Germany’s Great Depression and Sticky Wages

Reading Peter J. Evans on the Great Depression in Germany made me wonder whether the causes of the catastrophe without which, as Evans convincingly shows, Hitler would never have come to power were the same as in the US.

This paper suggests that indeed they largely were. If there is widespread deflation it means that the revenue of many firms falls. Firms need to slash costs, including wages. But if wages are not allowed to fall (enough), firms will have (regardless of any Keynesian demagoguery) to lay people off. Thus, you get the mass unemployment disaster in the US and Germany. In Germany it was due not to the then government’s activism but due to trade unions and probably the general atmosphere of violence at the time, especially the violence by unemployed communists.

Ironically, in contrast to Hoover in the US who did everything to make businesses keep wages from falling, German chancellor Heinrich Brüning tried to achieve the opposite result when the scope of the catastrophe became apparent. For this he was savaged and is still savaged by folks like Krugman.

The final interesting question is to what extent the unemployment created through wage fixing causes falling output. There are two such ways which can’t be captured by Keynesian-style aggregate reasoning. One is that it is generally not possible to immediately replace the laid-off workers by capital.

But there is another, a bit less obvious, reason. In the case of mass unemployment caused by preventing wages from falling in the face of deflation, people who retain their jobs with the same (or too high) wages are actually nominally better off than before the crisis because their purchasing power is higher. But the problem is that they can’t just replace the laid-off people’s consumption. One won’t necessarily increase the consumption of bread just because it’s price has fallen. Thus, to meet their additional needs, there should have been a substantial reshuffling of the production structure. Which of course takes time.

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