Why Wages Rise: 12. Riding The Waves Of Business

In the previous article, the problem of pricing one’s work was discussed. It was shown that wages are a price, subject to all the influences and char­acteristics that affect any other price.

Price has an important function to perform. It equates the wanting of things with the supplying of things. The two are in balance only at the free market price. Any other price, either higher or lower, causes a sur­plus or a shortage; it reduces trade; it penalizes economic welfare. And if the price of work is too high, it causes a labor surplus —"unemployment."

The number of jobs available is highly responsive to wage changes. Apparently a rise of wages by only one per cent above the free market level causes as much as 3 per cent unemployment.

In this, the final article in this series, our economic experiences of the past in the United States will be reviewed. In the light of these wage principles, what has been our experi­ence in pricing work in the market place for jobs?

When one first thinks about the price for work as having a three-times power over employ­ment, it may seem hard to believe.

Looking at only one job, it would seem to be filled or not filled com­pletely. So what does it mean to say that a rise in the wage rate by one per cent causes a 3 per cent layoff of workers? But for the country as a whole it works out that way. New jobs of all sorts are found when wages go down. But when wages go up beyond the free market point, some jobs close down completely and others close down part of the time.

To see how this works, one must look at an entire economy like a nation and not to one little spot, like only one job. He must look at the entire market of jobs available at the different prices.

That is what students of the subject, like Douglas and Pigou, have done for us in their studies. Both of these authorities found that each one per cent higher wage, from the point of a free market wage, will disemploy 3 per cent or more of the workers.1

Wages and Total Income

Even a child knows that the higher his wage the more will be his income — except that it isn’t so. This would be true only if one could keep his job at the higher wage. If it were true that I could keep my job anyway, then an in­finite wage would seem to be the ideal. The trouble is, however, that jobs are lost three times as fast as wages are raised.

This being true, the highest in­come is found at full employment.

Let us now assume that I change my wage and take the changing employment at my own job. As I raise wages above the free market point, I do not lose my job completely; but I will have to take my share of the loss of work that comes from an excessive wage. As my wage goes up, my job will have to be shortened more and more, by the proportion Douglas and Pigou found to apply.

If we assume that I work 1,800 hours in a year at $2.00 an hour, this is the way my income would work out:

Wage rate

Aprox hrs.

Yearly income

$2.O0* …….  



2.20 ………..  



2.40 ………..  



2.60 ………..



2.80 ………..  



3.00 ………..  



 *The free market wage

So my income for the year de­clines as wages rise above the free market point, for the simple rea­son that the work I lose more than offsets the gain in rate per hour. For instance, in the rise from $2.00 to $2.20 there is a loss of 450 hours of work at $2.00 ($900 loss); this exceeds the gain of 20 cents an hour on the 1,350 hours ($270 gain). So the net loss is $630 for the year.

Experience with Unemployment

How has this idea worked out in actual experience?

One cannot know the actual free market wage for a nation, of course. There are innumerable jobs and innumerable skills. There is really a free market wage for each person, and therefore millions of free market wage rates for differ­ent persons and different jobs.

Perhaps the best way to see how wage rates compare with the free market rate is to measure the sur­plus of labor unsold in the labor market. In other words, despite all the faults in such a statistic and all the perplexing problems of ar­riving at a figure, the number of persons unemployed is probably the best reflection of excessive wage rates.

During the first three decades of this century, unemployment sel­dom was more than a few per cent of the numbers at work. It was usually no more than those persons moving from job to job, or temporarily out of work for some reason other than lack of an available job. The year 1920 was one clear exception, at the time of the postwar collapse in prices. Nor has there been more than the so-called normal unemployment during the years since World War II. In both these peri­ods, then, wages were apparently in line with the free market al­most constantly. If they got out of line, adjustment was so rapid that unemployment never became a sus­tained problem to any extent or for long.

From 1930 to 1941, on the other hand, unemployment rose to a tremendous height — to as much as one-third of the number employed, at the peak in 1933. This indicates that there was a serious over­pricing of wage rates during the 1930′s.

Wages need not be far out of line on a percentage basis to cause even that degree of unemployment, however. On the basis of the three to one leverage, for instance, a wage rate only about 10 per cent too high could have caused that much unemployment.

The Danger of Controlled Wages

It is clear from this evidence that the conclusions of Douglas and Pigou as to the elasticity of wages found confirmation in the tragic experience of the 1930′s. It also shows that those who play with wage rates at the bargaining tables are toying with dynamite, not only as it endangers the work­er’s job but also his yearly income.

