Australia and the Great Depression: recovery was not driven by real wage cuts, devaluation or consumption

My Keynesian critic asserts that the “cut in nominal wages which was one of the reasons we got deflation…” This is nonsense. The deflation was triggered when the London funds started restricting credit in order to build up their reserves. The result was a massive contraction from March 1929 to September 1931 that saw M1 drop by 27.2 per cent and demand deposits by a whopping 33 per cent. This should not even have to be said but the cuts in nominal wages were in response to the deflation and in no way contributed to it. Moreover, it is ludicrous to even suggest that a fall in nominal wages could under any circumstances be deflationary. A deflation is a strictly monetary phenomenon1.

He is right, however, in stating that the appalling increase in the unemployment rate was largely due to the increase in real wages. However, his assertion that as other countries got inflation immediately after they devalued then the devaluation of the Australian pound in January 1931 must also have been followed by inflation is flat out wrong2. A picture, as they say, is worth a thousand words. Although Australia devalued in January 1931 chart 1 shows that retail prices continued their fall from 1929 and did not start rising again until 1934, three years from the devaluation.

retailprices Wholesale prices started a staggered decline which was not reversed until the second quarter of 1933, some 30 months after the devaluation while manufacturing prices did not start rising until 1937-38, some seven years or so after the devaluation. Moreover, instead of falling, real wages remained basically flat, as shown by chart 2. We can see that the real wage never fell below its 1928 level. Therefore, the assertion that the devaluation generated an inflation that put people back to work by cutting real wages is patently false3. A number of economists and historians have studied this period. To my knowledge not one of them argued that real wages fell. For example, Professor R. G. Gregory, a Keynesian, wrote:

During the depression, real wages measured in terms of consumer prices were above their historical trend. Real wages…did not vary significantly during the 1930s4.

This fact was confirmed by Commonwealth statisticians who stated that

real production per person engaged implies a high real wage for those in employment, and is consistent with available information concerning rate of effective or real wages, which more than maintained in recent years the high level reached in the years 1927 to 19295. (Emphasis added).

realaveragewagesBecause price indexes consist of a basket of goods they can be misleading. In general raw material prices for manufacturing fell by some 33 per cent or so from 1928 to 1935. For example, the period 1931 to 1936 saw prices for coal and metals, important manufacturing inputs, fall by 14.2 per cent6. Costs were further reduced by the substantial gains that the steel and iron industry made in productivity while productivity in general increased by approximately 1.5 per cent annually. As the real factory wage fell, while the real wage remained comparatively flat, the demand for factory labour steadily rose7, as one can see from chart 3.


The real factory wage (the ratio of the factory money wage to the money value of factory output) peaked at 130 and then started to fall. At this point the rapid fall in the money value of output slowed and factory employment levelled out. (The vertical black lines mark these turning points) As soon as the value of factory output began to rise the fall in the real factory wage rapidly declined.

The result was an immediate increase in the demand for labour that continued to 1938 when there was a slight reversal after which unemployment continued to fall. (In September 1939 the country was at war). So what Australia had was a major reduction in manufacturing costs that led to a production-driven recovery8, all the more remarkable considering the amount of imported inputs that manufacturing used9, that rapidly reduced the unemployment rate. What all of this means, as an economist would put it, is that the supply curve shifted to the right.

There appears to be a gross misunderstanding of the devaluation. The Australian pound was great overvalued against sterling and other currencies. In other words, Australia’s price level was out of kilter with those of its trading partners. The devaluation merely brought the Australian price level into line with other price levels, though it might have overshot somewhat. Therefore, the devaluation brought Australian industry to the stage where it should have been in any case if the currency had not been overvalued.

 Another way of putting it is to say that the exchange rate was adjusted to reflect purchasing power parity. Every classical economist fully understood this fact and knew that a devaluation was not a weapon to reduce costs — particularly real wages — but a process of bringing international prices into alignment. Anyone acquainted with the Bullion Controversy would know this. (It should be obvious that there is a fundamental difference between a genuine devaluation and inflation-driven depreciations specifically designed to drive down the exchange rate).

It is also important to note that Australia’s recovery did not begin until about fifteen months after the devaluation. This is a very long stretch for the devaluation to have worked the magic my critic claims for it10. Furthermore, a mere twelve months after the devaluation the Australian pound began to rise again as sterling strengthened. (This puts paid to any suggestion that the full effects of the devaluation were fully maintained throughout the remainder of the decade). In January 1931 the rate against sterling was set at 130. Given that the British pound was also overvalued when Australia tried to maintain parity it is no wonder that the country underwent a massive exchange rate adjustment.

