Echoes of the Great Depression

THE ECONOMIC POLICIES of the 1930s are a continuing source of myth and confusion. Many people believe that capitalism caused the Great Depression and that Pres. Franklin Roosevelt helped to end it. The events of the 1930s influence economic policymaking today. Many people think that we need a big government to prevent, or reverse, recessions. Yet, the 1930s illustrate that activist policies increase, not decrease, economic instability. Government interventions reduce the flexibility that markets need to adjust to shocks and return to growth.

The Depression was a uniquely severe contraction. Real gross domestic product fell for four years before finally beginning to recover. Real output only regained its 1929 level in 1936, but then plunged again in 1938. The unemployment rate stayed persistently high at more than 14% from 1931-40. Government policies, meanwhile, prevented the economy from recovering. The following are some key mistakes:

Monetary contraction. The Depression was precipitated by a one-third drop in the money supply from 1929-33, which mainly was the fault of the Federal Reserve. Moreover, an overwhelming flood of bank failures in the early 1930s compounded the money supply shrinkage and heightened economic fears. A key problem was that most states restricted bank branching, which prevented banks from diversifying their portfolios across jurisdictions. By contrast, Canada allowed nationwide branching and did not surfer a single bank failure during the Depression.

Tax hikes. In the early 1920s, Treasury Secretary Andrew Mellon ushered in an economic boom by championing income tax cuts that reduced the top individual rate from 73 to 25%. Yet, these lessons were forgotten as the economy headed downward after 1929. Pres. Herbert Hoover signed into law the Revenue Act of 1932, which was the largest peacetime tax increase in U.S. history. It upped the top individual tax rate from 25 to 63%. After his election in 1932, Roosevelt imposed further individual and corporate tax increases. These hikes killed incentives for work, investment, and entrepreneurship at a time when they were sorely needed.

International trade restrictions. In 1930, Pres. Hoover signed into law the infamous Smoot-Hawley Trade Act, which raised import tariffs to an average of 59% on more than 25,000 products. Over 60 countries retaliated by slapping new restrictions on imports of U.S. products. By 1933, world trade was down to just one-third of the 1929 level.

Keeping prices high. The centerpiece of FDR's New Deal was the National Industrial Recovery Act of 1933. It created "codes" or cartels in more than 500 industries in order to limit competition. Businesses were told to cut output and maintain high prices and wages. Businessmen who cut prices were cajoled, fined, and sometimes arrested. Fortunately for the country, NIRA was struck down by the Supreme Court in 1935. The Agricultural Adjustment Act of 1933 similarly restricted production to keep prices high. "Excess" output was destroyed or dumped abroad. While millions of Americans were going hungry, the government plowed under 10,000,000 acres of crops, slaughtered 6,000,000 pigs, and left fruit to rot. Production of milk, fruits, and other products was cartelized to boost prices under "marketing orders" begun in 1937. These policies reduced employment and burdened families with higher prices.

Keeping employment costs high. Many New Deal policies raised employer costs, contributing to the extraordinarily high unemployment of the 1930s. NIRA industry codes required high wages. The new Social Security tax increased compensation costs. New minimum wage rules reduced demand for low-skilled workers. The Davis-Bacon Act required the payment of excessively high wages on Federal contracts. Compulsory unionism and militant union tactics were encouraged under a series of laws. U.S. work stoppages soared as a result.

Harassment of businesses. Investment stagnated in the 1930s due to uncertainties in the economy and the new risks of adverse Federal actions. Roosevelt and members of his Administration demonized business leaders and investors in their speeches. FDR called them "economic royalists" and "privileged princes" seeking a "new despotism" and "industrial dictatorship." Laws and regulations poured forth from Washington like never before. Roosevelt issued more executive orders than all presidents from Harry Truman through Bill Clinton combined. Roosevelt's antitrust crusade typified his antimarket approach. The Justice Department hired hundreds of new attorneys and began a lawsuit blitzkrieg in 1938 against dozens of industries for conspiring to keep prices high. The irony was that Roosevelt had spent his first term encouraging cartels, monopoly unionism, and other policies designed to boost prices and production costs.

New Deal interventions not only were bad for the economy, but favored fat cats over average families. Most farm subsidies went to major landowners, not small-time farmers. Required reductions in farm acreage devastated poor sharecroppers. Efforts to keep farm prices high led to the destruction of food while millions of families went hungry. Compulsory unionism led to discrimination against blacks because it gave monopoly power to union bosses who often did not want them hired. NIRA cartels prevented entrepreneurs from cutting prices for consumers.

Roosevelt's strategies of handouts, Federal jobs, subsidized loans, demonizing businesses, and public works projects in swing states worked well politically. Economically, though, Roosevelt and his braintrust had no idea what they were doing. They attempted one failed intervention after another. The Great Depression was a disaster and, sadly, an avoidable one.

Chris Edwards is director of Tax Policy, Cato Institute, Washington, D.C.

COPYRIGHT 2005 Society for the Advancement of Education
COPYRIGHT 2005 Gale Group