It is clear, too, that those who play politically with wage controls are also playing with dynamite. The bitter experience of the thir­ties illustrates their chronic tend­ency to play their hand upside down, to the disadvantage of the presumed beneficiaries. Believing that nobody could want his in­come reduced, they use their power to the full to prevent wage rates from dropping. And the "buying power" theory comes to their as­sistance at such times, by which it is argued that incomes must be kept up if consumers are to be en­abled to buy back the things they have produced.

But keeping income up is not the same as keeping wages up, as we have seen.  Incomes move down as wages move up from the free market point.

Why Depressions Disrupt

What happens, then, under con­ditions like those of the early thirties? At the outset, for reasons we shall bypass here by merely saying that the trouble begins with "monetary causes," the money supply starts to shrink. This causes prices to decline, because less money leads to less price. If ab­solutely every form of price were to drop by the same amount, no serious harm would be done. Everything would then retain the same relationship as before to everything else, and business would go on about as usual except for the task of changing price tags on things, and such as that.

But prices do not all decline by the same amount. Our concern here is with wages, which fail to drop along with other things. Since they comprise three-fourths of total personal incomes, the serious ef­fect of excessive wages becomes extremely great on the economy as a whole.

Wages are to a considerable ex­tent under future contract. Even without a contract, wage reduc­tions are resisted strongly, even though with lower prices the lower wage would buy as much as before.

A wage that is supported at its former level when other prices are declining is the same as a wage increase when other prices are re­maining the same. And so in a depression like that of the thirties, supporting wages at their old level puts them above the free market level, just as if they had been pushed upward arbitrarily when prices were stable. The result is unemployment — three-to-one un­employment.

Politicians and business execu­tives also arrive on the stage at about this time to lend their "help." They also try to hold wages up. This is precisely the wrong thing to do. It merely makes mat­ters worse, like doing something to maintain the blood pressure of a person with high blood pressure.

All in all, "help" at such times is dangerous. Controlling wages amounts to threatening the life of the patient, who would quickly re­cover as he always has done in the past when left to resolve his own problems — if he is free to continue to work at the best price a free market will offer him.

Profits and Unemployment

In his surplus value theory, Karl Marx maintained that profits in­fringed on the welfare of the worker and should be reduced to zero.2 The conflict between this theory and the truth, as shown by experience, is revealed by the chart on unemployment and shares of the national income.

In two of these years the sur­plus value objective was attained, so far as corporate profits are con­cerned. And in those years the number of persons unemployed rose to a third of the number em­ployed. This was a high price to pay for an extra wage rate of 10 per cent — or whatever the figure was — as an average for those fortunate enough to have work. The price was especially high for those without work.

The agreement between changes in profits and changes in employ­ment is not exact, of course. But the similarity in a general way is clear. It definitely disproves the surplus value theory. Not only is the theory wrong, it is precisely upside down — at least when wage rates are pressing profits toward total disappearance, as in the 1930′s.

Sweeps of the Business Cycle

The notion persists that busi­ness swings upward and downward with more or less regularity, and that this is inherent or inevitable under private enterprise. It is also believed that these swings have been getting worse and worse as we have proceeded into a complex economy since the industrial revo­lution.

This latter notion is a favorite argument of persons bent on so­cializing this nation, especially those of political inclination. They say that as our economy becomes more complex — more integrated, more urbanized, more specialized —more and more of it must pass from personal ownership and con­trol and be brought under the wing of the government. The rea­soning sounds impressive, because the increasing complexity of our economy is perplexing to anyone who tries to see it all at once. But is it a fact?

The chart showing instability of business indicates this to be untrue over the history of the nation. But first a word of explanation about the design of the chart.

The base line of zero indicates a point of no deviations of business from the upward trend of increas­ing output — more people and more productivity, over the years. Zero represents unwavering stability, with business running smoothly along the trend of its growth.

The percentages above zero, rising vertically up the scale, rep­resent increasing instability of business. These are the percent­ages by which business fluctuated around the trend — either above or below the trend, with both con­sidered to be unstable by this measure.

A completely stable business would, then, run along the zero line. At 2 per cent there would be indicated fluctuations in business with a divergence from the trend averaging 2 per cent. And at 4 per cent, twice the average divergence of the 2 per cent point. And on up the scale.

From 1795 to 1928 the average instability was 7 per cent. This means that for the entire period a best guess of the level of business in any month would be 7 per cent away from the trend, either above the trend or below it.

The Myth of Instability

In general, over the period there was no distinct increase in the in­stability of business. There were recurrent depressions and boom-lets, but these were quickly cor­rected — short-lived, in almost all instances. If anything, business over this century and one-third was becoming more stable rather than less stable; this was certainly true up to the middle nineteenth century. And except for the effects of World War I, there was no evidence of an increasing instability of business even up to the depression of the 1930′s.

