False Dawn: FDR and the Great Depression

False Dawn: The New Deal and the Promise of Recovery, 1933–1947 is an academic economists’ look at all of the academic economists’ explanations for the Great Depression and how, with muscular government intervention led by a now-revered FDR, it could have lasted so much longer than economic downturns that happened in the U.S.’s free market period (1630-1930). (I introduced this book a few months ago with Philip’s Book Club: False Dawn.)

One popular theory is that World War II brought the U.S. out of the Depression after about a decade of failed federal government interventions. The book points out that calculating GNP during World War II is somewhat arbitrary:

But there is a deeper sense in which the wartime recovery, however and whenever it started, was no recovery at all. “In the crucial respect of waste of economic resources,” Broadus Mitchell (1947, 396) observes, “the war was, particularly for the United States, a deepening of the depression.” Tens of millions who had been either unemployed or employed in peacetime activities now took part in activities that, however crucial, continued to reduce instead of enhancing their own and the world’s living standards. To label such a state of affairs “full employment” was, Mitchell says, but “a flattering unction”: the employment thus generated was “for purposes which, by very definition, could have no place in a normal economy.” In short, the war was but a temporary solution to the problem of economic depression, and the more temporary the better. The point may seem trite. But it’s a necessary response to those—and there are many—who declare that World War II ended the Depression and just leave it at that.

… the most serious shortcoming of wartime output measures, namely, their tendency to overstate, perhaps dramatically, both the nominal value of war matériel and the extent to which it should be considered part of national output at all. As Higgs (1992, 45–47) reports, Kuznets, whose wartime and postwar deflators are among those that have been called into question by Friedman and Schwartz and others, had his own grave misgivings about the Commerce Department’s valuation of wartime output. “A major war,” he observed, “magnifies” the usual challenges involved in estimating national income, because war matériel isn’t sold at anything resembling “market” prices and also because wars blur “the distinction between intermediate and final products” (45).

Such considerations persuaded Kuznets to come up with several alternative measures of wartime and postwar GNP, all of which imply a less impressive wartime boom, or no boom at all, and no postwar slump. For example, according to Higgs (1992, 46), “whereas the Commerce Department’s latest estimate of real GNP drops precipitously in 1946 and remains at that low level for the rest of the decade,” Kuznets’s “wartime” estimate “increases in 1946 by about 8 percent, then rises slightly higher during the next three years.” Another Kuznets GNP estimate—what he called “peacetime” GNP—revises the record still further by valuing goods produced for military use at their nonmilitary surplus values only. According to that estimate, between 1945 and 1947 real output rose by almost 18 percent!

The above quote illustrates the principal flaw of the book for a non-academic reader. The author spends most of his ink summarizing and referencing the work of other academics. He’ll lay out four or five theories and deal with each one in turn, forcing the reader to tease out the author’s personal point of view. The book is more accurately characterized as a survey of 100 years of academic thought regarding the Great Depression than as an explanation of the Great Depression and subsequent recovery.

Another popular theory is that the New Deal was an example of Macro Economics 101 Keynesian deficit spending during a downturn. Two chapters are devoted to “The Keynesian Myth”. The author points out that Roosevelt was committed to a balanced budget and that Keynes himself wrote critically of American economic policy. The New Deal was a project to increase the power of the federal government in regulating business, not a deficit spending plan. Some of this project was abandoned when the federal government needed private industry to be its partner for World War II weapons production, but the effect was to stifle business investment and reduce personal consumption.

“Conventional wisdom has it,” Gary Best (1991, 222) observes, “that the massive government spending of World War II finally brought a Keynesian recovery from the depression.” However, Best continues, the fact that the government was no longer at war with business, as it had been during the original New Deal, deserves more credit. “That,” Best says, “and not the emphasis on spending alone, is the lesson that needs to be learned.”

On the extent to which there was any Keynesian borrowing:

