Out of Work: Lessons for Europe

The world is facing spiraling unemployment: especially Europe and the United States.  According to the Economist, unemployment in the United Kingdom rose to 7.6% up to May 2009.  Spain’s labor force is facing 17.4% unemployment, although the government announced two consecutive months of increased employment thanks to the credit stimulus.  The Economist suggests that those unemployed are shifting the blame to foreign workers, who are willing to work for lower wages (and may have more experience), but then says that a more realistic scenario is that the increase in unemployment is due to an increase in the minimum wage.  In this case, the Economist is correct, although they do not go far enough to unveil the labor rigidity enforced by the government.  These labor laws are guaranteeing long-term unemployment, at ever increasing rates.  What Europe needs are lower wages to allow businesses to maintain their labor force for a cheaper price.  Otherwise, Europe will find itself with companies which cannot afford the labor necessary to maintain their enterprise.  The worst part of it all is that even increasing the minimum wage is not maintaining the purchasing power of the average European citizen—thanks to the credit expansion, real wages are actually decreasing.

Labor rigidity is being tightened.  There has been much talk about increasing wage rates in both the United States and Europe, under the impression that a greater wage rate will lead to greater consumption.  In an era of economic decline, the affordability of these wage increases is in question.  Let us assume that the average monthly wage in Madrid is €1,000 (which is not too far off the mark, actually).  A 3% increase would entail a new average monthly wage of €1,030.  Arguably, the increase is not too dramatic, but spread over millions of workers the number becomes more serious.  Because businesses cannot increase the pool of money available to pay wage rates, any increases in one’s wage must come with a necessary decrease in another’s.  In other words, a euro that goes into one person’s wallet must come from another’s.  Despite the figures, there is no aggregate increase in wealth (aggregate productivity in the Euro zone fell by 2.5%).  The pool of money remains the same.  What does not remain the same is the employed labor force.  Businesses will inevitably lay off those who they cannot afford to maintain, and small companies who cannot operate under a specific number of employees will go under, causing an even greater amount of unemployment.

Admittedly, there has been a drive to lower wages.  In the autonomous region of Madrid, for example, there was a government-led effort to decrease average wages—these came to naught, although several syndicates have frozen wage increases in the region.  On average, however, private wages have increased by 2.8% in Spain.  Again, while in Madrid public workers will face a 2% decline in wage rates, the federal government declared that federal employees will see an increase in their wages by an estimated .05%.  These increases are also aimed to maintain purchasing power in the face of an estimated increase in the inflation rate to 1.6% in Spain.  But, this could prove disastrous.  The source of the inflation is misunderstood—what causes an increase in price level is an increase in the money supply, largely catalyzed by cheap credit creation by central banks.  There has been no increase in real wealth; productivity has decreased.  Spaniards, other Europeans and Americans alike will find their real wage rates decreasing over time.  There were similar trends present during the Great Depression.  According to Murray Rothbard’s America’s Great Depression, despite the maintenance of monetary wages at 100 (100 being wages at the base year, or 1929) through December 1930, real wages did not actually increase, and at certain points decreased.  But, when the average monetary wage fell to 77.1 in March 1933, the real wage rate actually increased to 108.3.

What allows for this is deflation of the average price level.  If central banks allowed prices to fall goods would be more affordable for the consumer.  A fall in wage rates would not be as “barbaric” as many people purport it to be.  Indeed, evidence suggests that real wages actually increase.  In other words, the purchasing power of the average household will increase, or that household has become wealthier.  Artificial maintenance of wage rates and the price level only guarantee long-term poverty.  Furthermore, if businesses could pay lower wages they could also hire more employees, decreasing unemployment.  Unfortunately, governments still operate under the illusion that maintaining wages above their market price will stimulate some kind of recovery.  In reality, it only stimulates greater loss of wealth.

Relating to today’s publication in the Economist (online), Richard Vedder and Lowell Gallaway—in Out of Work—suggest that trends in Britain today are similar to trends which existed during the Great Depression:

Dissimilar to the American experience, labor productivity in Britain actually rose, and rather sharply, during the downturn.  This further refutes the argument that the adjusted real wage model is not meaningful because productivity declines caused by shifts in aggregate demand cause the adjusted real wage rate to rise.  The growth in labor productivity in Britain during the early years of the Depression was in excess of the long-run historic trend.

In a policy sense, there was a decline in the money stock after 1929 that, while modest, worked to lower prices.  It probably reflected a determination on the part of the monetary authorities to maintain the pound at a $4.86 exchange rate in order to avoid going off the gold standard.  In the view of W.H. Hutt, the inflationary bias in Keynesian-style thinking in Britain even before the General Theory “caused an otherwise avoidable deflation to be essential.” In any case, the unanticipated deflation tended to increase real wages, which rose nearly 3 percent a year between 1929 and 1933, far in excess of the long-term historical trend.

It is arguable that Britain, unlike the United States, did not have a Depression in an output sense.  From peak (1929) to trough (1933), real output fell but 6 percent, and over the 1929-39 decade, it rose by 21 percent in real terms, with an annual growth rate of 1.94 percent, relatively high in a historical sense.  The Depression in Britain was an unemployment depression generated by out-of-equilibrium wages.  Amidst general prosperity, a portion of the British public suffered enormously.  The unjustness of this contributed to the political environment that led to the Keynesian revolution.  Yet, what was involved here was less market failure than institution failure—the workings of strong labor unions protected by government and a monetary policy that served to provide unanticipated real-wage windfalls for that portion of the population fortunate enough to be employed.

So, what is the lesson?  The lesson is that prosperity will only return after the government allows monetary wages to decrease and ends its attempts to “stabilize” prices by inflating the money supply.  Historic trends prove that while monetary wages may decrease during a depression, the decrease in the price level that comes from a contraction of the credit supply will actually cause an increase in real wage level, or purchasing power.  As it stands, current labor policies will only cause greater suffering in those countries where the labor market remains artificially rigid.