No Free Lunch: Economics for a Fallen World: Third Edition, Revised

Chapter Seventeen: A Short History of Macroeconomics 430 CHANGING ECONOMIC STRUCTURAL CONDITIONS AND THE KEYNESIAN REVOLUTION While the classical view of economics held in the latter nineteenth and early twentieth centuries, structural changes in the economy were creating strong headwinds in the face of business cycles. In the United States, there were many significant depressions in the 1800s, often connected with significant reallocation of resources in the economy. The world was transitioning from primarily agricultural production to manufacturing, and recessions/depressions in 1873, 1893, and 1907 were particularly severe. Yet as the economy was becoming more dynamic and productive through the industrial revolution, social conflict between capital and labor became more pronounced. Labor union membership rose and unions were able to influence the passage of pro-union legislation (such as gaining exemption from antitrust laws in the U.S. via the Clayton Act in 1914), which made price adjustment in the face of sectoral resource misallocation problematic. And precisely when labor adjustment was most needed (during the Great Depression), pro-union legislation exploded. While there was a significant increase in unionization in the U.S., in Great Britain it was larger, and certainly more virulent, with a major national strike in 1926. This made any necessary reallocation of labor very difficult, since labor wage rates were difficult to adjust. Many economists believe that monetary mismanagement is the causal reason for business cycles. Money enters into the economy at a specific place in time; that portion of the economy that new credit creation favors will grow relative to those sectors of the economy that do not receive new credit creation. Wages in those favored industries are bid up relative to the non-favored industries. Labor (and capital) will therefore tend to flow in the direction of the new credit creation. If the new credit is not based on real consumer preferences (along with associated savings), eventually there will be a conflict for resources (see chapter 12 for a review). When the bust occurs, the corrective mechanism includes adjustment of wage rates in each industry to align with true consumer preferences. Formerly favored laborers will need to take a relative wage cut, and other industries will see a relative increase in wage rates, until the supply and demand for workers (as well as capital) is consistent with true consumer preferences. One of the largest sources of monetary disorder has historically been associated with wars; countries seldom are willing to raise taxes to fund war efforts. The money supply often expands rapidly during wartime with increased government expenditures as seen in this chart from economist Ken Rogoff: