Monty Pelerin's World

“Falling wages rates are the consequence of prior bad policies and decisions.” Jerry O’Driscoll

Economic decline can be seen starting as early as three decades ago. The real weekly wage in the US is lower today than it was in 1964 (it crossed below that level in 1977 and has continued to drop). The pain of the decline was covered up by liberal, almost free credit to anyone either upright or breathing. To sustain a living standard that could no longer be paid for, Americans borrowed. Few realized, that while they were living better, it was mostly on other people’s money. When the debt load became too heavy, credit stopped and defaults started.

This economic crisis could easily have come five or ten years earlier or later. The collapse of the stock market in 2000 should have been the corrective crisis. Yet government, in typical kick-the-can-down-the-road fashion decided that a correction should not occur and flooded the housing market with easy credit. As a result, the distortions and mis-allocations that had built up in the economy were not corrected. They were sustained and added to. The latest credit bubble further distorted relative prices as well as absolute ones.

Now we have the current mess, much bigger than the one in 2000. The government is still trying not to face the music by attempting once again to “stimulate” the economy. It probably cannot work this time. Our banks are still filled with toxic assets that are carried at inflated values. Our consumers are forced to rearrange their over-leveraged balance sheets. Many are losing their homes and jobs. Government itself is now insolvent and eventually will crash and burn.

Inflation may raise wages in nominal terms, but not in real terms. Our living standards will decline.

Is there no solution? Economics and common sense provide answers. The burden of government must be dramatically reduced. It must be shrunk back to tasks that it can perform and the private sector cannot. There are very few of these. The percentage of people not working and being supported by the private sector must be reduced. You cannot increase a nation’s standard of living by having fewer people supporting ever-growing numbers of non-workers.

The new health care entitlement has one positive feature. Its first euthanasia patient will be the US government.  As “reform” it is the worst policy that could have been passed. It only hastens the reduction in living standards, reduces future economic growth and further destroys jobs. As such, it hastens the demise of government and the social welfare state.

Economics and common sense could solve our problems, but politics stands in the way. “Starting over” seems to be the only way out. Incremental political change will not work, because it goes in the wrong direction, at least in the political mind. The charade of “fixing” the economy will continue until the economy implodes.

Get ready for a very painful and perhaps dangerous couple of decades.

Below is a simple economic analysis of what is taking place. The reality is that wages are going down and there is little that can be done about that, given our current government-economy mix. Capital formation rather than capital destruction must be encouraged.

Falling Wage Rates

November 12, 2009

by Jerry O’Driscoll

In today’s Wall Street Journal, there is an article titled “Returning Workers Face Steep Pay Cuts.” The article cites research by Kenneth Couch of the University of Connecticut that returning workers are taking on average a 40% pay cut from their old jobs.  This is first and foremost a personal tragedy for those affected.  The question we must ask as economists is why?

Econometricians will still be picking over the data a decade from now. (And of course, they will be looking at revised data, rather than the data we are viewing today. But that is a subject for another post.)  One factor that must not be overlooked is that capital has been destroyed in the prior boom.  The so-called bust or crisis is the revelation of those losses.  Capital is heterogeneous.  The capital embodied in all those unoccupied homes in Las Vegas cannot be deployed to build goods and employ workers in the manufacturing sector.

Many analysts, myself included, argue that economic recovery will involve a switch to a lower consumption path.  In the process, proportionately more resources will be devoted to production of goods for rest of the world.  New savings will be needed to finance that transition.  But much accumulated savings have been lost due to capital misallocation. In order to be competitive in the global economy, the U.S. must become a country of lower wages. And we are witnessing that painful adjustment in real time.

The reflationists (whether monetary or fiscal) conflate cause and effect.  Falling wages rates are the consequence of prior bad policies and decisions.  They are not the cause of current problems.  Moreover, fiscal and monetary stimulus cannot restore the lost capital.  Printing money or redistributing income does not create real wealth.

Falling real wages and declining living standards put flesh on the skeleton of macroeconomic policy debates.  They are the real-world consequences of bad macroeconomic policy: easy money, politically directed investment and regulatory capture.  All those bad policies are being continued or enhanced.  Only further misery will flow from them.