World War II and economic recovery

Rationing

Defenders of Keynesian economics -- essentially, the idea that government spending can drive economic growth and progress -- have a real uphill task. While public sector expenditures can produce brief upticks in economic data, it has never produced long-term prosperity. The only possible exception to this is World War II, when vast levels of spending and an essentially centrally-run economy produced full employment.

This has led to to some rather weird nostalgia on the part of some on the left, who hearken back to World War II as a kind of golden era in the U.S. economy and evidence of the virtues of high government spending and economic planning. Except, as Charles Lane of The Washington Post writes, World War II was awful, even on the home front:

Gauzy memories of national unity notwithstanding, the World War II home front was actually a pretty conflictual place, and increasingly so as the war dragged on. Families chafed under the pressure of rationing and shortages; defense workers staged hundreds of wildcat strikes over unbearable working conditions. Americans hung together because they saw the war as finite and the alternative as catastrophically worse. Today’s polarized American electorate wouldn’t even tolerate a few cents of additional gas taxes, much less Greider’s big move.

What about “force-[feeding] the rapid development of new technologies and new basic industries?” Greider is right that World War II’s aircraft, tanks, bombs and bullets had profitable civilian spin-offs. But we would have built them anyway, because those were the implements of a war we had to win. Today, the choice of investment is a bit more complicated. If government borrows money to fund particular technologies, “green” or otherwise, they must meet the test of the market someday, lest they simply become permanent drains on the Treasury. Energy-saving technologies have a lot of promise, but their ultimate profitability is hostage to the world price of oil. Greider says we should build high-speed rail. Okay. But everywhere else in the world, it’s subsidized, even in densely-populated Japan. Why would it be a money-maker here?

Give the whole thing a read. Prosperity and full employment are not the same, and the post-World War II boom occurred in part because of pent-up demand stemming from all of the wartime rationing and deprivation. This is not a formula we should seek to repeat.

New Deal success and failure

Just as it is problematic to evaluate the impact of the current stimulus bill so too is it difficult to answer the question of whether the Depression-era New Deal was a success or failure. While there may be a temptation to declare it a success given that the U.S. eventually emerged from the Great Depression, that is insufficient. Given that the U.S. has recovered from every economic downturn the better metric would seem to be whether the New Deal resulted in this recovery occurring faster than otherwise would have been the case.

According to a new paper the answer to that question is an emphatic no:

The failure of the U.S. economy to recover from a downturn within a few years was unprecedented. Every previous economic crisis in the history of the United States, large or small, had been followed by a vigorous recovery. And by most objective measures, economy did seem poised to rebound quickly after the nadir in 1933. Deflation ended, financial liquidity was more than ample, borrowing costs were low and, thanks to the introduction of deposit insurance, bank panics were no longer a threat. Indeed, we have calculated that, on the basis of productivity growth alone, employment and investment should have been back to their normal levels by 1936.

But don’t take our word for it. The Nobel Prize-winning economist Robert Lucas and the economist Leonard Rapping calculated decades ago that the Federal Reserve’s efforts to expand the money supply should have brought the economy back on track by 1935.

So what went so badly wrong? Our research suggests that a slew of policies, specifically those that suppressed market competition, are central to understanding why the economy remained so weak for so long.

As I've written before, competition is the key.

HT: Hit and Run.

Lehigh update

Readers of this blog may recall that earlier this week I wrote about Scot Lehigh's column in the Boston Globe that attempted to defend the New Deal, which I found rather unconvincing. I also included the contents of a brief email he sent to me.

Today I received a follow-up, which said the following:

I've had so much response to my recent column on the New Deal that I wanted to send around a longer piece by Bruce Bartlett, who worked at treasury at the end of the Reagan administration and during George H.W. Bush's administration. If one is interested in this topic, his analysis is well worth reading. (I apologize for the group-list nature of this email.)

Cheers,

Scot

http://www.forbes.com/2009/02/12/stimulus-depression-deficits-opinions-columnists_0213_bruce_bartlett.html

I had actually already read this column, which was featured on realclearmarkets some days ago, and was familiar with its contents. Essentially Bruce Bartlett argues that the New Deal failed because budget deficits were too small under FDR.

