September 27, 2004

NO WONDER HE PROVOKED WAR:

The New Deal Debunked (again) (Thomas J. DiLorenzo, September 27, 2004, Mises.org)

Macroeconomic model builders have finally realized what Henry Hazlitt and John T. Flynn (among others) knew in the 1930s: FDR's New Deal made the Great Depression longer and deeper. It is a myth that Franklin D. Roosevelt "got us out of the Depression" and "saved capitalism from itself," as generations of Americans have been taught by the state's educational
establishment.

This realization on the part of macroeconomists comes in the form of an
article in the August 2004 Journal of Political Economy entitled "New Deal Policies and the Persistence of the Great Depression: A General Equilibrium Analysis" by UCLA economists Harold L. Cole and Lee E. Ohanian. This is a big deal, since the JPE is arguably the top academic economics journal in the world.

"Real gross domestic product per adult, which was 39 percent below trend at
the trough of the Depression in 1933, remained 27 percent below trend in
1939," the authors write. And "Similarly, private hours worked were 27
percent below trend in 1933 and remained 21 percent below trend in 1939."

This should be no surprise to anyone who has studied the reality of the
Great Depression, for U.S. Census Bureau statistics show that the official
unemployment rate was still 17.2 percent in 1939 despite seven years of
"economic salvation" at the hands of the Roosevelt administration (the
normal, pre-Depression unemployment rate was about 3 percent). Per capita
GDP was lower in 1939 than in 1929 ($847 vs. $857), as were personal
consumption expenditures ($67.6 billion vs. $78.9 billion), according to
Census Bureau data. Net private investment was minus $3.1 billion from
1930-40.

Cole and Ohanian write as though they were surprised--even shocked--to
discover these facts, not so much because they were bamboozled by The Myth
of the New Deal, but because of their devotion to "neoclassical model
building" as opposed to the study of economic reality. They label as
"striking" the fact that the recovery from the Great Depression was "very
weak" (a dramatic understatement). And why is it so striking? Because
"[t]hese data contrast sharply with neoclassical theory . . ." [...]

[V]irtually every single one of FDR's "New Deal" policies made things even worse and prolonged the Depression. Austrian economists have known this for decades, but at least the neoclassical model builders have finally caught on--we can hope.

Cole and Ohanian apparently emerged from the rarified world of macroeconomic
model building for a long enough period of time to discover that the
so-called First New Deal (1933-34) was one giant cartel scheme, whereby the
government attempted to enforce cartel pricing and output reductions in
hundreds of industries and in agriculture. This of course was well
documented in John T. Flynn's book, The Roosevelt Myth, first published in 1948. Henry Hazlitt had also written about it some fifteen years earlier. "New Deal cartelization policies are a key factor behind the weak recovery, accounting for about 60 percent of the difference between actual output and trend output," the authors write.

The fact that it has taken "mainstream" neoclassical economists so long to
recognize this fact is truly astounding. For generations their own
neoclassical textbooks have taught that cartels "restrict output" to raise
prices. It has also been no secret that the heart and soul of the First New
Deal was to use the coercive powers of government to prop up wages and
prices by cartelizing the entire economy.

FDR and his advisors mistakenly believed that the Depression was caused by
low prices, therefore, high prices--enforced by threats of violence, coercion and intimidation by the state--would be the "solution." Moreover, it is hardly a secret that if less production takes place, fewer workers will be needed by employers and unemployment will subsequently be higher. Thus, the First New Deal could not possibly have been anything but a gigantic unemployment-producing scheme according to standard neoclassical economic theory.


It is our great misfortune that the War came along to bail him out before the New Deal could be thoroughly discredited.


