How Keynesian economics gave us the disaster of big spending governments

Gerry Jackson

The present economic situation was brought to us by Keynes’ fallacious economic opinions. We now have a huge debt and politicians who are wedded to big-spending fallacies that will bring on another recession. These are ignoramuses who firmly believe the nonsense that any government spending is investment. It was Keynes who wrote that even

 ‘wasteful’ loan expenditure [credit expansion] may nevertheless enrich the community on balance. Pyramid-building,  earthquakes, even wars may serve to increase wealth,…1” (Italics added)

It should beggar belief that any reasonably intelligent person could swallow this oxymoronic statement. Demand deficiency lies at the heart of Keynes’ economics, so let us examine this fallacy.

When hiring labour employers do not take account of the real wage (the money wage adjusted for changes in the price level) but what they have to pay in money terms of money with respect to what they expect they will receive in nominal revenue from the services of the labour they hire. Therefore, if the price of labour services is raised above the value of what labour produces then unemployment will follow. In short, it is the ratio of the money wage rate  to the value of the output that matters to the employer. In the 1920s the late  British  economist  Professor  Frederic  Benham  studied  the connection between wage movements in Queensland and that state’s level of unemployment. By taking the ratio of the average Queensland wage  to  the  value  of  the  worker’s  output  he  established  that unemployment rose as wages rose “relatively to the value produced per worker” causing him to state that:

It would be hard to find a clearer proof of our thesis [meaning the marginal productivity theory of wages2]

We shall call Benham’s wage ratio the real factory wage. Chart 1 shows, with startling clarity, the ratio of the American factory wage to the value of output and its link to the  unemployment rate.

What we see here is basic economics. Raise the cost of labour above the value of its services and unemployment will emerge. The more labour costs are raised the more unemployment you  get. Chart3 CMNBK is just as telling as chart 1 and explains why Australia’s unemployment record during the Great Depression was greatly superior to America’s, despite Keynesian thinking to the contrary.

Australia, like America, also suffered a massive deflation. From March 1929 to September 1931 M1 fell by 27.2 per cent with demand deposits dropping by 33 per cent4. SCHED As we see from the chart, factory employment dived by 25 per cent and the value of factory output fell by 35 per cent. Note that the real factory wage peaked at 130 in the middle of 1931 and then began a slight decline. It was then that the contraction in factory employment came to a halt. Also note that at the same point there was a distinct slowdown in the rate at which the value of factory output was shrinking. During this period the money factory wage continued to fall until about June 1934 when it started to rise. The critical point is the middle of 1932 when the value of factory output started to rapidly increase and continued to do so throughout the remainder of the 1930s. (Not included in the chart was the dramatic drop in the prices of raw material inputs for manufactures.)

Charts 1 and 2 provide clear proof that the America’s high and persistent unemployment was the result of excessive wage rates as revealed by the real factory wage. This thesis is validated by the Australian experience. By excessive wage rates it is meant those in excess of the marginal value of the employee’s product and not his average productivity. These are entirely two different things. The principle point is very simple but rarely explained. It is blindingly obvious that if the value of a worker’s marginal product (the value of an additional unit of output) is x dollars but, let us say, unions insist on x+y dollars then unemployment must eventually emerge.

It also follows that the greater the gap between full employment wage rates and union-imposed rates the higher will be the level of unemployment. American money wages in manufacturing had been rising slowly through 1935 and up to October 1936. Then after the November there was an explosion of union activity. To extract higher wage rates from employers the union leadership organised a wave of strikes, violent confrontations, and mass sit-downs. This was combined with a union recruiting drive that virtually unionised the whole of manufacturing. The result was wage rate increases that gave America the depression within a depression.

The average manufacturing wage in 1936 was $22.60, average weekly hours of work were 39.1 and the hourly rate was $0.564. Thanks to the union-led wage push the hourly rate had increased in 1937 by 12.4 per cent, raising the weekly wage to $24.95. Employers immediately responded by reducing the average working week to 38.6 hours5. SAUS (Reducing working hours in these circumstances creates a form of hidden unemployment6). The situation was even worse in 1938 with the working week being further cut to 35.5 hours, dragging the weekly wage down to $22.70 and raising the level of hidden unemployment.

