Business Insider

Peter Crabb: Unlike past downturns, this one may bring lower wages

It could be different this time.

In an Associated Press report this week Tom Raum and Daniel Wagner show how hard it is to determine if the current economic problems constitute just a bad recession or a depression. They write “there are no firm rules for what makes a depression. Everyone at least seems to agree there hasn't been one since the epic hardship of the 1930s.”

In the fourth quarter of 2008 the U.S. economy contracted by more than we have seen in many decades. We are clearly in a bad recession, but we are unlikely to see anywhere near the problems of the Depression.

The Great Depression of the 1930s brought about much of the economic policy prescriptions we see today – higher government spending and greater unemployment benefits. John Maynard Keynes wrote his General Theory as a response to a deepening economic recession of the early 30s. At the time of its writing, the idea of a depression was unknown.

If we are going to call today’s economic climate a depression we have only one example to compare with. Furthermore, if we are going to apply the same prescriptions Keynes suggested for the problems he saw we better be sure the conditions are the same.

One of the fundamental principles behind the General Theory and more recent explanations the business cycle is the theory of sticky wages. According to the sticky-wage theory, an unexpected fall in the price level temporarily raises real wages, which induces firms to reduce employment and production.

Our wages are often slow to adjust to economic downturns due to the many long-term contracts we have signed, along with the social norms that suggest fairness in what we pay our workers. These social norms influence wage setting in many ways and are slow to change over time.

The theory therefore predicts that during recessions business cut back on production and lay off workers rather than simply paying them lower wages. If wages could be cut, the firm could keep jobs and maintain sales quantities by charging lower prices. What we see instead are increasing layoffs and increasing levels of unemployment.

Evidence is showing up this year that the social norms may be changing. Evan Ramstad, reporting for The Wall Street Journal this week, found significant wage concessions from unions around the world in the past months, designed to reduce layoffs. A Korean union at an auto-parts company reduced wages 20 percent and in Canada the United Steelworkers agreed to cut working hours by the same percentage.

Can this happen in the United States? Ford Motor executives agreed to 30 percent reductions in their salaries in exchange for an agreement from the autoworkers union support to cap wages. The need for lower wages, and thus more competitive pricing and competitive firms, is apparently understood only outside the country.

It would be very hard for me to accept a lower wage, but for workers at industrial firms facing such a high likelihood of layoff, the concession seems worthwhile. The eventually economic turnaround we are all waiting for is in desperate need of just such hard choices.

The financial markets are suggesting these choices have yet to be made and may be a long time coming. The stock market remains at decade-long lows and the bond market remains tight. One indicator is showing a possible drop in prices and wages. Over the past two weeks gold prices have fallen well off their highs of nearly $1,000 per ounce. The nearly 10 percent pullback in prices suggests that deflation, or declines in prices and wages, is much more likely than inflation.

It’s different this time. Unemployment is high, but not as high; the money supply is growing and not contracting; and the workers around the world are showing willingness to adjust prices. The sticky-wage theory identified from experience in the 1930s no longer holds.

.

Since 2000, Peter R. Crabb has been a professor of finance and economics at Northwest Nazarene University in Nampa. He earned his doctorate in international and financial economics from the University of Oregon

  Comments