MORE (via Mike Daley):
: A review of Rethinking the Great Depression, by Gene Smiley (Richard Vedder, August 31, 2004, Claremont Review of Books)

Over the last 60 years or so, there have been four kinds of explanations concerning why the Depression occurred. The first is the underspending hypothesis, the Keynesian favorite, which dominated discussion for several decades. According to this view, the Depression arose from underspending on consumer durables and housing in the very late '20s, which, in turn, may have been a byproduct of the maldistribution of income during that roaring decade (a twist favored by John Kenneth Galbraith). The stock market crash had a profoundly negative psychological impact, leading both consumers and investors to be cautious in their spending habits. Underinvestment and underconsumption following the stock market crash led to a need for "fiscal stimulus" in the form of government-induced increases in aggregate demand, preferably from government spending increases, but also from tax reductions. In the Keynesian view, that stimulus was not provided, at least not in sufficient doses. Smiley thinks, correctly in my judgment, that this explanation is fundamentally faulty, and largely ignores it.

A second explanation, which grew in popularity in the 1960s and 1970s, focuses on the money supply and the failure of the Federal Reserve to stem a sharp decline in it, which induced significant deflation, leading to bank failures and the subsequent paralysis of business. This monetarist
explanation, championed by Milton Friedman and others, is respected by
Smiley, who believes that bank failures and related happenings played a
major role in the big economic descent after 1929.

A third explanation builds on old neoclassical notions of the determinants
of employment and unemployment, and on the Austrian theory of Ludwig von
Mises and Friedrich Hayek. It argues that excessive monetary creation by the
Federal Reserve in the 1920s led to artificially low interest rates, which
induced a spending boom that set the stage for the 1929 stock market crash.
Subsequently, Hoover's and Roosevelt's coercion of American business
prevented appropriate wage adjustments from being taken to alleviate
unemployment. Other interferences in markets (e.g., price-fixing under the
National Industrial Recovery Act) helped prolong the downturn as well.
Smiley likes this perspective, and draws on works by Murray Rothbard, Lowell
Gallaway, and me in his account of it. For example, he provides rich detail
on how the High Wage policy worked in practice, both during the Hoover
downturn and the tepid Roosevelt recovery.

The final explanation emphasizes the international dimensions of the
downturn, a perspective stressed by Herbert Hoover himself and numerous
scholars since. The Federal Reserve's fixation on the maintenance of the
gold standard led to policies that were wholly inappropriate, such as in
1931 increasing the discount rate (interest rate) that banks had to pay to
borrow from the Fed at precisely the time when appropriate monetary policy
(from the domestic standpoint) would have been the opposite. Add to that the
folly of the Smoot-Hawley tariff, enacted in 1930, and its subsequent
disastrous impact on imports to the U.S., and you have the basis of a severe
and prolonged downturn. Smiley loves this explanation, advanced in modern
times by Barry Eichengreen and others, and gives it prime billing.

The three types of explanation that Smiley emphasizes focus on failures of
public policy-poor Federal Reserve decisions, inappropriate tariffs (not to
mention higher income taxes), government-induced manipulation of wages and
prices by presidential "jawboning," laws like the National Industrial
Recovery Act, and so forth. The modern literature, well-interpreted by
Smiley, has moved dramatically away from the traditional Keynesian story of
market failure-of the inability or unwillingness of individuals and
businesses to spend enough money to get us out of the Depression. A major
intellectual rationalization for modern big government-that it must play an
activist role to overcome market-induced spending deficiencies, thereby
preventing major downturns-stands largely discredited, not by right-wing
ideologues but by scholars of every political stripe investigating nearly
every aspect of the Depression. Perhaps unexpectedly, and certainly without
much public acknowledgement, the Depression's use as a laboratory to
evaluate economic theories has contributed to a sharp decline in Keynesian
influence in the economics profession. By masterfully summarizing most of
the research and making it accessible to the lay reader in a compelling
manner, Smiley provides a great public service.

Posted by Orrin Judd at September 27, 2004 11:40 AM
Comments

This has long been known. Watch the Kimmel-Short apologists sieze upon it to shore up their never-ending campaign to excuse their ancestors' culpable negligence.

