Tuesday, May 5, 2009

A Second Look at the Great Depression

Amity Shlaes, author of The Forgotten Man, a new look at government policy during the Great Depression, presents the key points of her (excellent) book in an article on Forbes.com. Her main thesis is that standard story of the depression is a myth. Hoover was not a "do nothing" president. Many of FDR's "experiments" deepened and prolonged the Depression. The Depression was not caused by a "failure of the market."

Shlaes recounts the typical high school history book story:
The trouble, we heard, started in the 1920s. The 1929 crash had something to do with bubbles, whether the stock market or the champagne varieties. Margins--margins calls, that is--and perhaps hemlines also played a role. Capitalism faltered, with deflation and asinine tariffs playing their part. Herbert Hoover, the laissez-faire president, failed by doing too little

Then Franklin Delano Roosevelt sailed in, cheering the country with his courage. Roosevelt's call to action--"bold, persistent experimentation" as he put it--was warranted. Heeding it, the economy stirred. Government spending and government leadership saved the country from despair or fascism.
However, the traditional story doesn't hold up to historical scrutiny:
1920s growth, it turns out, wasn't illusory; it was real. From rising companies to low unemployment to increases in GDP, the decade was a prodigious one. The Greenspan of the period, Andrew Mellon at the Treasury, presided over a series of tax cuts that pulled the top rate on the income tax down to 25%. These rate cuts generated government surpluses. In the last years, the stock market did move too high--but certainly not high enough to cause 11 years of misery.
Hoover has hardly a free-marketer:
[H]is tenure was marked not by laissez faire or respect for private property--indeed, Hoover had labeled property a "fetish" before he became president. The Great Engineer was in fact the Great Intervener, meddling in multiple areas, raising taxes and backing tariffs, to the economy's detriment. Mistrusting the stock market as unreal, Hoover berated short-sellers and exhorted businesses to keep wages high when they could ill afford it.
And FDR's New Deal was no panacea:
Roosevelt's National Recovery Administration, created in 1933, pulled wages up when perishing companies could not afford it; come 1935, the Wagner Act gave unions more bargaining power, forcing further wage increases on companies. Roosevelt's multiple tax increases caused businesses to postpone investment. Especially counterproductive was FDR's "undistributed profits tax," which punished firms for being cautious and forced them to disgorge cash at the worst possible moment.

Roosevelt's glee in prosecuting the business heroes of the '20s terrified market players. So did the president's 1937 inaugural speech, in which he told crowds that, in government, he and his administration sought "an instrument of unimagined power." In short, the caricature of the New Yorker cartoon is true: The businessman really did cry into his martini and wait for it all to be over.

The most unnecessary pain came in the so-called "Depression within the Depression" of the later 1930s, caused not only by monetary tightening but also by the political arrogance of the New Dealers following their 1936 electoral landslide. As for the Depression's end, the right question to ask is not how the war brought recovery, it is why the Depression lasted all the way up to the war.

Shlaes also offers a counter explanation of the Depression that illuminates what is going on today:
Another [explanation of the Great Depression] is the Public Choice theory of Nobel Laureate James Buchanan of George Mason University. Public Choicers would say that the 1930s story was also the story of a power struggle between public and private--and one in which the public sector gained ground. This clearly was true for the growth industry of the day the 1930s story was also the story of a power struggle between public and private--and one in, utilities. Scholar Robert Higgs holds that the very unpredictability of the government chilled markets, and this idea--what Higgs calls "Regime uncertainty"--is borne out by the data. The 1930s stock market is famous for its drops, but its second outstanding aspect is actually rallies, specifically micro-rallies of 10% or more. In other words, the abiding feature of the market was its volatility.
As the economist Russ Roberts has noted, the Depression is just one data point; it is a mistake to extrapolate policy decisions with so few degrees of freedom. Even worse, our understanding of that data point is shrouded in myth. This is why Shlaes's book is so important.