La Gran Depresion

My research on the Great Depression convinced me that sticky nominal hourly wages and government attempts to prop up wages were both factors that contributed to high unemployment.

Unemployment in Spain has now reached levels comparable to America during the Great Depression; 23% of the workforce is idle, and the rate is heading still higher.  This made me wonder what was wrong with the Spanish labor market.  Why weren’t wages adjusting to restore equilibrium?

Here’s The Economist:

Germany may have pursued wage restraint, but that is no easy route to prosperity. Indeed, dual labour markets are more likely to have the opposite effect. Permanent workers fearlessly seek higher wages, confident that job losses will fall first on temporary workers. Soaring Spanish unemployment has produced little wage moderation. During 2009 the pay of permanent workers rose by 4% in real terms.

And attractive as the German model is now, across decades American jobless rates are tough to match. The Anglo-Saxon preference for little or no employment protection may be the most effective at herding workers from declining industries to growing ones, driving job creation and innovation. Dyspeptic bond markets are now pushing Spain and others towards reforms that make it easier and cheaper to lay off workers again. Not before time.

So what should we blame; the ECB or Spanish labor laws?  The correct answer is both.

PS.  Those interested in European issues should check out a new blog called Bruegel.


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16 Responses to “La Gran Depresion”

  1. Gravatar of Rien Huizer Rien Huizer
    15. March 2012 at 05:40

    Scott,

    Spain had similar unemployment levels before 1996. Since then, an unviable construction industry grew up (and died again), and about a million immigrants joined the labor force. Of course there are institutional anachronisms (socialists would call them achievements) but they are on the way out. Maybe Spain’s natural level of unemployment is very high. HOw else can the coincidence of a freak construction sector and an influx of immigrants coexist? Not all the avialable work apperas to appeal to Spaniards and maybe they get away with it, at least the enfranchised ones and their unemployed, live-in children.

    The Spanish case is often mentioned and usually misunderstood. Makes great reading though..

  2. Gravatar of dwb dwb
    15. March 2012 at 06:00

    state protection of industries deserves some blame as well: in the US over time, either union wage and pension benefits are continually broken/renegotiated in bankruptcy (ala airlines and automakers) or else leaner meaner flexible-labor (usually but not always non-union companies), like steel dynamics and nucor take over market.

    state protection of the energy/power sector is often overlooked but is fundamental issue. An aluminum plant for example uses a phenomenal amount of electricity, and in Italy plants are constantly trying to renegotiate rates to lower costs. In the south, in the US, electricity is regulated but at least privatized… and we dont really care if Southern Company or Duke goes out of business. Whereas in France, EdF (Electricity de France) implicity (really explicity) has state protection. So much so that bond rating agencies say “were it not for state protection…”

  3. Gravatar of Cthorm Cthorm
    15. March 2012 at 06:20

    So what should we blame; the ECB or Spanish labor laws? The correct answer is both.

    I hope you are prepared to say the same for the Fed and US labor laws. Thankfully the US can coast on a long cultural tradition of free enterprise, individualism, and independence. But parts of our Labor market look a lot more Spanish now than they did 50 years ago. The worst offenders are public employee unions. Teachers, Firefighters, Policemen, Prison Guards, and ‘Service Workers’ are all protected professions in most areas of the country. They are entrenched and they continue to dig in through extraordinary volume of political spending and lobbying.

    If Obama wants to secure a positive legacy, he needs to make an ‘Eisenhower Military-Industrial Complex’ speech at the end of his term; Rahm Emanuel is bizarrely in a fight with Illinois teacher’s unions, and I can’t tell you how much my opinion of him has improved. I still hope Jerry Brown will pull something similar off in California. He is the best man to solve the issue, if he has the courage: PE unionization was first allowed under his 1970s term as Governor; he is certainly on his last term as Governor; he has a reputation for Quixotic ideas; and he is having a devil of a time in getting the unions to cooperate with him.

