Spain, the Great Depression and the need to spend

The Great Depression and the Roosevelt Administration's response is a subject of endless debate. Perhaps the most common narrative is that FDR took office and opened the government spigots, spending the economy into recovery. A quick look at the unemployment figures at the time would seem to support this line of thinking:

There are at least two potential problems with this theory, however. The first is that the government, while increasing spending, did not run massive deficits. This means that it was simply sucking money out of the economy via taxes and then reallocating it rather than injecting borrowed money as this graph illustrates:


While spending was higher than normal, as a percentage of GDP the deficit wasn't overly exceptional and similar to the level of the 1980s. If this chart is accurate it also shows that Obama's spending is already resulting in deficits higher than FDR's.

Another potential problem is that the New Deal was just as much, if not more, about regulation than spending. A slew of new agencies, programs and regulations were unveiled, upon which some agreement exists that they played a counterproductive role and actually hindered recovery.

In evaluating the success of the New Deal and FDR's response we have to ask whether it resulted in an economy that was more or less robust than otherwise would have been the case had the government offered a more muted response and kept policy more constant. Engaging in counter-factuals is always difficult, especially with the New Deal since few if any parallels exist.

The example of Spain, however, may offer an interesting case. In the mid-1990s the country had unemployment that approached that of the U.S. at the height of the Depression at about 25 percent. In about eight years it succeeded in reducing that to about 10 percent, similar to the reduction seen in the first graph during the New Deal:

What is interesting here is that Spain's approach seems to be quite different than that taken by Roosevelt, appearing to favor more free-market policies including privatization and budget austerity:

The Aznar Government (Government) maintained the commitment of the previous government to join the European Union's single currency and showed itself willing to take political risks in order to meet the requirements for membership. In the summer of 1996 it announced a decision to freeze the wages of civil servants in the following year and stood by that decision throughout the fall, despite a series of union-led demonstrations that culminated in protest marches by tens of thousands of Spaniards throughout the nation on 11 December.

The Government, with the backing of regional nationalist parties, passed a strict 1997 budget on 27 December, four days before time would have run out for its approval. The opposition United Left coalition argued that the spending cuts and tax adjustments contained in the budget would hurt the disadvantaged and benefit the rich. The budget aimed to enable Spain to lower its deficit to below 3% of gross domestic product, a requirement for joining the EU's single currency. Some critics note that this wasn't the only way of doing so.

...Aznar also announced the sale early in 1997 of the nation's remaining minority stake (golden shares) in the Telefónica telecommunications company and the petroleum group Repsol. These golden shares in Telefonica and Repsol YPF, as well as in Endesa, Argentaria and Tabacalera, all presided over by people close to Aznar, have since been declared illegal by the European Union. This marked the beginning of a period of privatizations after the previous PSOE government had nationalized parts of the economy.

Granted, such parallels are never perfect, but the fact remains that the Aznar took a different approach and achieved a similar result, which avoided the debt accumulated by FDR during the 1930s. It's something to ponder as the New Deal is cited as a justification for the spending spree that the Obama Administration is engaged in.

Update: Related point in this interview with economist Robert Barro of Harvard University:

B: I thought that the Great Depression was the ultimate cautionary tale on the dangers of protectionism. That’s not the case?

RB: No I think what is much clearer is the role of the financial system and the credit implosion, both in the 1930s and today. The rest of the stuff may just be a sideshow, it may not be that important. There’s a strong tendency for the economy to recover on its own, as long as it’s not subject to further new shocks, so a likely scenario is that that is what will happen today as well. And then the Obama administration will say that it’s because of our policy that things recovered, and there won’t be any way to prove whether that’s right or wrong.

Two key points. The first is that, as Barro notes, economies tend to recover on their own. People and companies make adjustments to their behavior and position themselves for new growth.

The second, and related, point is that correlation does not equal causation. Just because two events, such as government spending and economic recovery, occur at the same time does not mean that one caused the other. A decline in unemployment under the New Deal does not mean that the New Deal is responsible for the decline. As Barro points out, economies tend to recover.

Indeed, you can make an argument that our own economy is already starting to recover, and the actions of the Obama Administration will have little to do with it. But you can bet who will reap the credit, and it sure won't be the private sector.