 When we look at some individual industries we can see just how destructive the union wage push really was. The steel industry was a huge target (we should say victim) of the union leadership. Its average wage 1936 was $27.42 and the hourly rate was $0.671 cents while weekly hours of work were 40.9. The following year the unions had rammed the hourly rate up by 22 per cent. The weekly wage jumped to $31.64 and working hours fell to 38.7. (One should note that the fall in working hours means that output was contracting). The full impact on jobs and wages was revealed in 1938 when the average manufacturing wage had fallen to $23.92 and working hours to 28.718.

To get some idea of how a surge in excessive wages rate (still bearing in mind that by excessive we mean in excess of the value of the marginal product) let us imagine a manufacturer with a slim net return of 6 per cent and total operating costs of $100,000,000 with $30,000,000 being wages. A 22 per cent jump in the wage rate would wipe out his price margin and immediately put him in the red. Although this is a hypothetical example it is basically what happened to the steel industry. In fact, once we include the benefits of union-enforced work rules, pay roll taxes and other Roosevelt imposed burdens the total increase in labour costs must have exceeded 25 per cent. The same holds for other industries.

Let us look at several more industries. The hourly rate in cast-iron production was pushed up by 11.2 per cent: the weekly wage rose from $18.99 in 1936 to $21.17 in 1937, weekly hours fell from 38.2 to 37.8. In 1938 the hourly rate was now 15 per cent over the 1936 rate, but the weekly wage had fallen to $19.15 and the working week to 32.8 hours. It was the same story for steam systems and fittings. In 1936 the average weekly wage was $24.25 and working hours averaged 42.2. The following year saw the hourly rate driven up by 13.2 per cent and the weekly wage rise to $25.02 while hours of work dropped to 40. The hourly rate in 1938 was raised again so that it stood at 19.4 per cent over the 1936 rate. The average wage now fell to $23.15 while working hours dived to 33.1, creating even more hidden unemployment.

The average wage in 1936 in the foundry and machine-shop products industry was $25.56, weekly hours were 42.4 and the hourly rate was $0.601 cents. In 1937 the unions lifted the hourly rate by 13 per cent. They lifted it again in 1938 so that it was now 18.3 per cent above the 1936 rate. The weekly wage was now $24.94 but the working had been cut to 35 hours. Weekly wages in the machine tools industry were $28.40 in 1936, the hourly rate was $0.636 cents and the working week averaged 44.6 hours.

By 1938 the unions had succeeded in raising the hourly rate by 20 per cent. Employers responded by lowering the working week to 36.3 hours, bringing the weekly wage down to $26.61. We find the same thing with aluminum (sic) manufactures. The industry’s average wage for 1936 was $23.38 and the working week was 41.3 hours. In 1938 the hourly rate was up by 20 per cent, working hours were down to 36.3 but the average weekly wage was now $24.07. (The figures are from the Statistical Abstract of the United States 1939, p. 329).

The 1937-38 depression was not caused by demand deficiency nor was it caused by a money contraction or a reduction in federal spending. The sole cause of the disaster was a brutal wage push by a militant union leadership. Huge percentage increases in wage rates savaged company price margins causing a massive contraction in production. It was this that triggered the monetary contraction that monetarists mistakenly think caused the crash. It is true that some historians point to Roosevelt’s destructive undistributed profits tax, the payroll tax and other imposts as at least contributing factors. Damaging as these were there is absolutely no way they could have caused the crash. For instance, the undistributed profits tax was a direct tax on capital accumulation, a fact that an economic illiterate like Roosevelt was unable to grasp. This tax combined with the other factors would simply have kept the economy depressed.


Charts 1 and 2 conclusively show the vital relationship between the real factory wage and the value of manufacturing output. (Australia’s real factory wage fell by nearly 43 per cent from its peak of 130 in 1931 to 75 in 1939). Now the Australian experience demonstrates with indisputable clarity that no matter what happens to government spending unemployment can continue to fall so long as the ratio of the wage rate to the value of the output is allowed to decline. Although it is not immediately apparent the ratio approach confirms the marginal productivity theory of wages. If the theory was false then there would be no inverse correlation between the real factory wage and the value of manufacturing output that charts 1 and 2 reveal.

The standard economic theory of wages stands vindicated. Therefore, the solution for the problem of persistent wide-spread unemployment is clear. Labour costs must be brought into line with the marginal value of the product, which is what the Australian experience amply demonstrates. There are really only two ways in which this can be done7: increase productivity to the extent where it continues to reduce the ratio until full employment is restored or use inflation to cut real wage rates. The latter is achieved by using inflation to raise the money price of the product relative to the wage rate. This is the Keynesian solution.