  4. Gravatar of ssumner ssumner
    15. March 2012 at 07:20

    Rien, That’s my point. Spanish labor laws have created a high natural rate. But the rate is still very cyclical, due to unstable monetary policy.

    dwb and Cthorm, I agree.

  5. Gravatar of bob bob
    15. March 2012 at 10:14

    The creation of the dual market was Aznar’s doing, but the critics were stomped due to thconstuction boom that started at aout the same time.

    Spain also has very large cultural issues that make well paid, productive employment difficult. There is no culture that rewards achievement: Work harder, and you will neither get better pay, a promotion, or better job switching prospects. When the employee does not believe that productivity helps him, and the employer does not try to convince him otherwise, how can the country compete with Germany?

  6. Gravatar of MMJ MMJ
    15. March 2012 at 11:48

    Note that the Spaniards told the IMF last year that they refused to even consider abandoning wage indexation. While that was under Zapatero, Rajoy hasn’t proposed any changes to indexation, either.

  7. Gravatar of Lorenzo from Oz Lorenzo from Oz
    15. March 2012 at 12:21

    Given the ECB’s tight money policy imposed on institutionally diverse countries, of course the impact is worst on the more indebted AND inflexible economies. Surely, there is no mystery to this.

    There is much to say on what sort of rigidities exist and why: the Spanish labour market has been a disaster for a long time. The level of employment protection being a prime culprit.

    Bob: it is amazing how culture can change if you change the incentives.

  8. Gravatar of ssumner ssumner
    15. March 2012 at 16:06

    bob, That’s probably true. Of course cultures change, and they change faster when economic policy changes.

    MMJ, That’s quite interesting. It’s really shocking the level of economic ignorance in some countries. I’m not talking about the indexation per se, although I think that’s a bad idea. Rather I’m referring the the ABSOLUTELY INSANE idea that one can join a single currency like the euro and maintain wage indexation. You literally have no adjustment mechanism at all. Chile went through this around 1982.

    Lorenzo, Good point.

  9. Gravatar of Major_Freedom Major_Freedom
    16. March 2012 at 04:59

    ssumner:

    My research on the Great Depression convinced me that sticky nominal hourly wages and government attempts to prop up wages were both factors that contributed to high unemployment.

    Those are not two separate factors. The latter is a cause of the former.

  10. Gravatar of ssumner ssumner
    16. March 2012 at 11:08

    MF, The partly overlap, but wages are sticky even without government intervention.

  11. Gravatar of Major_Freedom Major_Freedom
    16. March 2012 at 12:17

    MF, The partly overlap, but wages are sticky even without government intervention.

    “Partly” overlap? You don’t see that they almost completely overlap, and that in a market without any government intervention, prices are MAXIMALLY flexible?

    To whatever extent wages are sticky even without government intervention, they cannot be so sticky so as to result in potential wage earners choosing zero income over a positive income. They cannot be so stubborn so as to starve. Wage prices will be come down, and the longer they take to adjust, the quicker the adjustment will be when it happens. Imagine yourself not earning any income at all and holding out for a price of $1 million an hour and see how long you can last. You’ll realize just how unsticky wage rates can be.

    The same holds true, by the way, for employers and the prices they set for their goods. Output prices cannot be so sticky so as to result in potential sellers choosing zero revenues and stubbornly holding out for higher prices, or so few revenues so as to generate losses.

    Regardless of how “sticky” prices really are, a policy of inflation cannot possibly be the solution, because inflation just makes prices MORE sticky, as people become accustomed to rising prices and thus hold out on their higher asking prices beyond what is justified by prevailing monetary conditions that can only support lower prices.

    For example, wage rates plummeted 20% during the 1920-1921 depression, and they would have kept falling relative to NGDP/GDP if the Fed remained indifferent for a longer period.

