The New Deal... Was A Bad Deal!

[Don Buckbee]

By Meg Sullivan

Two UCLA economists say they have figured out why the Great Depression dragged on for almost 15 years, and they blame a suspect previously thought to be beyond reproach: President Franklin D. Roosevelt.

After scrutinizing Roosevelt's record for four years, Harold L. Cole and Lee E. Ohanian conclude in a new study that New Deal policies signed into law 71 years ago thwarted economic recovery for seven long years.

"Why the Great Depression lasted so long has always been a great mystery, and because we never really knew the reason, we have always worried whether we would have another 10- to 15-year economic slump," said Ohanian, vice chair of UCLA's Department of Economics. "We found that a relapse isn't likely unless lawmakers gum up a recovery with ill-conceived stimulus policies."

In an article in the August issue of the Journal of Political Economy, Ohanian and Cole blame specific anti-competition and pro-labor measures that Roosevelt promoted and signed into law June 16, 1933.

"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," said Cole, also a UCLA professor of economics. "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."

Using data collected in 1929 by the Conference Board and the Bureau of Labor Statistics, Cole and Ohanian were able to establish average wages and prices across a range of industries just prior to the Depression. By adjusting for annual increases in productivity, they were able to use the 1929 benchmark to figure out what prices and wages would have been during every year of the Depression had Roosevelt's policies not gone into effect. They then compared those figures with actual prices and wages as reflected in the Conference Board data.

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, the economists calculate. 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.

"High wages and high prices in an economic slump run contrary to everything we know about market forces in economic downturns," Ohanian said. "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."

The policies were contained in the National Industrial Recovery Act (NIRA), which exempted industries 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 took the bait, Cole and Ohanian found. 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.

Cole and Ohanian calculate that 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.

Roosevelt's role in lifting the nation out of the Great Depression has been so revered that Time magazine readers cited it in 1999 when naming him the 20th century's second-most influential figure.

"This is exciting and valuable research," said Robert E. Lucas Jr., the 1995 Nobel Laureate in economics, and the John Dewey Distinguished Service Professor of Economics at the University of Chicago. "The prevention and cure of depressions is a central mission of macroeconomics, and if we can't understand what happened in the 1930s, how can we be sure it won't happen again?"

NIRA's role in prolonging the Depression has not been more closely scrutinized because the Supreme Court declared the act unconstitutional within two years of its passage.

"Historians have assumed that the policies didn't have an impact because they were too short-lived, but the proof is in the pudding," Ohanian said. "We show that they really did artificially inflate wages and prices."

Even after being deemed unconstitutional, Roosevelt's anti-competition policies persisted — albeit under a different guise, the scholars found. Ohanian and Cole painstakingly documented the extent to which the Roosevelt administration looked the other way as industries once protected by NIRA continued to engage in price-fixing practices for four more years.

The number of antitrust cases brought by the Department of Justice fell from an average of 12.5 cases per year during the 1920s to an average of 6.5 cases per year from 1935 to 1938, the scholars found. Collusion had become so widespread that one Department of Interior official complained of receiving identical bids from a protected industry (steel) on 257 different occasions between mid-1935 and mid-1936. The bids were not only identical but also 50 percent higher than foreign steel prices. Without competition, wholesale prices remained inflated, averaging 14 percent higher than they would have been without the troublesome practices, the UCLA economists calculate.

NIRA's labor provisions, meanwhile, were strengthened in the National Relations Act, signed into law in 1935. As union membership doubled, so did labor's bargaining power, rising from 14 million strike days in 1936 to about 28 million in 1937. By 1939 wages in protected industries remained 24 percent to 33 percent above where they should have been, based on 1929 figures, Cole and Ohanian calculate. Unemployment persisted. By 1939 the U.S. unemployment rate was 17.2 percent, down somewhat from its 1933 peak of 24.9 percent but still remarkably high. By comparison, in May 2003, the unemployment rate of 6.1 percent was the highest in nine years.

Recovery came only after the Department of Justice dramatically stepped enforcement of antitrust cases nearly four-fold and organized labor suffered a string of setbacks, the economists found.

"The fact that the Depression dragged on for years convinced generations of economists and policy-makers that capitalism could not be trusted to recover from depressions and that significant government intervention was required to achieve good outcomes," Cole said. "Ironically, our work shows that the recovery would have been very rapid had the government not intervened."

[dcd_enterprises]

Thanks, Don.

Government intervention failing? Say it isn't so.

[momo]

What got us out of the Great Depression was World War II. On December 8, 1941 we had instant full employment.

[CampingJosh]

Originally Posted by momo

What got us out of the Great Depression was World War II. On December 8, 1941 we had instant full employment.

Momo, I have to disagree. The markets in Europe crashed after the markets in the US, but we stayed in a depression for years beyond when the European economies revived. Why? The government.

Another explanation comes from the Austrian School of economics. Theorists of the "Austrian School" who wrote about the Depression include Austrian economist Friedrich Hayek and American economist Murray Rothbard, who wrote America's Great Depression (1963). In their view, the key cause of the Depression was the expansion of the money supply in the 1920s that led to an unsustainable credit-driven boom. In their view, the Federal Reserve, which was created in 1913, shoulders much of the blame.

In opinion, Hayek, writing for the Austrian Institute of Economic Research Report in February 1929[18] predicted the economic downturn, stating that "the boom will collapse within the next few months."

Ludwig von Mises also expected this financial catastrophe, and is quoted as stating "A great crash is coming, and I don't want my name in any way connected with it,"[19] when he turned down an important job at the Kreditanstalt Bank in early 1929.

One reason for the monetary inflation was to help Great Britain, which, in the 1920s, was struggling with its plans to return to the gold standard at pre-war (World War I) parity. Returning to the gold standard at this rate meant that the British economy was facing deflationary pressure.[20] According to Rothbard, the lack of price flexibility in Britain meant that unemployment shot up, and the American government was asked to help. The United States was receiving a net inflow of gold, and inflated further in order to help Britain return to the gold standard. Montagu Norman, head of the Bank of England, had an especially good relationship with Benjamin Strong, the de facto head of the Federal Reserve. Norman pressured the heads of the central banks of France and Germany to inflate as well, but unlike Strong, they refused.[20] Rothbard says American inflation was meant to allow Britain to inflate as well, because under the gold standard, Britain could not inflate on its own.

In the Austrian view it was this inflation of the money supply that led to an unsustainable boom in both asset prices (stocks and bonds) and capital goods. By the time the Fed belatedly tightened in 1928, it was far too late and, in the Austrian view, a depression was inevitable.

The artificial interference in the economy was a disaster prior to the Depression, and government efforts to prop up the economy after the crash of 1929 only made things worse. According to Rothbard, government intervention delayed the market's adjustment and made the road to complete recovery more difficult.[21]

Furthermore, Rothbard criticizes Milton Friedman's assertion that the central bank failed to inflate the supply of money. Rothbard asserts that the Federal Reserve bought $1.1 billion of government securities from February to July 1932, raising its total holding to $1.8 billion. Total bank reserves rose by only $212 million, but Rothbard argues that this was because the American populace lost faith in the banking system and began hoarding more cash, a factor quite beyond the control of the Central Bank. The potential for a run on the banks caused local bankers to be more conservative in lending out their reserves, and this, Rothbard argues, was the cause of the Federal Reserve's inability to inflate.[22]

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In as much as World War II brought us out of the Great Depression, it only did so by distracting our government into leaving the markets alone.