Oddly enough, the vast majority of Keynesians are genuinely oblivious to the fact that their policy proposal actually confirms the classical view that they believe Keynes refuted. They are also equally oblivious to the fact that the classical economists were aware of this deception and its dangers8. These economists fully understood that purchasing power springs from production (Say’s law) and this is why they rightly attacked as extremely dangerous the economic fallacy that consumer spending drives an economy. In 1937 three economists pointed out what should have been obvious to the profession as a whole:

The larger number of payments is not from consumers to producers, but is made between producers and producers, and tends to cancel out in any computation of net income of net product value. “In fact, income produced or net product is roughly only about one-third of gross income.” What is cost for one producer is in part income for some other producer, but part of that income the latter has to pay out in costs to other producers in another stage of the productive process (for intermediate products, raw materials, supplies, etc.), and so on. All that is necessary in order that equilibrium be maintained is that consumers’ incomes equal the cost of producing consumers’ goods; the total of producers’ payments necessarily exceeds that of consumers’ incomes9.

John Stuart Mill used what he called the Fourth Proposition of Capital to express this fact in another way when presenting the classical case against what we now call Keynesian thinking:

Demand for commodities is not demand for labour. The demand for commodities determines in what particular branch of production the labour and capital shall be employed; it determines the direction of the labour; but not the more or less of the labour itself, or of the maintenance or payment of the labour10.

Once we grasp the fundamental truth that the classical economists understood then we can see why Roosevelt’s New Deal economics were an utter failure and why by 1938 Australian unemployment had fallen from its peak of 30 per cent in 1932 to 8.8 per cent while American unemployment stood at 20 per cent against its peak of 25 per cent in 1933. The comparison between factory employment in both countries is even more striking.

In 1938 US manufacturing employment was 14 per cent below its 1928 level while in Australia it was 26 per cent higher than the 1928 rate and still growing. Moreover, during the depression hours of work in Australian manufacturing never fell below 44. In 1938 the average working week for US manufacturing was 35.5 hours against 44.82 hours in Australia. (This figure covers all industrial groups except shipbuilding). Furthermore, weekly hours of work in American manufacturing clearly indicate that the real unemployment rate certainly exceeded the official figure.

The extent to which Australia took (albeit unintentionally) a near-classical approach to the depression explains why she did so much better than Roosevelt’s America.


1Maynard Keynes, General Theory of Employment, Interest and Money, Macmillan, ST. Martin’s Press, 1973, p. 129.

2Frederic C. Benham, The Prosperity of Australia, P. S. King & Son, LTD, Orchard House, Westminster, 1928, pp. 210-211.

3Official Yearbook of the Commonwealth of Australia, 1935 and1940.

4The monetary figures are from Schedvin. He made the mistake of adding time deposits to M1. But these deposits were not chequing accounts and therefore did not add to the money supply. Genuine time deposits transfer purchasing power they do not, unlike demand deposits, create it,

Boris Schedvin, Australia and the Great Depression, Sydney University Press, 1988 p. 386-387.

5Statistical Abstract of the United States, 194.

6Working hours in Australian manufacturing never fell below 44. In short, there was no hidden unemployment.

7The Keynesian solution is to use inflation to cut real wage rates. Thornton

8Henry Thornton noted that inflation increases the demand for labour by lowering the cost of labour. He also drew attention to the consequences of sticky wages during a deflation.

Henry Thornton, 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.

Robert Torrens made the same observation in An Essay on the Production of Wealth,  Longman, Hurst, Rees, Orme, and Brown, Paternoster Row, 1821, pp. 326-27.

These men fully understood that inflation restored price margins and increased the demand for labour by raising prices.

9C. A. Phillips, T. F. McManus and R. W. Nelson, Banking and the Business Cycle, Macmillan and Company 1937, p. 71.

10John Stuart Mill, Principles of Political Economy, Vol, Liberty Fund, 2005, p. 78.)

3 thoughts on “How Keynesian economics gave us the disaster of big spending governments”

  1. No amount of arguing with facts will change the minds of big spending policitians. These people are stupid. Albanese honestly thinks you can run the economy on sunlight and the wind. There is nothing you can do with these drongos.

  2. I think the real problem, Ygor, is that politicians have swallowed Keynesian thinking. Gerry is the only one exposing it as rubbish. No one else is attacking and I don’t think they will, certainly not the IPA. I followed Gerry’s link to the Australian Institute for Progress and found them to be useless.

  3. This is the only site where I can get any real economics. The Spectator, the IPA and the newspapers are hopeless. Theyre bloody hopelss.

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