Sunday, 16 November 2008
Getting out of the depression
Steve Pierson over at the Labour Party site, The Standard, has been writing on the Great Depression. Unfortunately largely wrongly. He writes
Laissez-faire capitalism, whereby the ‘invisible hand of the market’ ruled, had failed ...
Well no. "Laissez-faire capitalism" didn't fail as it had never been tried. Pierson goes on
President Roosevelt termed his economic program to lift the US out of the Great Depression ‘the New Deal’.
and
A new deal was needed to restore the living conditions of workers and, ultimately, to protect capital from revolution. The New Deal replaced hands-off government with active state capitalism - the Government increased participation in the economy by investing in new sectors and job-intensive infrastructure, created better unemployment benefits, and improved regulation of financial markets. It also increased the legal powers of organised labour to put unions on a more equal footing with capital.
While it is true Roosevelt called it a New Deal, it is not true that it lifted the US out of the depression. The New Deal is often seen, in part, as a fiscal driven economic stimulus package. But it is debatable as how much stimulus it actually gave. Also as economic historian Christina Romer has written, see here for more,
This paper examines the role of aggregate demand stimulus in ending the Great Depression. A simple calculation indicates that nearly all of the observed recovery of the U.S. economy prior to 1942 was due to monetary expansion.
Ben Bernanke isn't that enthusiastic about the New Deal's results in dealing with the depression either. He writes, see here for more,
Our [work with Martin Parkinson] own view at present is that the New Deal is better characterized as having "cleared the way" for a natural recovery (e.g., by ending deflation and rehabilitating the financial system), rather than as being the engine of recovery itself.
So monetary policy not fiscal policy got the US out of the depression. Is the US different in this regard? No seems the best answer to that. As Mark Koyama has said of the situation in the UK, for more see here,
In the UK however as in the US expansionary fiscal policy was not used. The 'Treasury view' prevailed and the first 'Keynesian budget' had to wait until 1941 and then it was used to check inflation and not to stimulate demand (readers with access to JSTOR can read Alan's Booth 1983 paper here). Monetary policy drove the recovery by sparking a boom in the construction industry.
What of New Zealand? See here for evidence that changes to New Zealand's monetary regime were behind the recovery from the depression. So all of these cases show monetary policy to be the main driver of the escape from the depression, not New deals.
What then did the New Deal do? Donald J. Boudreaux writes,
Andrew Wilson is right: the New Deal did not end the Great Depression ("Five Myths About the Great Depression," November 4). No less an authority than FDR's Treasury secretary and close friend, Henry Morganthau, conceded this fact to Congressional Democrats in May 1939: "We have tried spending money. We are spending more than we have ever spent before and it does not work. And I have just one interest, and if I am wrong ... somebody else can have my job. I want to see this country prosperous. I want to see people get a job. I want to see people get enough to eat. We have never made good on our promises ... I say after eight years of this Administration we have just as much unemployment as when we started ... And an enormous debt to boot!"*
Indeed, FDR's market-suffocating policies are almost surely what put the "Great" in "Great Depression."
Why did the New Deal put the "Great" in "Great Depression? One reason is the notion of regime uncertainty which is due to the economic historian Robert Higgs. Higgs introduced the idea in a paper Regime Uncertainty: Why the Great Depression Lasted So Long and Why Prosperity Resumed after the War. His purpose was to explain why the depression lasted so long in the US. Higgs writes,
I shall argue here that the economy remained in the depression as late as 1940 because private investment had never recovered sufficiently after its collapse during the Great Contraction. (p.563)
The Great Contraction refers to the macroeconomic collapse that occurred between 1929 and 1933. Higgs goes on to say,
I shall argue further that the insufficiency of private investment from 1935 through 1940 reflected a pervasive uncertainty among investors about the security of their property rights in their capital and its prospective returns. (p.563)
If businesspeople are uncertain as to whether or not they will capture the returns to their investments they will be reluctant to invest. Later Higgs explains,
The hypothesis is a variant of an old idea: the willingness of businesspeople to invest requires a sufficiently healthy state of “business confidence,” and the Second New Deal ravaged the requisite confidence. (p.568)
and
To narrow the concept of business confidence, I adopt the interpretation that businesspeople may be more or less “uncertain about the regime,” by which I mean, distressed that investors’ private property rights in their capital and the income it yields will be attenuated further by government action. (p.568)
Another reason for the prolonged depression comes from the work UCLA economists Harold L. Cole and Lee E. Ohanian. They conclude in their 2004 study that New Deal policies thwarted economic recovery for seven years. The study, "New Deal Policies and the Persistence of the Great Depression: A General Equilibrium Analysis", appeared in the Journal of Political Economy, 2004, vol. 112, no. 4, p.779-816.
In a news release on the paper Cole is quoted as saying
"President Roosevelt believed that excessive competition was responsible for the Depression by reducing prices and wages, and by extension reducing employment and demand for goods and services," [...] "So he came up with a recovery package that would be unimaginable today, allowing businesses in every industry to collude without the threat of antitrust prosecution and workers to demand salaries about 25 percent above where they ought to have been, given market forces. The economy was poised for a beautiful recovery, but that recovery was stalled by these misguided policies."
Ohanian and Cole use data collected in 1929 by the Conference Board and the Bureau of Labor Statistics. Using this they were able to calculate average prices and wages across a number of industries just prior to the start of the Great Depression. Then they worked out a counter factual of what would have happened if Roosevelt's policies not been put in place. By adjusting for annual increases in productivity, they were able to use the 1929 benchmark to work out what prices and wages would have been during every year of the Depression without Roosevelt's interventions. They then compared those figures with actual prices and wages as reflected in the Conference Board data.
One result they found was that in the three years following the implementation of Roosevelt's policies, wages in 11 key industries averaged 25 percent higher than they otherwise would have done. But unemployment was also 25 percent higher than it should have been, given gains in productivity.
Meanwhile, prices across 19 industries averaged 23 percent above where they should have been, given the state of the economy. With goods and services that much harder for consumers to afford, demand stalled and the gross national product floundered at 27 percent below where it otherwise might have been.
The news release quotes Ohanian as pointing out that
"High wages and high prices in an economic slump run contrary to everything we know about market forces in economic downturns." [...] "As we've seen in the past several years, salaries and prices fall when unemployment is high. By artificially inflating both, the New Deal policies short-circuited the market's self-correcting forces."
An important point noted by Cole and Ohanian is that under the National Industrial Recovery Act (NIRA), industries were exempted from antitrust prosecution if they agreed to enter into collective bargaining agreements that significantly raised wages. Because protection from antitrust prosecution all but ensured higher prices for goods and services, a wide range of industries agreed. In fact by 1934 more than 500 industries, which accounted for nearly 80 percent of private, non-agricultural employment, had entered into the collective bargaining agreements called for under NIRA.
According to Cole and Ohanian the NIRA and its aftermath account for 60 percent of the weak recovery. Without the policies, they contend that the Depression would have ended in 1936 instead of the year when they believe the slump actually ended: 1943.
So we can conclude that the New Deal didn't get the US out of the Great Depression, monetary policy did, and that the New Deal may have extended the depression.
Thus before Pierson calls for a new New Deal, he should understand the old one a little better than he does.
Posted by Paul Walker at 11:19 AM
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