Now in December 1932 the dollar exchange rate was $2.62 but by 1934 the exchange rate had risen to over $4, a rise of more 50 per cent. Imports also started to increase fairly soon after the devaluation. From 1932-33 to 1936-37 per capita imports rose by more than 55 per cent. These facts are needed to put the devaluation in some perspective. They should also disabuse anyone of the notion that the devaluation meant that imports did not increase again during the depression and that the Australian exchange rate did not rise against other currencies.

There is absolutely nothing inflationary about the devaluation process and it is absurd to suggest otherwise. That there is a fundamental difference between how a genuine devaluation works and how inflation operates is something my critic, like so many others who push this line, completely fails to grasp.

No matter what anyone might think the devaluation does not vindicate Keynesianism. Even if the devaluation had been entirely responsible for the drop in employment and the economic expansion it still would not justify Keynesian policies because there is absolutely nothing Keynesian about devaluations. I am against the devaluation explanation for recovery simply because it does not fit the facts, specially when it comes to real wages.

What is truly striking about Australia’s performance during the Great Depression and the thing that really scares Keynesians is that the government cut spending in the depths of the depression by 15 per cent and then ran surpluses until WWII. The result was a rapid and continuing expansion in manufacturing accompanied by a steady and continual drop in an unemployment rate that at one point reached 30 per cent. According to Keynesians this policy should have resulted in an appalling economic disaster.

To sum up: Devaluation did not trigger an inflation and real wages did not fall. Moreover, the evidence clearly shows that the recovery was production-driven. As someone once said: “Facts are stubborn things”.

There will be more on this subject in my next post in which I tackle Roosevelt’s 1937-1938 depression. I shall pay particular attention to the Keynesian absurdity of blaming the contraction on the drop in federal spending.

* * * * *

1Deflation is a monetary contraction. It is associated with swelling inventories, mounting bankruptcies, negative profit margins, widespread unemployment and falling prices. Given these facts it is truly a marvel that a situation where, thanks to technological improvements and entrepreneurial flair, prices continually fall while prosperity rises and real profit margins are maintained can be considered deflationary, even though the money supply is increasing.

2The worst a devaluation can do with respect to prices is bring about a one-off increase. A continuing rise in prices requires an inflationary monetary policy. To argue that the Australian devaluation was the means to lower costs is a serious error and it is one that Sinclair Davidson and Julie Novak made (Institute of Public Affairs: 5½ big things Kevin Rudd doesn’t understand about the Australian economy).

The effect of an overvalued currency is to artificially lower the prices of imported goods relative to domestically produced goods. This means that thanks to her overvalued pound Australian prices in terms of international prices had been artificially increased. The devaluation merely restored the market balance.

3That inflation can increase the demand for labour by lowering real wages is no Keynesian insight. Henry Thornton discussed this very point 210 years ago. He clearly saw that this was done by allowing the money wage to fall behind the general rise in prices. It was not a policy he approved of. (An Enquiry into the Nature and Effects of the Paper Credit of Great Britain, 1802, Augustus M. Kelley, New York 1965, pp. 118, 189-90).

4Recovery from the Depression: Australia and the World Economy in the 1930s, edited by R. G. Gregory and N. G. Butlin, Cambridge University Press 1988, p. 218.

5Labour Report, 1938. No, 29. March, 1940, p.71.

6Official Year Book of the Commonwealth of Australia, No. 32, 1939, p. 424.

7The real wage is determined by dividing the nominal wage by the price level. But employers hire people not according to this wage but the money wage they must pay relative to the value of a worker’s product. Therefore, if the value of the product rises relative to the wage rate the demand for labour will increase.

This thesis is confirmed when the money factory wage is divided by the money value of factory output. The result is an inverse correlation of 0.978. As expected, when the real factory wage fell relative to the value of the output the demand for factory labour rose thereby confirming the standard economic theory regarding wages and the demand for labour. It should also be noted that by reducing the cost of labour relative to the value of the product an increase in productivity would also strengthen the demand for labour.

8Steve Kates has engaged the post-Keynesian Louis-Philippe Rochon in a debate over Keynesianism and aggregate demand. I cannot see how Kates’ approach will sway anyone who is not already committed. You cannot defeat Keynesians without detailed historical examples to bolster your case. Kates is not doing this. He has also failed to grasp the fact that the gross spending approach that Austrians use destroys Rochon’s consumption-drives-demand argument. His response to Rochon’s pent-demand argument regarding 1945 revealed an appalling ignorance of the Keynesian argument regarding America’s post-WWII economy. Worst of all, before the debate had really started Kates conceded a Key point to Rochon: markets are unstable and that’s why we get these booms, busts and financial crises.

9Australia imported the great majority of its capital goods.

