Would Americans trade a short severe recession for a long and grueling (but not as extreme) depression?
Harold Cole, a professor of economics at the University of Pennsylvania, and Lee Ohanian, a professor of economics and director of the Ettinger Family Program in Macroeconomic Research at UCLA, argue in new research summarized in today's WSJ that the answer is resoundingly yes.
They examine the Great Depression (that's 80 years ago, not today) and the impact of FDR's New Deal on it. Their central thesis is this:
Why wasn't the Depression followed by a vigorous recovery, like every other cycle? It should have been. The economic fundamentals that drive all expansions were very favorable during the New Deal. Productivity grew very rapidly after 1933, the price level was stable, real interest rates were low, and liquidity was plentiful. We have calculated on the basis of just productivity growth that employment and investment should have been back to normal levels by 1936. Similarly, Nobel Laureate Robert Lucas and Leonard Rapping calculated on the basis of just expansionary Federal Reserve policy that the economy should have been back to normal by 1935.
So what stopped a blockbuster recovery from ever starting? The New Deal.
Their research shows, astoundingly, that the New Deal prolonged the Depression by 7 years (!) and prevented a significant recovery from following it (that would have to wait more than a decade for World War II). Primarily, New Deal policies so distorted the economy away from efficient levels that it was unable to resume them when it normally would. Every economics student learns about the so-called "deadweight loss" associated with price floors, quotas, and the like. This was DWL on a massive scale.
Government encouraged what FDR later called a "concealed cartel system like Europe," and NIRA policies (the organization itself would later be declared unconstitutional) which raised wages 25% above their optimal level "benefited the few that were fortunate to have a job in those industries, [but] they significantly depressed production and employment, as the growth in wage costs far exceeded productivity growth."
The government created an enforced what they believed was a "controlled" departure from free markets, full of stimuli, benefit packages, and producer and labor market support. What they got was a monstrosity approaching one of the worst socialist regimes this side of the Kremlin. Many of the programs were shut down as WWII loomed, and the bulk of the remainder survived until the re-rise of conservatism in the 70's and 80's. Today, the only lasting hallmarks of the New Deal are:
- Social Security (the only Ponzi scheme bigger than Madoff!)
- the SEC (we almost caught Madoff!)
- Fannie Mae (who is this Madoff and can we give him a loan?)
Seven years - two Presidential terms - was the Depression extended by shoddy economic reasoning. As we prepare to ratify nearly $1 trillion in new spending, we need to make sure it is applied properly -- not to bolster failing businesses as if the damage were idiosyncratic and not systemic, but to seed investment where it is lacking without cause and solve the liquidity crisis.
The main lesson we have learned from the New Deal is that wholesale government intervention can -- and does -- deliver the most unintended of consequences. This was true in the 1930s, when artificially high wages and prices kept us depressed for more than a decade, it was true in the 1970s when price controls were used to combat inflation but just produced shortages. It is true today, when poorly designed regulation produced a banking system that took on too much risk.
I find it interesting, in retrospect, that I have often heard some variant of, "The Great Depression was so bad that it took World War II to bring us out of it" but so rarely have I heard "The New Deal did not work." The two phrases are mutually synonymous. There is a great myth perpetrated that the New Deal was an effective solution to the crisis. Perhaps it lives on in part because of a phenomenon in statistics called spurious correlation -- Americans observe economic improvement (if only barely) on the one hand, and see the Government enacting massive policies and claiming credit (how convenient) for the progress. It is natural to assume cause and effect; the professors, however, show that in reality the Government hindered progress dramatically. A similarly spurious argument is frequently made every time a President presides over an economic boom, since inevitably he claims responsibility for it.
Wikipedia informs us that
"When the Gallup poll in 1939 asked, 'Do you think the attitude of the Roosevelt administration toward business is delaying business recovery?' the American people responded 'yes' by a margin of more than two-to-one. The business community felt even more strongly so. Treasury Secretary, Henry Morgenthau, angry at the Keynesian spenders, confided to his diary 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 now if I am wrong somebody else can have my job. I want to see this country prosper. 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 enormous debt to boot.'"
The efforts to support broken unions and unemployed workers sounds considerably like contemporary efforts to support foreclosed homes and unpaid mortgages. Few people want to entertain the idea that attempts to "help" actually do more damage. Our shortsightedness and myopia are a poor combination, since they lead us to favor expensive solutions in the future in order to avoid pain immediately.
Would Americans trade a short severe recession for a grueling depression? Just as soon as they would pay tomorrow to get something today.