But I think it’s worth pointing out why Ms. Shlaes thinks the New Deal was destructive of employment: namely, that it raised wages. Funny she should mention that — because the effect of wage changes on employment was the subject of a whole chapter in Keynes’s General Theory.
And what Keynes had to say then is as valid as ever: under depression-type conditions, with short-term interest rates near zero, there’s no reason to think that lower wages for all workers — as opposed to lower wages for a particular group of workers — would lead to higher employment.
Suppose that wages across the US economy had been, say, 20 percent lower than they actually were. You might be tempted to say that this would make hiring workers more attractive. But to a first approximation, prices would also have been 20 percent lower — so the real wage would not have been reduced. So how would lower wages lead to higher demand for labor?
Well, the real money supply would have been larger — but the normal channel through which this might increase demand, lower interest rates, was blocked by the zero lower bound. Yes, there would have been a slight Pigou effect: real private sector wealth would have been higher, because cash under the mattress (or wherever) was worth more. But on the other hand, real debt burdens would also have been higher, probably exerting a contractionary effect. Overall, there’s no good reason to think that lower wages would have helped raise employment.
And once you realize that, the whole argument that FDR prolonged the Depression by sustaining wages evaporates.
I'm no expert on Keynes, but I can't make heads or tails out of what Krugman is saying. My understanding of Shlaes is this: If the government forces wages to rise above market wages, for example by instituting minimum wage laws or encouraging unionization through government intervention (both of which the government did in the 1930s, first through the NIRA and then through the NLRA and FLSA), unemployment will result. Imagine, for example, that the government passed a law tomorrow dictating that as of January 1, everyone with a job will get a 20% raise, but employers are not required to retain any employees. Undoubtedly, some individuals will retain their jobs, but many others will be laid off. If the new wages are thereafter applied to new employees, employers will hire far fewer workers. Let's say the government on January 2 realized it made a big mistake, and restored the status quote ante. Does Krugman really believe that this backtracking would not lead to a "higher demand for labor?"
More generally, Krugman's recent blog posts suggest that he thinks that the New Dealers were operating within some sort of methodical Keynesian framework. In fact, the New Dealers believed all sorts of nonsense: that the U.S. was suffering from "overproduction;" that productivity followed wages, rather than vice versa; and, perniciously, that low-wage industries should be shut down, because these "parasitic" industries employed "defective" workers (often immigrants or African Americans) whose low wages showed that they were not capable of competing in a modern labor market, and were dragging down wages for everyone else.
So, for example, when the NIRA's cotton wage code led to massive unemployment in the industry, the Cotton Code Garment Authority bragged about the reduction of the use of "sweated, underpaid workers" in the garment industry. The Authority said it was necessary "to remove thousands of these substandard workers," who were "replaced by fewer, but far higher paid and more productive wage earners."
With regard to minimum wage laws, as economic historian Bruce Shulman has pointed out,
if the FLSA imperiled any southern jobs, the President and other New Dealers assumed only substandard jobs were at risk and bade them good riddance.... Stable family employment and high family wages mattered more to federal authorities than did the total number employed. One of the perceived evils of low southern wages was that they made a man unable to support his family and force his wife and children to work.
In short, the New Dealers' policies were designed to keep private sector unemployment high, at least in the short term, from a combination of economic ignorance, lack of concern for the short-term fate of the lowest echelon of workers, and political considerations (screwing the "conservative" rural South).
(I have a draft paper coauthored with Tim Leonard of Princeton that touches on some of these issues, but it's not ready to be circulated.)