  12. Gravatar of ssumner ssumner
    17. March 2012 at 06:01

    MF, Wages were sticky in the 1921 depression, falling less than prices. That’s why unemployed soared.

    You don’t understand how free labor markets work. An unemployed worker can’t go up to a non-union auto plant in the south, say he’ll work for the minimum wage, and get a job.

  13. Gravatar of Major_Freedom Major_Freedom
    17. March 2012 at 07:13

    MF, Wages were sticky in the 1921 depression, falling less than prices. That’s why unemployed soared.

    Sure, but the point is wages were falling and would have otherwise continued to fall.

    Prices in general cannot instantly be adjusted to total dispersed information by individual acting persons. Yes, if the standard you use to judge price flexibility is a superhuman one, where prices instantly change according to every instant change in preferences, information, technology, and monetary conditions, then if the real world were like that, the price system would break down. Prices would be changing constantly, at least every second. Planning would become impossible.

    If the standard is the REAL WORLD instead, then prices are not sticky at all. They are exactly non-sticky according to individual acting persons’ knowledge, preferences, and planning.

    Even if you utilize the unreal standard of no acting persons, and you view the market from a God’s perspective, then inflating the money supply would also be faced with “sticky” prices. When the Fed inflates the money supply, it is not the case that all prices increase equally. Some prices increase before others. Prices are “sticky” upwards with inflation of the money supply and volume of spending as well.

    We see this price “stickiness” upwards in the form of noticing certain “booms” and certain “bull markets”. We might see housing prices rise a lot faster than general prices. We might see tuition prices rise a lot faster than general prices. We might see bond prices rise a lot faster than general prices. We might see dot com stock prices rising a lot faster than general prices. We might see whole stock market booms rise a lot faster than general prices.

  14. Gravatar of Major_Freedom Major_Freedom
    19. March 2012 at 13:08

    ssumner:

    You don’t understand how free labor markets work. An unemployed worker can’t go up to a non-union auto plant in the south, say he’ll work for the minimum wage, and get a job.

    Minimum wage laws are not a reflection of a free labor market.

    You clearly don’t understand how a free labor market works.

    A free labor market means if a worker and employer are willing to trade at ANY positive price, then they are free to do so. Therefore, an unemployed worker who offers his services to the market, will eventually find positive bidders for his labor.

    Of course there are subsidiary issues like search costs, time required to search, etc, but this inherent in human life. That is the standard. From this standard, prices are maximally flexible. Inflation of the money supply carries the same issues. Workers have to find who is getting an increase in incomes first on account of the inflation so as to offer his services to those employers. It’s the same with and without inflation.

  15. Gravatar of Mike Sax Mike Sax
    19. March 2012 at 13:40

    Major Freedom who do you imagine is holding out for $1 million an hour other than a baseball player.

    You must not have much experience being unemployed so it’s easy to think the workers are just greedy. As someone who has been unemployed I know what is is to be willing to work for viritually anything.

    The issue is not new hires but those already employed-that’s where the wages are sticky. Companies very really demand that current workers take a pay cut realizing that there is little that would better serve to demoralize a workplace.

  16. Gravatar of Major_Freedom Major_Freedom
    20. March 2012 at 08:49

    Mike Sax:

    Major Freedom who do you imagine is holding out for $1 million an hour other than a baseball player.

    It’s a thought experiment Mike. It’s not an empirical description. It’s meant to isolate certain criteria.

    You must not have much experience being unemployed so it’s easy to think the workers are just greedy. As someone who has been unemployed I know what is is to be willing to work for viritually anything.

    Of course. But the point is someone has to OFFER you that money. My thought experiment abstracts away from that and holds money offered constant.

    The issue is not new hires but those already employed-that’s where the wages are sticky. Companies very really demand that current workers take a pay cut realizing that there is little that would better serve to demoralize a workplace.

    It’s more demoralizing to be unemployed than employed at a lower wage rate than you would like in an ideal world.

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