Posted by: Lou Gots at September 27, 2004 11:51 AM

People who bash FDR obviously would prefer the dictatorship of either Communism or Fascism that would have replaced him in 1932. Or maybe OJ prefers Huey Long. I still have living relatives who remember that year. They said almost everyone thought that democracy was finished. FDR was the last hope.

Certainly the New Deal did not end the Depression and many mistakes were made. But it gave people hope, preserved democracy, and gave the elderly food and a roof.

Posted by: Chris Durnell at September 27, 2004 2:38 PM

Chris:

Hoover wasn't Huey.

Posted by: oj at September 27, 2004 2:54 PM

Chris: That argument is contradicted by the better performance of other economies during the same period (e.g., England) who did not implement Roosevelt's disastrous policies and were more fertile grounds for Communist incursion.

Posted by: jd watson at September 27, 2004 2:56 PM

As noted, but ignored, the New Deal was strangled in its cradle by the Supreme Court -- why else did Roosevelt think he needed to pack the Court in 1937?

Theorists can say whatever they like about what bad things the New Deal might have accomplished, but only the psychotic think it was tried.

Posted by: Harry Eagar at September 28, 2004 12:41 AM

Tried, failed, not coming back no matter how much you old Marxist/socialists cling to the dream.

Posted by: oj at September 28, 2004 7:27 AM

Nice article by DiLorenzo. Although the man is kind of a crackpot when it comes to the Civil War.

Posted by: M Ali Choudhury at September 28, 2004 9:04 AM

It wasn't tried.

AAA, which was the cornerstone, didn't survive even one growing season.

In any case, it is crazy to prescribe more of the poison that wrecked the economy as a cure.

Homeopathic economics -- crazy as homeopathic medicine

Posted by: Harry Eagar at September 28, 2004 2:11 PM

But that's what you're advocating, an unending system of government functionaries making crappy decisions that can never be corrected by the market. Look at Europe or the New Deal--it doesn't work.

Posted by: oj at September 28, 2004 4:17 PM

I'm quite disturbed that there is so little emphasis placed on the change in agriculture employment. As I recall, it dropped, hugely, between 1925 and 1935. The fact that so many poor farm workers were looking were for work, and even poorer scab workers, means any policies would have problems.

Posted by: Tom Grey - Liberty Dad at September 28, 2004 10:41 PM

M Ali:

That's why I skipped over the Di Lorenzo excerpt.

Posted by: Eugene S. at September 29, 2004 12:45 PM

Tom Grey:

Makes sense to me.

I guess the recent drop in manufacturing employment has not been as devastating because it was not as steep and because nowadays there is so much public wealth that we can pay for retraining and otherwise soften the blow through income transfer?

Posted by: Eugene S. at September 29, 2004 12:52 PM

Mr. Grey:

Except that's largely myth:

http://www.newcriterion.com/archive/20/jun02/steinbeck.htm

Posted by: oj at September 29, 2004 1:05 PM

Not me, Orrin. The Columbia economists advocated reflation and then a return to markets, though with some safeguards, such as an SEC.

You don't know what you're talking about.

Anyhow, hard to run a consumer economy when 40 percent of the designated consumers have no disposal income, which is what went on during the '20s.

To blame Roosevelt for failing to rescue an economy in less than 12 months after it took the Republicans 12 full years to wreck it is hardly reasonable.

Posted by: Harry Eagar at September 29, 2004 5:48 PM

Harry:

He's blamed, along with Hoover whose response was similar and the Fed, for not rescuing the economy after twelve years. They should have given the consumers more money, not less.

Posted by: oj at September 29, 2004 6:44 PM

Since the 40% were producers, the way to give them more money was to raise producer prices.

That's just what Coolidge prosperity failed to do.

Wage scales were not the problem in the 1920s, producer returns were the problem.

But your fantasy is a good example of why tax obsession conceals economic realities.

The Joads were not forced to move by high income taxes.

Posted by: Harry Eagar at September 30, 2004 4:48 PM

Harry:

Forget taxes, just given them money.

Posted by: oj at September 30, 2004 6:17 PM
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