10My critic claimed that “Gerry wants to believe the lag associated with the devaluation was the longest recorded in economic history.” Nonsense. I said nothing about historic records. I merely pointed out the very simple fact that the lapse of time between the devaluation and the beginning of the recovery weakens the devaluation argument. No more and no less than that.

26 thoughts on “Australia and the Great Depression: recovery was not driven by real wage cuts, devaluation or consumption”

  1. Nottrampis is not interested in facts. He is a true believer. He produces no statistics to refute Gerry but insists he is right and Gerry is wrong. He should put up or shut up.

  2. Dead right, Sarah. Nottrampis demands his stats on Australia’s gdp be accepted and anything else he puts up but then he rejects Gerry’s stats when they prove him wrong.

  3. This post finished it for me. The statistics have completely destroyed nottrampis. I know it wont make any difference because Sarah is right about him being a true believer. True believers are never persuaded by facts.

  4. I followed the link to Kates at Catallaxy. Hes really off-putting. Reading him you would think he is the only anti-Keynesian in the country. Gerry is dead right about the guy not providing any evidence to support his argument. That’s something he has in common with Nottrampis.

  5. I went there too. All they did was throw assertions at each other. Gerry’s comment about that this pair makes me think he might be going after them. He should. This is where the real debate is happening and the catallaxy crowd knows it.

  6. The stats and quotes prove Gerry is right. It makes sense that if prices didn’t rise and real wages didn’t fall then costs must have fallen.

  7. Gerry,

    Thanks for the articles.

    Regarding footnote 3: Is the reason that real wages do not rise while there is an increase in general prices as simple as it is a lot easier to change prices for products and services throughout the year while nominal wages are generally locked in for a year’s period? Further, while the prices of non-wage inputs to products and services may increase more frequently, wages usually make up the majority of the cost of a product or service and so overall employers can still “benefit” from inflation?

  8. I’m not quite sure what elefb is saying. Thing is that Nottrampis argued that unemployment fell because devaluation cut real wages. Gerry showed that real wages never fell but stayed level.

  9. Gerry,
    Any real wage is merely the nominal wage increase less the rate of inflation.
    Your real factory wage versus real wage is a contradiction in terms.

    If you merely look at annual prices or growth then you will miss out when recovery or prices started rising. If output fell in 1932 but it must have started to rise in that year if growth rose in 1933. if prices rise in in 1934 then they must have started to rise at some stage in 1933.

    You do not seem to understand the structural part of the budget. It clearly went into surplus in 19312 hence 1032 went backwards. It did not get any bigger after that thus fiscal policy was either neutral or slightly expansionary from 1032 onwards.

    Simply because a budget is in surplus does not mean it is cointractionary.

    you need to explain why a contractionary budget is expansionary in Australia in 1932 whilst it clearly wasn’t in the USA in 1937 nor in Germany in the early 30s.

    I’m a bit busy so I will leave it at that.

    Good to see you are now in good health.

  10. Fantastic response Nottrampis. Keynesians are now telling us that budget surpluses are contractionary except when they are expansionary. Your brilliance stuns me. The great thing about Gerry is that he explains himself. You never do. You just throw assertions at him in the hope one of them will trip him up. Pathetic

  11. To clarify. It was more of a general question about the concept of raising employment through inflation than a specific statement about this particular scenario. And, of course, that should read “Is the reason that *nominal* wages do not rise…”; a typo. Apologies for the confusion.

  12. Unbelievable! Gerry used official statistics to calculate real wages and Nottrampis questioned their accuracy and insisted wages fell. Now Nottrampis unquestionably accepts price indexes because he thinks they will get him out of the corner he painted himself into.

    What kills me about this is that Gerry explained that these indexes are flawed and concealed important price movements and he gave us examples but nottrampis ignored them,

    He cannot hide from the fact that when Australia cut spending and ran surpluses the economy started a recovery. I’m no economist but even I know that Keynesians say thats impossible in a depression.

  13. Nottrampis is impossible to deal with. Gerry pointed out that wholesale prices did not start rising until “30 months after the devaluation” and “manufacturing prices did not start rising until 1937-38”. He also showed that the real wage did not fall. Notrampis whole argument is based on real wages falling. Gerry showed they did not.

    I went over Gerry’s post again. He never said the contractionary budget was expansionary. Nottrampis made that up. All Gerry did was point out that unemployment fell when spending was still falling. Notrampis’s “real factory wage versus real wage” comment is plain stupid. I know I’m not the brightest bulb in town but I could see that Gerry was talking about two different things.

    Where does Gerry get his patience?

  14. Gerry did Nottrampis like a Sunday roast. That’s why he’s reduced to nitpicking. Sarah is spot on with this guy. Why bother with someone who cannot find any stats to support him?

