Wednesday, January 31, 2018

Lessons from the Great Depression: Wages (Part 1 of 2)

Click here to read the original Cautious Optimism Facebook post with comments

11 MIN READ - Enjoy this highly informative piece from the Cautious Optimism Correspondent for Economic affairs and other Egghead stuff on the Great Depression and Wages.

Episodes of soaring unemployment correspond perfectly with government wage floor programs

The most crucial yet mostly forgotten job-killing government policies of the 1930's manipulated prices and wages. Although Herbert Hoover and Franklin Roosevelt’s hefty tax increases and profligate spending had extensive effects on unemployment, wage policy more directly influenced the fate of American workers. Federal intervention induced downward wage rigidity and precipitated unemployment levels never seen in American history then or ever since. This article examines those policies in detail.


The first major policy act of the Herbert Hoover administration after the October 1929 stock market crash was to convene a meeting of American business leaders to coordinate his novel wage policy. On November 21st, 1929 dozens of executives from an array of industries arrived at the White House to hear Hoover’s plan to mitigate any upcoming depression and hasten recovery. Among the delegates present were Henry Ford, Alfred Sloan (General Motors), Pierre Dupont, Julius Rosenwald (Sears), Owen Young (RCA), Walter Teagle (Standard Oil), William Butterworth (Deere Company) and many more.

Hoover’s pitch? In past depressions American business had always dealt with dwindling sales by selfishly cutting worker pay. But this, according to Hoover, was a mistake—precisely the opposite of what they should do. Instead American business should make a short-term sacrifice by keeping wages high for, as Hoover believed, higher wages were the wellspring of economic prosperity. In his own words:

“The very essence of great production is high wages and low prices, because it depends upon a widening range of consumption only to be obtained from the purchasing power of high real wages and increasing standards of living."
-Commerce Secretary Herbert Hoover speech on labor relations: May 12, 1926 (source: Hoover Memoirs Volume 2)

“I have instituted ... systematic ... cooperation with business ... that wages and therefore earning power shall not be reduced and that a special effort shall be made to expand construction ... a very large degree of individual suffering and unemployment has been prevented.”
-President Hoover address to Congress: December 3, 1929

Of course the labor market quickly learned that the reality is precisely the opposite. Greater production—the outgrowth of business investment in labor saving capital tools and machines that increase productivity per worker—is the true source of higher wages, not the other way around. Simply pushing up wages doesn’t create economic prosperity. Productivity gains leading to lower unit production costs and greater purchasing power per dollar earned does.

Nevertheless, Hoover sold his “new economic science” to American business with the added encouragement of patriotic exhortation—urging them to do their duty as Americans to keep wages high for the sake of the nation and to think of the [macro] economy before themselves. And that in the long run they would be rewarded as a high-wage policy would blunt the pains of the depression and translate into a healthier business environment.

American business leaders were duly inspired and vowed to maintain wage rates—all under the watchful eye of the Commerce Department. Henry Ford, in a brave moment of enthusiasm, emphatically pledged to raise wages. Hoover and his business cohorts appeared united before the press as the President announced that their coordinated plan of attack would hasten the arrival of prosperity. And in a separate meeting with railroad executives Hoover extracted the same pledge.


The consequences of Hoover’s high-wage policy, predictable for anyone who understands elemental microeconomics, did not bode well for the American employment picture. Not only do price floors, when set above market equilibrium prices, create unsold surpluses (“unsold” or unemployed labor), but America also suffered from the famous deflation of 1929-1933 which further exacerbated the impact.

The U.S. economy suffered three major banking panics (1930, 1931, and the largest by far in early 1933) during Hoover’s term, due to a combination of factors including restrictive unit banking regulations, the shocking suspension of gold convertibility by the Bank of England in 1931, and most importantly the Federal Reserve’s policy of refusing to carry out its lender of last resort role for banks suffering from temporary liquidity shortfalls—especially banks perceived as having loaned to fuel stock market speculation in the late 1920’s.

