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November 08, 2009

US Jobless Hits 10.2 per cent and Government Supporters Blame Rising Productivity
by Gerard Jackson

The same media types who screamed blue murder with undisguised glee when unemployment hit 5 per cent under Bush are now telling us that the current 10.2 per cent rate is being driven by rising productivity and so there is little that can be done about it in the near future. I find this reasoning very suspicious. It looks to me as if Obama supporters have resigned themselves to a persistent high rate of unemployment and are looking for an excuse to rationalise it. Now let's take a look at their simplistic reasoning. As two of these brilliant economic analysts put it:

As long as companies can get their workers to produce more, they have little reason to hire -- at least until consumer spending picks up. And the squeeze on incomes could depress consumer spending, putting the economic recovery at risk. (Productivity gains may be bad news for job seekers, Martin Crutsinger and Stephen Manning, AP, 5 November).

We actually have several fallacies here. The very idea that rising productivity can create widespread unemployment stands refuted by economic theory and the historical record. It evidently did not occur to this pair that they were regurgitating -- in another form -- the old fallacy of technological unemployment, the obverse of which is less technology means more jobs. One should note that the reason for the increase in productivity was not been mentioned, probably because the leftwing journalistic mindset is incapable of independent thought.

A genuinely enquiring mind would have quickly realised that in an effort to stay afloat during a recession, especially very severe ones, firms will eliminate marginal operations and, particularly in the case of manufacturers, shut down inefficient plants. To do otherwise is to risk bankruptcy followed by 100 per cent dismissals. (Regardless of leftwing folklore and Hollywood idiocy, capitalists are not moustache-twirling villains who delight in evicting widows and orphans.) The result is usually a rise in productivity not only because more efficient plant are operating but also because fewer hours are being worked. Normally this process is followed by an increase in the demand for labour because the effect of an increase in productivity is to reduce the cost of labour relative to the price of the product.

The charts below neatly illustrate this point by showing what happened to unemployment in Australia during the Great Depression. The first chart shows productivity beginning to rise in 1931-32 while the second chart shows that unemployment began to fall at the same time and continued to drop as productivity rose. During this period the real wage rate index varied between 98 and 100, making it virtually constant. By 1938 payrolls had expanded considerably and unemployment had fallen to 8.9 per cent while in the US it had risen to 19 per cent. Moreover, Australian governments actually cut spending, the very opposite of Roosevelt's policy of spend, spend and then spend some more.

Source: Recovery from the Depression: Australia and the World Economy in the 1930s, Cambridge University Press, edited by R. G. Gregory & N. G. Butlin, 2002,p. 268

Unlike Australia the US did not experience a sustained drop in productivity at any time during the Great Depression despite the massive contraction in output. From June-July 1929 to February-March 1933 manufacturing production plummeted by 51 per cent. By the following June-July output increased 20 per centage point. Therefore, from mid-1929 to mid-1933 production fell by 29 per cent while unemployment rocketed from 3.2 per cent to 24.9 per cent. However, output per man hour rose by 19 per cent despite the fact that by February 1933 output per worker was 85 per cent of the 1929 level. By the following June output per worker exceeded the 1929 level by 9 per cent. (Frederick C. Mills, Prices in Recession and Recovery, The National Bureau of Economic Research, Inc., New York, 1936, pp. 328-31.)

So how did Australia manage a sustained fall in unemployment in the absence of big government spending programs while the US suffered higher levels of unemployment accompanied by a severe fluctuation in 1937-38? The answer lies in the real wage rate. During this whole period Roosevelt and his union allies prevented the real wage rate from fully adjusted to changes in productivity. (Obama's union policy is poison for the US economy.) If real wages had remained largely unchanged -- as happened in Australia to a considerable degree -- then the level of American unemployment would have followed the Australian pattern.

Like the rest of the economic commentariat -- left and right -- Crutsinger and Manning take it for granted that consumer spending drives the economy. This is because about 70 per cent of GDP consists of consumer spending. But what is not understood by these people is that the practice of omitting spending on intermediate goods is a dangerous fallacy that skews the national accounts in the direction of consumption. What matter is total spending. Once we take account of that consumer spending falls to about one-third of total spending. (The Bureau of Economic Analysis has been taking this approach for some years.) Therefore it is business spending that drives the economy, a fact that was once well known. Moreover, the emphasis on consumer spending is tacitly assuming a two-stage economy: production and consumption. But as was pointed out more than 70 years ago:

The larger number of payments is not from consumers to producers, but is made between producers and producers, and tends to cancel out in any computation of net incomer of net product value. "In fact, income produced or net product is roughly only about one-third of gross income." [Italics added]. What is cost for one producer is in part income for some other producer, but part of that income the latter has to pay out in costs to other producers in another stage of the productive process (for intermediate products, raw materials, supplies, etc.), and so on. All that is necessary in order that equilibrium be maintained is that consumers' incomes equal the cost of producing consumers' goods; the total of producers' payments necessarily exceeds that of consumers' incomes. (C. A. Phillips, T. F. McManus and R. W. Nelson, Banking and the Business Cycle, Macmillan and Company 1937, p. 71).

Leaving aside the theoretical argument against consumer spending we find that the idea is not even supported by the facts. If consumer spending does fuel an economy then it follows that a significant fall in consumption must lower the demand for labour and raise the level of unemployment. Yet we find the very opposite happened in Nazi Germany. From the beginning of Hitler's chancellorship to 1939 unemployment fell to the extent that severe labour shortages emerged. Yet real consumer spending contracted. Without a doubt living standards were significantly lower than in 1929 and yet the demand for labour kept rising*. Why was this? Because massive amounts were being spent on plant and equipment for war materiel at the expense of consumer goods.

It is not changes in productivity that determine the level of unemployment but the ratio of the real wage rate to the value of the worker's marginal product. This makes nonsense of the assertion that Americans must now tolerate a high rate of unemployment because there is a Democrat in the White House.

Several things are going on here. I think the malinvestments created by the previous credit expansion are still creating unemployment as the necessary readjustments are made. Secondly, Obama's policies are creating an enormous amount of uncertainty. His proposed taxes and plan for 'health reform' are not good for business, particularly small business. I think it quite possible that these policies now form a substantial impediment to hiring labour and could help explain why corporate cash balances are piling up. His massive spending and borrowing program would cripple investment while his energy policy alone is enough to devastate the economy. In short, his economic policies are the real barrier to full employment and sustained economic growth.

*There is no contradiction between a fall in the "intensity of demand" for labour with a monetary rise in the demand for labour. A fall in the former simply means a drop in the real wage rate. If the real wage falls as the ratio of capital to labour increases then this means masses of capital are being wasted. In other words, they are not being directed to an increase in consumption.

Gerard Jackson
BrookesNews.Com

Gerard Jackson is Brookes economics editor.

Copyright © 2005-2010 Gerard Jackson

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