  15. I gave this a bit of thought, elefb. Basically, quoting Gerry, you increase the demand for labor by using rising prices to cut the cost of real wages. The producer gets more money for his products but pays out the same in wages. The worker has the same wages but cannot buy as much as he did before.

  16. Hi Lenny,

    Thanks. I guess what I am trying to understand is the “why”: why do wages remain the same while general prices for goods and services can increase. Wouldn’t there be a clamouring by workers to get their pay increased to match the general increase in the prices of goods and services? So is it because wages generally get negotiated only once a year while the prices of goods and services can be changed a lot more frequently and easily?

  17. Ref: Nottrampis

    By the numbers

    1. You are completely confused regarding real wages. The real factory wage is not “a contradiction in terms”. It is the average factory money wage divided by the value of factory output. The real wage (meaning purchasing power) is the money wage divided by the price level. They are two different concepts. It is the real factory wage that determined manufacturers’ demand for labour, not the real wage.

    The idea for the real factory wage comes from Professor Frederic C. Benham “The Prosperity of Australia”, P. S. King & Son Ltd, Orchard House, Westminster, 1928, pp. 205-13. Benham made it clear, as I myself tried to do, that this confirms standard economic theory usually known as the marginal productivity theory of wages.

    Anyone acquainted with marginal productivity theory should have immediately spotted what I was doing.

    2. Prices. What more can I say? The devaluation was in January 1931 but the wholesale price index did not start its upward trend until into the second quarter of 1933: 30 months after the devaluation. Retail prices flattened out in the latter half of 1933. It was in the first and second quarters of 1934 that the retail price index started its upward trend. (Official Year Book of the Commonwealth of Australia 1934, p. 696). And did I not point out that key prices did not start rising until even later? And why are you focusing on prices when I have shown that real wages did not fall?

    3. Going into surplus did not send the economy “backwards”. If it had done so then it would have accelerated the contraction. I do not know of any evidence that shows this happened. If you have any statistics to the contrary, please produce them.

    4. “Simply because a budget is in surplus does not mean it is contractionary”. Keynesianism 101: surpluses take spending out of an economy. In other words, spending is lower than it would otherwise be. This is why surpluses have been recommended to slowdown an economy that is “over heating”.

    5. I did not say that the “contractionary budget” was expansionary any more than I said it was contractionary. I merely said that spending was cut and surpluses emerged and this was supposed to be ruinous according to Keynesian thinking. It is they who need to do the explaining, not me. In any case, I am going to deal with this in my next post on the depression and Roosevelt.



  18. Gerry,

    1) Real wages are wages subtracted from inflation.
    you simply used the wrong concept which had nothing to do with inflation. Manufacturing output rising after tariffs and a massive devaluation ( 25% I think against the pound). Not surprising.

    2) you avoid my point. Disappointing

    3)Yes it did. GDP was rising beforehand and then it fell

    4) Sorry mate but as I have shown surpluses can be expansionary 9 Australia 2007) and deficits can be contractionay ( Roosevelt 1937 or Europe just recently.) If you can’t get you head around that you simply do not understand Fiscal policy.
    The best example is Wayne Swan’s last budger. It was a deficit but it detracted 0.7 percentage points from GDP. It is easily the tightest in budget history. Our Mate Davidson laughingly called it expansionary

    5) Why did Australia ‘expand’ under such policies but the US and Germany didn’t?

  19. There is still this notion that the deflation caused by banks failing during the early 1930s caused the Great Depression because there was a decline in prices and high unemployment. What prolonged what should have been a short contraction relatively to what occurred, were all the interventions that distorted prices. For example, the propping up of wages during the 1929-1932 period when there was a 30% decline in the money supply caused businesses to be able to afford to pay less workers at pre-deflation wages which resulted in unemployment.

    It’s important to note that a depression with high unemployment could occur in an inflationary environment as well if wages were propped up above market clearing rates. If wages in an inflationary environment were propped up to a high level and inflation was not high enough to widen profit margins sufficiently then unemployment would result.

    What’s interesting is a research paper from the Federal Reserve Bank of Minneapolis that did a broad historical study of inflation and real output growth for 17 countries over a 100 year period and found that deflation and depression are not empirically linked. Deflation and depression do seem to have been linked during the 1930s in which the paper found:

    … the only episode in which we find evidence of a link between deflation and depression is the Great Depression (1929-34). We find virtually no evidence of such a link in any other period. … What is striking is that nearly 90% of the episodes with deflation did not have depression. In a broad historical context, beyond the Great Depression, the notion that deflation and depression are linked virtually disappears. (1)

    1. Atkeson, Andrew and Kehoe, Patrick. Federal Reserve Bank of Minneapolis. Deflation and Depression: Is There an Empirical Link? January 2004.

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