Sticky Wages

A common view among economists is that wage stickiness is one of the reasons for the high levels of unemployment during the great depression. In most markets, excess supply pushes prices down which increase demand until the market is cleared. They argue that this cannot happen in the labour market, because unions prevent wages from falling. Unemployment, which is excess supply of labour, becomes a problem because high wages prevent the labour market from clearing. These economists argue that unemployment would not have been a problem during the great depression, if wages had been allowed to fall.

There are two problems with this view. Firstly, all wages do not need to fall to clear the market. If all wages were forced down, the capacity of employees to consume is severely restrained, which harms the economy. Fortunately, prices only have to fall at the margin to clear a market.. The price only has to fall for those goods currently on offer for sale, not for all those that have been sold previously.

Wages only have to fall at the margin for unemployment to be cleared and this happens anyway. People who lose their jobs usually have to take lower-paying work to get another position. When a business replaces people, it can usually take on less experienced people who are not paid so much. These two effects mean that wages do tend to fall at the margin during times of unemployment.

The second problem is that business declined so rapidly during the Great Depression that the marginal wage would have had to fall to zero to clear the market. The collapse of the banking sector and the collapse of commodity prices killed off many businesses. These were the problems that had to be resolved, before the labour market could return to normal. An overall decline in wages was not the solution.

The crisis in the 1930s was caused by problems in the capital markets and not in the labour market. The depression was the consequence of a distortion of the capital markets. Wages could not adjust enough to resolve a problem in the capital market.