Nobel Prize winning economist Paul Krugman writes today in The New York Times about why the economy will never recover until the jobs situation is improved. Krugman says that when the economy pulls out of recession in a year or so it will be a jobless recovery, which will keep the economy weak. Right now, many people are losing jobs. But those that kept their jobs had to take a pay cut to keep them. And that is a real problem, says Krugman.
But why is that a bad thing? After all, many workers are accepting pay cuts in order to save jobs. What's wrong with that?
The answer lies in one of those paradoxes that plague our economy right now. We're suffering from the paradox of thrift: saving is a virtue, but when everyone tries to sharply increase saving at the same time, the effect is a depressed economy. We’re suffering from the paradox of deleveraging: reducing debt and cleaning up balance sheets is good, but when everyone tries to sell off assets and pay down debt at the same time, the result is a financial crisis.
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In particular, falling wages, and hence falling incomes, worsen the problem of excessive debt: your monthly mortgage payments don't go down with your paycheck. America came into this crisis with household debt as a percentage of income at its highest level since the 1930s. Families are trying to work that debt down by saving more than they have in a decade -- but as wages fall, they're chasing a moving target. And the rising burden of debt will put downward pressure on consumer spending, keeping the economy depressed.
Things get even worse if businesses and consumers expect wages to fall further in the future. John Maynard Keynes put it clearly, more than 70 years ago: "The effect of an expectation that wages are going to sag by, say, 2 percent in the coming year will be roughly equivalent to the effect of a rise of 2 percent in the amount of interest payable for the same period." And a rise in the effective interest rate is the last thing this economy needs.
Concern about falling wages isn't just theory. Japan — where private-sector wages fell an average of more than 1 percent a year from 1997 to 2003 — is an object lesson in how wage deflation can contribute to economic stagnation.
Krugman doesn't make specific proposals to fix the job situation. Generally speaking, he advocates more stimulus spending by the government. But many taxpayers are unhappy with the way the bailout has been going so far. In any event, it seems clear that until the jobs situation is fixed, there will be no real recovery, especially in the retail and fashion industries.