Then came the Great Depres­sion. A break in the line was made in 1929 because of the violent change in stability before and after that date, making it seem wise to treat the data as two separate series.

Instability of business since 1929, and continuing even up to the present, is something unprecedented in our history. This insta­bility of the last quarter century certainly cannot be called, cor­rectly, a continuation of any long­time upward trend in business fluctuations under our increasing industrialization of the past cen­tury. It is something distinct and suddenly new in our economy — a degree of instability above any­thing we have ever before known in this country.

It is necessary, then, to conclude that the argument about the in­creasing instability of business is a creation of the imagination or of socialistic invention. Being un­true, it is certainly not a reason for more and more controls over our business affairs. As has been pointed out, controls seem to have done precisely the wrong thing. They have unstabilized business and caused unemployment rather than stabilizing it. It would seem that the controllers know what not to do and put it into practice — rather than what to do at such times.

Business will undoubtedly con­tinue to fluctuate in some degree in the future, controls or no controls. We can expect that. The problem is to adjust as quickly as possible to these changes in conditions, to whatever extent they are beyond our ability to foresee and to pre­vent.

Cycles Not All Bad

Not all fluctuations in business are undesirable, to be prevented if possible. Take house building, for instance. I have built only one house in my life; and had I continued to live there, I should prob­ably never want to build another. The building of it took about half a year. The result was about as intense fluctuation in my building activity as you could imagine — an intense activity for six months, preceded and followed by building activity at zero so far as I was concerned. I had only one cycle in my building, and then it was all over.

Were a business statistician to study my economic affairs, he would find my house building to be tragically unstable. Suppose he then teamed up with some politi­cian bent on stabilizing business for the general welfare. How would he be able to do it? He would have to determine in advance the probable length of time I would want a house — say fifty years —and then force me to build one-fiftieth of my house in each of those years. That is the only way stability in my house building could be accomplished.

The Human Factor

But being human, I am con­cerned with my own general wel­fare, too. As one among supposedly free people exercising economic choices, I don’t want to stabilize my house building. There comes a day when I finally decide that I want a house and can afford to build one. I get some help and go ahead with the job as quickly as I can; then it is done. I don’t want to be forced to build the house be­fore I want it, and I don’t want to be forced to build another one later that I don’t want — merely to stabilize some statistic.

And you, I dare say, feel the same about building your house. And so does everyone else.

If as a consequence fewer people want to build houses this year than last year, what is wrong with that? The statistic for the nation is unequal, to be sure, as between the two years. What is to be done about that? Should some people have been prevented last year from building houses that they wanted to build, that they had money saved with which to build, and when building employees and available materials were ready for the job to be done? Or should some persons this year be forced to build houses they do not want, just because the statistic is declining?

This sort of business fluctuation runs all through our daily lives. There is a violent fluctuation, for instance, in the harvest of straw­berries at different times during the year. Should we grow enough strawberries in greenhouses so as to stabilize that part of our econ­omy throughout the year?

Sales of toys and Christmas decorations are quite unstable, too. Should we make people buy them equally throughout the year, so as to stabilize production?

Weddings and the sale of affil­iated goods and services are highly unstable during the year, and over the years. And so are the sales of baby carriages. Should we stabilize all these month by month and year by year? How?

Remove the Prohibitions

My own conclusion is that we should not worry about all such fluctuations in business at all. We should worry only about those fluc­tuations which are due to prohibi­tions on the rights of each person to work at a job of his choice —either for himself or for an em­ployer who wants his labor — at a wage mutually satisfactory between them. We should worry only about prohibitions on the spending of his income for what he wants most, among things offered by others who have produced them from their own labors.

If we do this, business fluctua­tions will be reduced to whatever fluctuation people want — not being forced to build houses when they don’t want them, or being forced to get married when they don’t want to. Wages would then be as high and would rise as rapidly as is possible. Leisure, to the extent one can afford it and wants it, would then be chosen as each per­son so desires. These conditions would give the maximum of wel­fare possible for us to attain at any time. It would be as near a utopia as can be hoped for in eco­nomic affairs this side of Heaven.

Foot Notes

¹Technically, this is an elasticity of de­mand for labor of— 3.0 or a little more. For reference sources, see "Why Wages Rise: 11. Pricing an Hour of Work," The Freeman, January 1957. p. 19.

2See "Why Wages Rise: 3. Dividing the Pie," The Freeman, May 1956. pp. 27-32.