Bryan Caplan deserves praise for calling on free market economists to pay more attention to the "grave evil" of unemployment. I fear, though, that he overstates what free market policies can contribute to solving the problem.
And this was during a period of as free markets as one could practically get.
This undermines at least three "free market" explanations for unemployment:
- "Welfare benefits mean the unemployed have little incentive to get work." In the 19th C, though, the only state support the unemployed got was in the Workhouse - and even as late as in my lifetime, this was spoken of with terror.
- "Big government and taxes deter job creation." But public spending in this time averaged only around 10% of GDP, and labour market regulation except for a few Factory Acts was nugatory by modern standards.
- "Wages are too rigid". But wages fell in nominal terms in 13 of the 59 years here, and in real terms in 12 of these years. Average nominal wages fell by 9% between 1874 and 1879, which is consistent with some sectors seeing very large falls.
There is, though, an alternative theory that fits these data. It's that a free market will see large swings in aggregate demand and employment, and that unemployment cannot be prevented by wage reductions alone. This was pointed out most famously - well famous in my house anyway - by Michal Kalecki in 1935:
One of the main features of the capitalist system is the fact that what is to the advantage of a single entrepreneur does not necessarily benefit all entrepreneurs as a class. If one entrepreneur reduces wages he is able ceteris paribus to expand production; but once all entrepreneurs do the same thing - the result will be entirely different.
Let us assume that wages have been in fact generally reduced...and in consequence unemployment vanishes. Has depression thus been overcome? By no means, as the goods produced have still to be sold...A precondition for an equilibrium at this new higher level is that the part of production which is not consumed by workers or by civil servants should be acquired by capitalists for their increased profits;in other words, the capitalists must spend immediately all their additional profits on consumption or investment. It is however most unlikely that this should happen...It is true that increased profitability stimulates investment but this stimulus will not work right away since the entrepreneurs will temporise until they are convinced that higher profitability is going to last...A reduction of wages does not constitute a way out of depression, because the gains are not used immediately by the capitalists for purchase of investment goods. (Selected Essays on the Dynamics of the Capitalist Economy, p26-28).
There's a good reason why almost all major economies abandoned free market economics. It's that such economies didn't and couldn't avoid mass unemployment.
I'll concede - much more than most lefties - that there's a big place for free market economics. But the labour market ain't it.
Note: data comes from the Bank of England.