Lower Wages: Not Necessarily a Solution to Unemployment

The argument is simple;  in times of distress wage reductions will lead to a decrease of aggregate demand, reducing sales in turn decreasing demand for labor and wages.  One has a vicious circle of decreasing wealth and employment.

Some industries where wages / prices are very flexible are particularly vulnerable to this dynamic, agriculture being one. In the great depression farmers where hit particularly hard, prices collapsed and many defaulted on their mortgages. The goal of Franklin D. Roosevelt’s Farm Strategy And The Agricultural Adjustment Act of 1936 was precisely to stabilize agricultural prices and reestablish the purchasing power of the farmers. 

The common notion among economists, is exactly the opposite, that lower wages will increase employment. This sounds logical and is probably most often true, but its important to understand that the dynamics of economics are ever-changing and no universal laws can be made. By looking at – not only – the supply-side of the economy, but also at the demand-side, one realizes that if there is no one to buy your goods it doesn’t matter how cheap you produce them. This follows the reasoning of Henry Ford who argued that the role of a good industrialist was to set wages as high as possible and that all of his workers should afford a Ford Model – T. He reasoned that without demand, there is nothing to sell.

For more on this  see “On the Consequences of Nominal Wage Flexibility” at Economist’s View