I really don't know what to make of this given that Bartlett argues from the perspective that the New Deal was a failure while Lehigh attempted to defend it. Has Lehigh now changed his mind? Or is he oblivious to the fact that the very column he is now citing takes issue with his central thesis that the New Deal worked?

Update: I emailed Lehigh to ask him the above questions and he responds:

I think I said it was a success but a limited success, no? That one criticism is that it was too small a stimulus? And that the war, economically speaking, can be seen as a bigger stimulus?

It's true, at the conclusion of his column he did say these things, ultimately calling the New Deal a "success, but a limited one" and stating that "reality also argues for the efficacy of Keynesian remedies; economically, the war constituted a huge government stimulus, financed by massive deficit spending."

As I wrote to Lehigh in my response, to even call the New Deal a limited success one has to demonstrate that unemployment went down by an amount than would otherwise be the case if nothing was done. Also, separating the impact of government spending from unemployment and economic recovery is difficult to do since so much of the New Deal was much more than simply shoveling money out the door.

Quite simply the New Deal was a massive government intervention in the economy. If the government had simply spent a bunch of money to hire people to plant trees and build bridges that would be one thing, but that's not the case.

Indeed, the first New Deal of 1933 included the establishment of the National Recovery Administration. This is how wikipedia describes the NRA:

The NRA allowed industries to create "codes of fair competition," which were intended to reduce "destructive competition" and to help workers by setting minimum wages and maximum weekly hours. It also allowed industry heads to collectively set minimum prices. In 1935, the United States Supreme Court unanimously declared the NRA as unconstitutional in the court case of Schechter Poultry Corp. v. US, on the grounds that it violated the Constitution's separation of powers.^[1] The NRA quickly stopped operations, but many of its labor provisions reappeared in the Wagner Act of 1935.

Clearly this is a government means of reorganizing the economy. Other key elements of the New Deal include the establishment of Social Security, the Federal Housing Administration, the Securities and Exchange Commission and Fannie Mae.

Lehigh uses the New Deal as a justification for Obama's spending spree -- even though he can only bring himself to call it a limited success -- but I am increasingly wondering if he even knows all that the New Deal really was.

Defending the New Deal

Scott Lehigh of the Boston Globe attempts to defend the New Deal:

The argument that the New Deal failed is easy to make.

You start with unemployment figures that exclude those who labored in work-relief programs like the WPA or its various cousins. Yes, that's passing strange, given the many worthwhile tasks those public employees accomplished, but sophistry has its demands.

Next you present a misleading juxtaposition of that exclusionary unemployment data, noting that the 19 percent joblessness rate in 1938 wasn't all that much better than the 25 percent of 1933, FDR's first year in office.

Then you add the well-worn 1939 quote from Henry Morgenthau Jr., FDR's treasury secretary, that government spending hadn't produced a recovery, and, for professorial effect, perhaps even toss in George Santayana's observation about those who cannot learn from history.

Presto: You've got yourself a paint-by-numbers conservative polemic.

But what do unemployment figures from the era actually show? The best regarded data excluding public-works employees traces a steady decline in joblessness through the first five years of the New Deal, from 25 percent when FDR took office to 14.3 percent in 1937. Then, however, joblessness rose, hitting 19.1 percent in 1938 before dropping back to 14.6 percent in 1940 and 9.9 percent in 1941.

For the record, here are the unemployment stats for the 1930s:

1930 8.7%
1931 15.9%
1932 23.6%
1933 24.9%
1934 21.7%
1935 20.1%
1936 16.9%
1937 14.3%
1938 19.0%
1939 17.2%

As you can see it's rather obvious why Lehigh cherry-picked 1937. But leaving that detail aside, consider the fact that unemployment didn't drop below 14% until 1941 -- eight years after FDR took office -- and this is offered up as a defense?

Update: I emailed Scot Lehigh to tell him that I was rather unimpressed with his New Deal defense. His one sentence response:

I bet you would have if you were one of the 25 percent (or higher, in some estimates) without a job.

