be largely explained by the productivity shock, the very sharp rise in unemployment in 1931 was not related to further declines in output per worker. Productivity per worker changed little, actually rising somewhat…Money wages fell, but rather anemically. Whereas in the 1920-1922 depression a roughly 20 percent fall in money wages was observed in one year, the 1931 decline was less than 3 percent. By contrast, prices fell more substantially, 8.8 percent, so real wages actually rose significantly in 1931, and were higher in that year than in 1929, despite lower output per worker. The 1931 price [declines], accompanied by a failure of money wages to adjust…seemed to be the root cause of the rise in unemployment to over 15 percent in 1931. [Vedder and Galloway quoted in Murphy pp. 40-41]

So clearly something really drastic changed in the American business landscape in a decade. For some reason, money-wages became much more rigid downward. I don’t think it’s crazy to think that the president’s quite organized campaign–which was praised by a union editorial in January 1930, as I quote in my book too–had something to do with this.