Should Wages Never Fall?

Sudeep Reddy, writing on the front page of January 11th’s Wall Street Journal, claims that one of the “ugly” legacies of the current economic crisis is a “lasting drop in wages”. Following National Public Radio’s modus operandi for reporting “news”, he supplies some human-interest stories recounting the experiences of former money managers and other high-income people who have been forced to take jobs at hourly pay rates far less than needed to support the lifestyles to which they had become accustomed.

While one would have to possess a heart of stone not to be moved by such personalized accounts of job losses and tragic career disruptions, the fact of the matter is that economic recovery cannot begin until markets for labor—and for real estate and other assets—have adjusted prices downward to reflect their now-lower values.

It was a fundamental mistake of the presidential administrations of Herbert Hoover and Franklin Delano Roosevelt to respond to the unprecedented economic contraction of 1929–1933 by adopting policies intended to prop up wages and prices at a time when market forces were driving them to new, lower equilibrium levels. By delaying necessary adjustments, those policies actually deepened and prolonged the Great Depression.

The rational ignorance of ordinary voters grants politicians discretion to adopt postures suggesting that they can somehow short-circuit the purgative (and salutary) operations of freely functioning markets. They cannot do so, except by undermining the capitalist system that heretofore has allowed the United States to generate the highest average standard of living in all of humankind’s recorded history.

If wages and prices are allowed to fall in the short-run, economic recovery will be more robust and growth will return to its long-run path much sooner than otherwise.