New Deal deficits were less impressive than New Deal spending because the Roosevelt administration went to considerable lengths to boost tax revenues and did so even when it meant relying heavily on taxes that mostly burdened low-income Americans. For that reason, the administration chose not only to retain and then repeatedly extend most of the excise taxes imposed as part of Hoover’s 1932 budget—taxes Herbert Stein (1966, 210) considers “the purest act of pre-revolutionary fiscal policy”—but also to increase taxes on gasoline and tobacco, revive the liquor tax upon the repeal of Prohibition, and introduce its AAA tax on food processors. Because they fell on consumers, either directly or indirectly, excise taxes, which eventually funded 60 percent of the government’s “ordinary” revenues (Leff 1984, 147), tended to be deflationary even when fully offset by government spending. Such taxes therefore had little to recommend them from a countercyclical fiscal policy perspective (Brown 1956, 868; Leff 1984, 39). But because excise taxes were revenue workhorses, to an administration not much less determined to limit deficits than Hoover’s had been, they made perfect sense. At the height of the New Deal, Mark Leff (1984, 38) points out, the tax on food processors alone “accounted for one-eighth of total tax revenues,” which was more than the yield from either the personal income tax or the corporate income tax. For this reason, after the tax on food processors was struck down, Roosevelt “continued to suggest processing taxes to balance the budget and to fund farm subsidies” (Leff 1984, 44). What was true of excise taxes was truer still of the Social Security payroll tax that the government began collecting in January 1937. According to Leff (1984, 45), when Roosevelt first came up with his plan for funding Social Security, his advisers warned that because it would draw purchasing power from consumers for the purpose of establishing a $47 billion reserve fund without making any like disbursements from that fund for many years, the plan would be dangerously deflationary. Still, Roosevelt insisted on it, saying that it would assist in balancing the budget while projecting “an image of fiscal responsibility” (47). According to Sherwood Fine (1944, 114), the regressive Social Security tax diverted “more than a billion dollars of purchasing power . . . away from an industrial establishment sensitively attuned to consumer demand” in the midst of a severe economic downturn. “Running along, as we are, on a low level,” Alvin Hansen (1939b, 283) wrote afterward, when various amendments to the Social Security Act were under consideration, “we cannot afford . . . the luxury of a Social Security Program which turns out in effect to be essentially a compulsory savings program, and which thereby seriously curtails the volume of consumption expenditures.”

France was the only significant (imagine that there was a time when France was significant!) foreign nation inspired to follow our example:

France was one of the few countries and the only major one to take longer to recover from the Great Depression than the United States. France was also the only country that resorted to policies closely resembling—indeed inspired by—the New Deal, including NRA-style codes. And it was the only country that did not experience a substantial improvement in output after devaluing its currency. As Barry Eichengreen (1992a, 349) observes, France’s example shows, even more clearly than that of the United States, that “devaluation was necessary but not sufficient for economic recovery.” France’s first stab at New Deal–style industrial planning consisted of the so-called Flandrin experiment, an attempt by the conservative ministry of Pierre-Etienne Flandrin (November 1934–May 1935), directly inspired by the NRA, to cartelize French industries and reduce workers’ working hours. Flandrin’s experiment went no further, and his government fell after six months. But several weeks after decisively winning France’s May 3, 1936, parliamentary election, the Popular Front—an alliance of French radicals, socialists, and communists—implemented an NRA-inspired plan of its own. That plan was so aggressive that recent scholars have dubbed it “a sort of NIRA on steroids” (Cohen-Setton, Hausman, and Wieland 2017). As Barry Eichengreen (1992a, 375–76) explains, “Employers were compelled to sign the Accord de Matignon granting trade union recognition, collective bargaining privileges, and wage increases. . . . [T]he work week was shortened again, but this time without any corresponding reduction in pay. The government legislated an annual paid vacation and a 40-hour week. Wages were raised by 7 percent for high-paid workers and by up to 15 percent for the lower paid. . . . Other elements of the French ‘New Deal’ raised the school-leaving age and nationalized the armaments industry.” The Matignon Agreements’ mandatory wage rate increases went into effect at once, raising nominal labor costs by between 7 and 15 percent (Cohen-Setton, Hausman, and Wieland 2017, 279). The rest of the Popular Front’s plan, including its forty-hour week provision, was phased in industry by industry between then and the end of the year.

Noting how after 1936 France’s industrial output was persistently 30 percent below its long-run trend, Paul Beaudry and Franck Portier (2002) consider various possible explanations, including technological stagnation, only to conclude that the best is the simplest: French output fell 30 percent because between them the Blum government’s labor market legislation and strikes caused total hours worked to fall 25 percent. A decline in the ratio of investment to output, itself traceable to France’s New Deal legislation, accounts for the remaining five percentage points by which output fell.

What did cause the early-1930s collapse, then? The author points to an agriculture boom during World War I that led inevitably to a bust after WWI that dragged down most of America’s banks.

Bank lending to farmers itself doubled between the start of the war and 1920. After the war, both crop prices and US farm exports fell as sharply as they’d risen during it, triggering a farm crisis that was to ruin many farmers over the course of the next decade, often bringing their banks down with them (Belongia and Gilbert 1985). In 1921 alone more than 500 banks failed, topping the previous record established during the Panic of 1893. The 1921 failures coincided with the general economic depression of that year. But while most other industries recovered quickly from the downturn, and did so with little help from either the Federal Reserve or the Treasury, agriculture and banking didn’t. Instead, bank failures mounted.

Although thousands of US banks managed to survive the 1920s, many were in no condition to withstand any further shocks. So when commodity and security prices sagged after the onset of the Depression, bank failures became even more frequent. Rural banks were still the main casualties, although now instead of being concentrated in the western grain-growing states, bank failures were especially frequent in the South and the Midwest, where collapsing cotton, tobacco, and livestock prices combined with reduced cotton and wheat yields—a result of what the Weather Bureau described as “the most severe drought in the climatological history of the United States”—proved to be the last straw (Hamilton 1985, 602).