From 1929 to early 1933 the broadest US money supply measure fell by nearly a third, and prices fell by nearly as much. A purchase that required one dollar in October 1929 only cost 93 cents in December of 1930, 84 cents by the end of 1931, 75 cents by the end of 1932, and 72 cents by the final banking panic in the spring of 1933 (source: BEA). Therefore, maintaining a wage of one-dollar per hour from October 1929 at one dollar in the spring of 1933 was the equivalent of paying $1.39 in real terms.

As deflation set in across the country, nominal business sales/revenues fell accordingly. But due to their pledge to maintain wage rates, American business—at least American big business—kept worker pay inflexible and therefore wages actually rose in real terms. All labor employed by industrial America was getting a 39% pay raise!

British economist John Maynard Keynes, who was well aware of the effect of price and wage floors, toured America in 1931 praising the high-wage policy both publicly and in his reports to British Labour Prime Minister Ramsay MacDonald. According to Keynes, high wages would spur greater demand/spending power and rapidly end the slump. Clearly they were of the same mindset as Hoover who, even on the 1932 campaign trail, boasted:

“For the first time in the history of depression, dividends, profits, and the cost of living, have been reduced before wages have suffered. . . . They were maintained until the cost of living had decreased and the profits had practically vanished. They are now the highest real wages in the world.”

But the reality on the financial books of American business painted a different picture. Companies could not endure revenues falling eventually by 28% due to deflation alone, plus business weakness due to depression, while wages remained constant. Losses quickly set in and widened every year as nominal prices fell further.

Corporations bravely tried to hold out, but the only way to maintain 1929 nominal wages in light of falling revenues was job cuts. Workers were steadily fired—first, the least productive but eventually even key personnel—and by the end of 1931 the unemployment rate was already 15.8%. By 1932 businesses started to defect from the plan entirely and began quietly lowering wages, but not enough abandoned ship before the notorious banking panic of 1933 which marked the nadir of the depression. At its early 1933 peak, the unemployment rate reached 25.9%.


By the beginning of the Roosevelt administration American businesses had abandoned rigidly high wages and were entirely focused on survival mode. With the introduction of Federal Deposit Insurance, closing of insolvent banks over the Bank Holiday, and to a lesser extent the end of the dollar’s gold convertibility, the US money supply and prices stabilized. More importantly bank customers began to redeposit their cash in the financial system, encouraged by FDIC guarantees that their money would be reimbursed should their bank fail, and prices began to rise. 

Banks were able to begin normal lending operations again, free of worries that depositors would start a run that required them to boost reserves and curtail lending. And the high-wage commitment was all but gone. Wages and prices were, for the moment, flexible again and free to adjust to changes in supply and demand.

The recovery beginning in March of 1933 was staggering. Jason E. Taylor, Professor of Economics at Central Michigan University and a Great Depression specialist, calculates that from March to August of 1933 GDP and employment rose so quickly that at that continued rate the USA would have returned to 1929 levels of activity by the end of the year. And by early 1934 the US economy would be at levels that implied no Great Depression had ever occurred and that the USA had grown steadily at a 3% clip from late 1929 onward. There has been no five months of growth like March-August 1933 in American history.

But the new administration wasn’t ready to give up manipulating wage-rates upwards yet.

In a grand pattern of boom-and-bust the rally came to an abrupt halt in August of 1933 and promptly reversed course. In just four months during the fall of 1933, manufacturing retreated by a third and US GDP fell by over 5%, more than during the 2007-09 Great Recession. But instead of contracting 5% across a 19 month period as it did from December 2007 to June 2009, the 1933 contraction was compressed into just four harrowing months.

Ironically, since the downturn didn’t last six months—the official definition of a recession—it’s not recorded in any history books as the Recession of 1933, yet in that brief time the economy contracted more severely than during the 2007-09 Great Recession. And unemployment rose accordingly—up five percentage points in just five months.

