The “New Economics” of Herbert Hoover Made Real Wages Rise During the Early 1930s

Summarizing his boss's position (whether or not he personally thought it wise), Treasury Secretary Mellon explained in 1931:

In this country, there has been a concerted and determined effort on the part of both government and business not only to prevent any reduction in wages but to keep the maximum number of men employed, and thereby to increase consumption.

It must be remembered that the all-important factor is purchasing power, and purchasing power. . . is dependent to a great extent on the standard of living. . . that standard of living must be maintained at all costs.

Economic historians have shown that Hoover and Mellon were not blowing smoke to the voters. What economists call “real wages” actually rose during the early 1930s, because businesses cut money-wages either not at all or very reluctantly, while the prices of most goods and services were plummeting. This perversely made labor relatively more expensive for businesses to hire, and guess what? During a huge economic slump, when the relative price of workers rose (because of Hoover's misguided worldview), businesses hired fewer workers. Economists Richard Vedder and Lowell Gallaway explain:

While the initial increase in unemployment can be largely explained by the productivity shock, the very sharp rise in unemployment in 1931 was not related to further declines in output per worker. Productivity per worker changed little, actually rising somewhat. . . . Money wages fell, but rather anemically. Whereas in the 1920-1922 depression a roughly 20 percent fall in money wages was observed in one year, the 1931 decline was less than 3 percent. By contrast, prices fell more substantially, 8.8 percent, so real wages actually rose significantly in 1931, and were higher in that year than in 1929, despite lower output per worker. The 1931 price [declines], accompanied by a failure of money wages to adjust. . . seemed to be the root cause of the rise in unemployment to over 15 percent in 1931.

The comparison with the previous depression of the early 1920s is instructive. Herbert Hoover and his allies in the labor movement thought it unconscionable that labor should have been “liquidated”during that downturn, to use Andrew Mellon's politically incorrect term. Indeed, during that earlier depression it must have seemed unbearable for workers to see their paychecks slashed by 20 percent in a single year (though other prices were falling too, cushioning the blow). Yet when the economy must readjust after an unsustainable boom, the prices of resources—including labor—need to change in order to facilitate the movement of workers to the correct sectors.

Things were very bad—briefly—during the earlier depression. The annual unemployment rate peaked at 11.7 percent in 1921, but it had fallen to 6.7 percent by the following year, and was down to an incredible 2.4 percent by 1923. That is how a market with flexible wages and prices quickly corrects itself after a Fed-induced inflationary boom. But because the “compassionate” Hoover forbade businesses from cutting wages after the 1929 crash, unemployment went up and up and up, hitting the unimaginable monthly peak of 28.3 percent in March 1933. For the quarter of the labor force thrown out of work, the fact that “[f]or the first time in the history of depression, dividends, profits, and the cost of living have been reduced before wages have suffered,” was little consolation.

—Robert P. Murphy, The Politically Incorrect Guide to the Great Depression and the New Deal (Washington, DC: Regnery Publishing, 2009), 39-42.