An industry-level panel analysis of Vedder and Gallaway's adjusted real wage model in the interwar era

In their 1993 book, Richard Vedder and Lowell Gallaway contend that US unemployment during the twentieth century can be largely explained by movements in the "adjusted real wage rate", that is, the real hourly wage rate divided by labor productivity. In particular, the authors suggest that high-wage policies by both Presidents Herbert Hoover and Franklin Roosevelt played a major propagation role in the Great Depression of the 1930s. A potential criticism of Vedder and Gallaway's simple time-series model is that wages and employment may be endogenous. We employ techniques such as a Pedroni Dynamic Panel OLS and a Panel VAR, that explicitly allow for endogeneity. The results suggest, consistent with Vedder and Gallaway's thesis, that shocks to an industry's adjusted real wage rate caused negative movements in industry employment between June 1920 and December 1938. This supports the Austrian interpretation that the Great Depression was less a failure of markets than a failure of policy.