What caused this giant U-turn in America’s economic fortunes? The frenzy of FDR’s famous “First 100 Days” of legislation was long over by the winter, so what other external factor or policy initiative could have caused such a negative reversal in the job market?

Taylor places blame squarely on the passage of the National Industrial Recovery Act (NIRA or NRA). Signed in June of 1933 but slow to ramp up, the NIRA is most famous for suspending antitrust laws and forcing big business to cartelize, collude, and artificially set prices above the market level. This misguided and patently absurd program had the effect of creating price floors for American goods and the result—much like unemployed labor—was a pileup of unsold merchandise. Faced with rising inventories due to falling demand, businesses cut back on production as well as jobs.

But what the NIRA is less famous for is the reintroduction of wage floors for workers—only this time coerced instead of sold via patriotic appeals by the Hoover White House. The NIRA authorized the “Presidential Reemployment Agreement” (PRA) which was enacted on August 1, 1933.

The PRA officially called for reducing hours to share labor across more workers—so-called “worksharing” agreements—but it also bullied businesses for a minimum pay rate of $15/week for workers in any city of greater than 500,000 people within a broad array of industries—20% above the average pay rate at the time and well above the equivalent minimum wage introduced in 1938 especially when considering the PRA’s reduced work hours provision and inflation adjustments for the 1933-1938 period. Smaller cities fared little better as the PRA called for a $14 to $14.50/week minimum wage for any city larger than 2,500 people. A new minimum wage had been created that went far above the level of the least skilled workers and encroached into salary levels in the nation’s factories.

Although the minimum wage was not technically mandatory, FDR offered businesses that agreed the right to display the NIRA “Blue Eagle” emblem on their storefronts, publicly encouraged Americans to shop at Blue Eagle businesses, and more importantly called for a nationwide boycott against businesses that didn’t display the emblem. The coercive message was clear and American business overwhelmingly complied out of fear of reprisals.

(for the full text of the PRA mandates go to

Once again, corporate managers were faced with expectations—indeed coercion this time—to pay many skilled and industrial workers above the market equilibrium rate—at a time when unemployment, while falling, was still at 17% and 18%. Wages on average were artificially boosted 20% overnight in contrast to the Hoover high-wage agreement where real wages rose a higher 39% but over a much longer period of 40 months.

Higher skilled manufacturing jobs weren’t as heavily affected, since their market wage tended to be above the PRA floor. But lower skill manufacturing jobs such as textiles and clothing saw wage increases of even greater than the 20% average. Suddenly millions of American workers became unemployable moneylosers for their employers.

FDR extended the PRA wage mandates again in January of 1934, but by 1934 legal challenges to the NIRA and PRA began to pile up. The National Recovery Administration went through several restructurings and lost its effectiveness. Many businesses soon calculated the higher operating costs were not worth the marginal gains in customers, especially as public support for the NIRA’s Blue Eagle campaign waned. Eventually the entire NIRA was ruled unconstitutional and overturned by the Supreme Court in 1935, but enforcement of the NIRA, uncertainty surrounding its legality, and a general lack of enthusiasm by the public had already set in by mid-1934.

“By the end of 1934, NRA leaders had practically abandoned the progressive interventionist policy which motivated the Act's passage, and were supporting free-market philosophies—contributing to the collapse of almost all industry codes.”
-from Wikipedia

Professor Taylor once again points to the NIRA—only this time via its demise—as the catalyst for a second recovery in the job market. By mid-1934 unemployment began a rapid decline coincident with the largest wage policy change at the time—the beginning of the unraveling of the NIRA. For the second time in two years government control over wage-rates was abandoned, allowing prices to adjust freely and the market for goods and labor to clear. Twice now a rapid recovery in employment was underway.

Stay tuned next month for Part 2 of this Great Depression installment on wages.

ps. For more information on Professor Taylor’s NIRA and PRA work analyzing late 1933 job losses, listen to his Mercatus Center interview here:

…or read his more detailed research paper here:

No comments:

Post a Comment

Note: Only a member of this blog may post a comment.