How much can we rely on expert analysis and wisdom? The author points out that all of the best minds of economics were in agreement that there would be a depression following World War II due to soldiers returning and finding themselves unemployed and the government ceasing purchases of weapons. Business managers, on the other hand, were investing and preparing for an economic boom.

Keynesian economists weren’t alone in dreading that shock [of peace]. Writing in November 1944, the Swedish economist and future Nobel Prize winner Gunnar Myrdal feared that 14.5 million people would find themselves unemployed after the war and that, unless the government provided for them somehow, it could look forward to “a high degree of unrest” if not “an epidemic of violence” (Henderson 2010, 4). Newsweek, Time, United States News, and most of the liberal-leaning press also “feared a gradual slide into a major depression” rivaling that of the early 1930s, with between five million and seven million former workers and soldiers on the dole by end of 1945 (Hinchey 1965, 125). Not to be outdone, Business Week put peak unemployment at nine million, or about 14 percent of the labor force. But even that was nothing compared to Senator Harley Kilgore’s (D-WV) prediction that the new depression would be far greater than the Great Depression, with eighteen million men and women failing to find jobs (126). Finally, Leo Cherne of the Research Institute of America and Boris Shishkin, an economist for the American Federation of Labor, topped all the others by forecasting nineteen million and twenty million unemployed, respectively, or unemployment rates in excess of 35 percent! (Taylor and Vedder 2010, 6). But not everyone took part in such foreboding. The chief exceptions were businessmen, the very people who had been the previous decades’ outstanding pessimists. More than a few now looked forward to a postwar boom (Wasem 2013, 47), and many nodded their heads when Russell Leffingwell, a J. P. Morgan and Company partner then serving as president of the Council on Foreign Relations, predicted in 1945 that instead of unemployment, the main economic challenge confronting the government would be inflation (Krooss 1970, 217). That same year Robert Wood, the chairman of Sears, Roebuck, staked $300 million on the prospect of a postwar boom.

About half of 1945’s GDP had been war production, paid for by the government. Between then and 1947 defense-related federal spending fell by more than 75 percent, while the share of GDP consisting of current federal expenditures fell by one-half, from about 32 percent to about 16 percent. Finally, that year’s wartime deficit of $32 billion, instead of being replaced by a peacetime deficit of at least a third of that amount as Keynesian economists had recommended, became a peacetime surplus of $2.5 billion. These cutbacks were even larger—considerably larger—than the government’s economists had allowed for in their most pessimistic forecasts.

Yet peace did not bring mass unemployment, at least not according to official statistics. Far from returning to prewar levels, the unemployment rate never rose above 4.26 percent until 1949 and was generally between 3.5 and 4 percent, levels comparable to if not below those for the Roaring Twenties. The total number of unemployed persons reached its peak of 2.7 million, not quite half of whom were recently returned veterans, in March 1946, and was generally closer to 2 million. Such levels were well within wartime forecasts of postwar “frictional” unemployment, meaning short-term unemployment of workers seeking (and eventually finding) jobs, as opposed to unemployment resulting from a lack of job openings. As such, they were consistent with the accepted meaning of “full” employment.

One popular explanation among today’s feminists is that women were forced out of the workforce after WWII and that opened up jobs for returning men. The author says that in unionized workplaces there was some evidence for this, but not in any free labor markets (which makes sense since employers would be happier to have a larger labor pool and pay lower wages; see also, open borders!).

One of those surveys, by the Woman’s Bureau [of the federal Labor Department], found that of over thirteen thousand women workers surveyed in ten major “war production centers” during 1944 and early 1945, 25 percent, including most married Rosies, didn’t wish to continue working after it. Those who wanted to stay employed, in contrast, were for the most part not “those who had been swept into the labor force during its wartime expansion” (US Department of Labor 1946b, 5).

When the option was available, women preferred to get married, become mothers, and live off their husbands’ wages. The labor market then handled a supply increase from returning soldiers just as the labor market today handles a supply increase from migrants: by delivering a lower market-clearing wage.

Women who couldn’t afford to quit working suffered not by becoming so discouraged that they quit the labor force but by becoming temporarily (and officially) unemployed at first and then, like some former women war workers in Lowell, by accepting jobs that paid much less and were otherwise less satisfying than their wartime jobs. As Sheila Tobias and Lisa Anderson put it, “Rosie stopped riveting, but she did not stop working” (quoted in Kossoudji and Dresser 1992, 434). More accurately, Rosie didn’t stop working unless she no longer had to work.

Let’s close on a positive note:

This isn’t to say that the New Deal, properly understood, contributed nothing to postwar stability and growth. First and most importantly, New Dealers managed—albeit with plenty of help from Herbert Hoover’s men—to put an end to the monetary crisis that had brought an already depressed US economy to its knees. For decades (not forever, alas), early New Deal reforms made bank runs rare while making banking crises appear to be a thing of the past. How long the Great Depression might have lasted had the banking situation not been stabilized is anyone’s guess.

More: Read False Dawn: The New Deal and the Promise of Recovery, 1933–1947