Hey, Keynes, leave them wage-earners alone! [update 2]

It's gratifying to see that one after another the non-solutions to the economic crisis proposed at the Key Government's Jobs Summit are falling by the wayside. The latest is the "fund for struggling businesses," that banks have pulled the pin on this morning. This is good news. Not one of these fatuous ideas made any serious economic sense. They were only ever political solutions, and underlying all their madness was the notion that "something must be done" by government to "fix" the crisis that can't be done by the market itself.

This is rubbish -- especially since anything governments propose will only get in the way of genuine recovery.

There's one simple thing the market needs to do to fix the crisis that only the market can do: to let wages and prices fall to meet the new economic realities.* There's less cash in the system because people are spending less? Less credit because too much capital has already been consumed? Less to spend on wages? No problem: meet the new economic reality with prices and wages to match the new, lower, levels of demand -- and since one man's prices are another man's costs, this allows employers to emply all who are loking for work, and healthy businesses to make ends meet and begin putting themselves back on the road to recovery. The overall result is what economist George Reisman characterises as opening up virtual springs to prosperity.

But there's a problem. Governments, at the behest of governments and labour unions, have closed off these springs.

Mainstream economists insist that prices must always be rising, and never ever falling -- they erroneously call this "deflation" -- and labour unions and mainstream economists insist that wages are "sticky downwards," meaning they're unable to fall when needed to (which goes against history, amongst other things), and since the coming of Mr Keynes they've championed laws to ensure their theory is mandated by law, making it all but impossible for wages to fall when necessary.

Backing up their arguments is the popular Keynesian nostrum, championed above all by the labor unions, "that a fall in wage rates, in reducing the incomes of wage earners, causes a fall in consumer spending, which allegedly serves to worsen the problem of unemployment."

George Reisman puts this foolish and destructive nonsense to the sword.

First of all, it overlooks the fact that at lower wage rates more workers will be employed. The effect of this is to enable total wage payments and consumer spending in the economic system to remain the same or even increase while the wages of the individual worker decline. For example, 10 workers each employed at 90 percent of the wages earn the same total wages and can spend just as much in buying consumers’ goods as could 9 workers each earning the original wage. (It’s as simple as the fact that 10 times .9 equals 9 times 1.) And, of course, more than 10 workers employed at 90 percent of the wage per worker would earn more collectively and spend more for consumers’ goods collectively than was possible before.
The popular version of the Keynesian doctrine also overlooks the fact that even if total wage payments and consumer spending did decline, business sales revenues would not decline insofar as reduced wage payments made possible increased expenditures for capital goods. Indeed, to the extent that additional spending for capital goods took the place of wage payments and the consumer spending supported by wage payments, not only would sales revenues in the economic system remain the same, but, what is particularly important for the process of economic recovery, the amount of profit earned on those same total sales revenues would actually increase.

That's only a very small part of Reisman's explanation of how this popular Keynesian notion is wrong, and that to the extent that they're accepted any recovery will be delayed, if not destroyed.

The essential conclusions to be drawn from this lengthy analysis is that once the process of financial contraction in a depression comes to an end, and existing business assets have been re-priced to reflect the deflationary aftermath of credit expansion—once this has occurred, a fall in wage rates will in fact serve to achieve the reemployment of the unemployed. Moreover, it will do so in a such way that the increase in employment is more than proportionate to the fall in wage rates. At the same time, as part of the same process, the decrease in the demand for money for cash holding that occurs in response to the necessary fall in wage rates, manifests itself in a rise in productive expenditure not only for labor but also for capital goods. As the result of the rise in productive expenditure, sales revenues, profits, and net investment in the economic system all rise together.
The fall in wage rates thus serves as an essential component of a full and complete economic recovery, one that entails full employment and the achievement of a substantially increased rate of profit that will be more than sufficient to make investment worthwhile.
The economic policy that is implied by these findings of economic theory is one of a fully free labor market. That is, a labor market free of coercive labor-union interference, free of minimum-wage laws, and free of all other laws that mandate expenditures by employers on behalf of the workers they employ. All legal obstacles in the way of wage rates falling, counting as part of wages the cost of so-called fringe benefits, must be swept aside. This is the policy that will allow the cost of employing labor to fall and thus the quantity of labor demanded to increase, and will thereby achieve the employment of everyone able and willing to work, i.e., full employment.

I suggest you head to Professor Reisman's site, print off the post, and read and digest it over your lunch hour. It might be the most productive thing you do today.

* And since prices fall as wages fall, real wages themselves may actually be the same as before, even if monetary wages are not.

UPDATE 1: It's not just the Jobs Summit's non-solutions fortunately falling by the wayside, so too is the local stimulunacy.

Prime Minister John Key has . . . decided against any fresh fiscal stimulus in the May 28 budget because it cannot afford to provoke ratings agency Standard & Poor’s into downgrading New Zealand’s AA+ sovereign credit rating, Key told the Financial Times in an interview over the weekend New Zealand “cannot afford” to provide fresh fiscal spending for its embattled economy and was instead planning to cut government expenditure . . .

Hallelujah! Though I doubt those cuts will be big enough to avoid a budget deficit, nor anywhere near as big as I would like.

UPDATE 2:  A commenter at the Mises Economics Blog makes a useful point about the natural  "springs to prosperity" that turn around a slump:

I think Dr. Reisman’s 'accounting' approach can be wedded to Hayek’s Ricardo Effect for an even more powerful explanation of the natural recovery process from a depression. Falling wages tend to happen to the largest degree in the capital goods industries where the depression is the worst. Wages don’t fall as much in the consumer goods industries, while prices do. The profits squeeze in the consumer goods industries encourages businessmen to purchase labor-saving equipment to offset relatively high labor costs. (This is basic micro econ, too.) The demand for capital equipment wedded to falling wages in the capital equipment sector causes profits to rise in that sector and encourage investment and employment.