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Breaking Commitments

I’m about as big a fan of markets you will find from someone on the center-left (a very imprecise designation). I prefer the government allow free interaction between people as much as possible unless the negative externalities outweigh the positive consequences of the exchange. But certain recessions seem to call out for intervention.

So I have a serious question for all readers that favor government inaction during strong recessions and high unemployment. Let’s abstract away from our current economic predicament. Paul Krugman in an interview with Rachel Maddow discussed our current unemployment mess, but regardless of if you think his analysis of the current economy is accurate try to grapple with this chain of logic:

We don’t have jobs because businesses aren’t hiring. Businesses aren’t hiring because they don’t have sales. Businesses don’t have sales because people don’t have money. People don’t have money because they don’t have jobs.

He believes in these situations the government needs to step in to break that cycle by boosting aggregate demand and putting people to work. For those who don’t favor fiscal or monetary stimulus, what is supposed to break that cycle? Falling prices don’t seem to do it. First deflationary cycles can happen and those are very dangerous. Also “sticky wages” won’t allow businesses to cut nominal wages enough for the market to easily self adjust. Economists George Akerlof and Robert Shiller in Animal Spirits discuss the topic.

Yale’s Truman Bewley gives qualitative evidence on money wage stickiness. He conducted an intensive interview study of New Englanders involved in the wage setting process. He asked why money wages had not declined in the New England recession of 1991-92. With the high unemployment of the time, any worker who might quit in response to a wage cut could have been replaced easily and rapidly. But Bewley found that employers were loath to reduce wages during the recession. In the employers’ opinion workers would view such wage cuts as unfair. They would reduce their commitment to their jobs. Furthermore, when the economy revived they would still be angry and thus more likely to quit. Bewley found a few firms that made such cuts, but only after considerable agonizing and also after continued losses. In those rare instances workers accepted wage cuts as fair. They were a last resort, necessary to save their jobs.

It might be an irrational feature of human nature that causes that but it exists and can’t be wished away to fit an ideological commitment to free markets. I suppose one could argue that after the economy completely crashes with prolonged periods of high unemployment which causes huge amounts of human suffering, economic loss, and lost opportunity the economy might eventually self-correct. That might be a necessary evil if it prevented all future recessions, but it obviously wouldn’t.

What is supposed to break that cycle? Are you conceding that a devastating depression is necessary for the market to realign? If so, why is your commitment to markets stronger than it is to people?

  1. Bill
    December 30, 2010 at 9:32 pm

    Dan- I totally agree with your take on this. Krugman is the only one offering consistent and logical advice that makes sense (at least to me). I am hearing no solutions from the right other than the need to cut spending and deficits (except for tax breaks for the wealthy). They feel this will boost market confidence and result in a “trickle down” effect to improve the economy. I think this is a bunch of bull, and seemingly, so does the CBO. So the spending vs. austerity beat goes on…at our expense.

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