Krugman's Hooverite View on Wages
First, Bryan points out that “Krugman forgets that wage rigidity is the fundamental cause of involuntary unemployment.” I agree with Bryan about the harmful effects of wage rigidity. What we are seeing here in Krugman’s article is that he is throwing out the Keynesian view, not just the New Keynesian view but also the earlier view of James Tobin, Franco Modigliani, and the other 1960s Keynesians that wage inflexibility is the problem. Krugman is going right back to an interpretation of Keynes that, Krugman points out, can be attributed to Keynes, but Bryan is right that this is simply bad economics.
Second, Krugman is taking Herbert Hoover’s view of wages. In his article on the Great Depression, Gene Smiley writes:
In previous depressions, wage rates typically fell 9-10 percent during a one- to two-year contraction; these falling wages made it possible for more workers than otherwise to keep their jobs. However, in the Great Depression, manufacturing firms kept wage rates nearly constant into 1931, something commentators considered quite unusual. With falling prices and constant wage rates, real hourly wages rose sharply in 1930 and 1931. Though some spreading of work did occur, firms primarily laid off workers. As a result, unemployment began to soar amid plummeting production, particularly in the durable manufacturing sector, where production fell 36 percent between the end of 1929 and the end of 1930 and then fell another 36 percent between the end of 1930 and the end of 1931.
Why had wages not fallen as they had in previous contractions? One reason was that President Herbert Hoover prevented them from falling. He had been appalled by the wage rate cuts in the 1920-1921 depression and had preached a “high wage” policy throughout the 1920s. By the late 1920s, many business and labor leaders and academic economists believed that policies to keep wage rates high would maintain workers’ level of purchasing, providing the “steadier” markets necessary to thwart economic contractions. When President Hoover organized conferences in December 1929 to urge business, industrial, and labor leaders to hold the line on wage rates and dividends, he found a willing audience.
Third, one of the commenters on Bryan’s post said, on the basis of his criticism of Krugman’s NY Times article, that he couldn’t believe Bryan assigns a book by Krugman. Another commenter, johnleemk, caught the obvious problem: it makes no sense to reject good work by someone who has done bad work. Krugman was an incredible educator in economics in the 1990s. I told my students the other night (at a Masters in macro course that I teach this semester at San Jose State University) that Krugman’s classic, “Ricardo’s Difficult Idea,” is one of the top 30 articles ever in economics. Maybe I’m exaggerating, but not by much. The point is that with Paul Krugman, as with all of life, we need to keep the wheat and discard the chaff.