Academic journal article Policy Review

Why Johnny Can't Work: The Causes of Unemployment

Academic journal article Policy Review

Why Johnny Can't Work: The Causes of Unemployment

Article excerpt

Whenever high unemployment persists for several years, it is because the costs of labor are rising more rapidly than its productivity. This was true in the 1930s, when the labor policies of Herbert Hoover and Franklin Roosevelt helped turn a temporary downturn into a decade-long Depression. It was true from 1979 to 1982, when the rapid slashing of inflation led to a sharp increase in the real wages of those who remained working. And it is true in 1992, as the minimum wage and unemployment compensation policies of President Bush and the Democratic majority in Congress have priced millions of Americans out of the job market.

Labor can become too expensive for employers in three ways. Most obviously, money wages (including fringe benefits) and/or payroll taxes can increase, without compensating improvements in productivity. Second, prices might fall, increasing the real purchasing power of wages but lowering the monetary value of each worker's output. Third, the productivity of labor may fall, raising unit labor costs as each worker produces less.

Healthy growth in real wages is compatible with full employment--if labor productivity rises sufficiently. Indeed, our nation's economic history is one of generally rising real wages and employment levels accompanied by rising labor productivity. The interludes of high unemployment have coincided with rises in the "adjusted real wage"--the costs of labor minus its productivity.

The Depression That Ended Quickly

Consider, for example, the difference between the 1920-1922 and 1929-1941 depressions. By most measures, the 1920-1922 downturn was initially a more severe contraction than the 1929 one. Industrial production fell by over 30 percent five quarters after the downturn began in 1920, compared with 28 percent over the first five months of the Great Depression. Twelve quarters after the 1920-1922 downturn began, however, industrial production was healthily above the 1920 high. In the Great Depression, by contrast, industrial production 12 quarters into the downturn had declined more than 50 percent. In the Great Depression, unemployment continuously rose for four consecutive years, and recovery to normal levels took another nine years.

Why? In the 1920-1922 downturn, the federal government did not interfere with the working of market forces. The sharp inflation associated with World War I turned abruptly to deflation in early 1920. Prices fell sharply, faster than money wages, pushing real wages up. Some labor was priced out of the market, and unemployment rose sharply. But by late 1921, wages were tumbling faster than prices, and the decline in real wages prompted a rise in employment and an end to the recession.

The failure of the government to act in 1920 partly reflected the classical faith in the self-correcting market mechanism. It also reflected the lack of strong direction in Washington, since President Wilson was seriously ill. His innate activism was tempered by his poor health. The new president in March 1921, Warren G. Harding, was opposed to governmental involvement, but in any case market forces started relieving the problem shortly after he took office.

Hoover's Biggest Mistake

In 1929, by contrast, America was led by a president, Herbert Hoover, who believed that high wages regardless of productivity were the key to prosperity, since high wages increased worker purchasing power and sales. Hoover was not alone in advocating an "enlightened" approach to business prosperity, a proto-Keynesian view that stressed the importance of high wages to maintain purchasing power. The nation's most prominent industrialist, the legendary Henry Ford, constantly preached the need for higher wages. Famous retailer Edward Filene and General Electric president Gerald Swope made similar arguments.

When the nation moved into a downturn in the fall of 1929 after the stock market crash, Hoover behaved in an activist fashion, calling business leaders to meetings at the White House. …

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