Lehigh suffers from a lack of imagination and the ability to critically analyze. You can't simply point out that unemployment declined and argue that therefore the New Deal was a success. Rather you have to make the case that the New Deal reduced unemployment more than would otherwise be the case if either no government action was taken or a different course of action was taken.

The U.S. economy has recovered from every economic recession and depression it has ever suffered. It is unrealistic in the extreme to think that 25 percent unemployment would have continued in perpetuity. The fact that we had double digit unemployment right up until the onset of World War II (ok, I am rounding up on the 9.9 percent unemployment in 1941) is more of a damning indictment of the New Deal than a cause for uncorking champagne.

New Deal stats

On Sunday I addressed the misconception that has taken hold of Herbert Hoover as some market fundamentalist. Now let's take a look at the New Deal itself with a couple of graphs from Megan McArdle:

Unemployment:

GDP:

These tell an interesting tale. In popular mythology FDR's New Deal ended the Great Depression, however we can see that in reality after 7 years of government spending and massive intervention (setting minimum prices on all sorts of things, for example, including the price of apples) that unemployment was around 17% and that GDP was about where it was 9 years prior.

The notion that the New Deal did not end -- and in fact likely prolonged -- the Great Depression has gained increasing currency in recent years, leaving more and more people to argue that it was actually government spending in World War II that lifted us out of the economic doldrums of the 1930s. This is, after all, the only possible example we have in history of us spending ourselves into prosperity.

But let's stop and think about that. During World War II we had just about the closest thing to full employment in the history of the country, that much is true. But remember, having a job is merely a means to an end. We go to work for the paycheck that allows us to buy goods, rarely for the work itself. During World War II there was little that one could spend their paycheck on. Food and consumers goods were strictly rationed. In the guns vs. butter trade-off we were heavy on guns and short on butter. It wasn't much fun. While everyone had a job, it's hard to say that we were very prosperous. Then, after the war, most of the fruit of the country's labor was various instruments of war that no longer served any purpose.

We really need to think twice before deciding whether such a path is the answer to our economic problems.

Same old New Deal?

It is little surprise that recent increased talk about an economic depression has also produced renewed calls for a New Deal type response. After all, in popular lore the massive government intervention that was the New Deal economic program solved the Great Depression. But is that true? George Will had a wonderful column on the topic this weekend:

The assumption is that the New Deal vanquished the Depression. Intelligent, informed people differ about why the Depression lasted so long. But people whose recipe for recovery today is another New Deal should remember that America's biggest industrial collapse occurred in 1937, eight years after the 1929 stock market crash and nearly five years into the New Deal. In 1939, after a decade of frantic federal spending -- President Herbert Hoover increased it more than 50 percent between 1929 and the inauguration of Franklin Roosevelt -- unemployment was 17.2 percent. "I say after eight years of this administration we have just as much unemployment as when we started," lamented Henry Morgenthau, FDR's Treasury secretary. Unemployment declined when America began selling materials to nations engaged in a war America would soon join.

The sentence that Will uses is taken from this Morgenthau statement, which is worth quoting at length:

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 if I am wrong ... somebody else can have my job. I want to see this country prosperous. 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 an enormous debt to boot!

That's not much of a surprise. After all, the government can only engage in wealth transfer, shifting the allocation of resources around. What it cannot do is increase wealth. Massive government intervention only makes sense if you think that the politicians have a better idea of how to allocate resources than the collective knowledge of the marketplace, which I find absurd.

Indeed, as Will notes, recent research suggests that the government actually prolonged the Depression:

In a 2004 paper, Harold L. Cole of the University of California at Los Angeles and Lee E. Ohanian of UCLA and the Federal Reserve Bank of Minneapolis argued that the Depression would have ended in 1936, rather than in 1943, were it not for policies that magnified the power of labor and encouraged the cartelization of industries. These policies expressed the New Deal premise that the Depression was caused by excessive competition that first reduced prices and wages and then reduced employment and consumer demand. In a forthcoming paper, Ohanian argues that "much of the depth of the Depression" is explained by Hoover's policy -- a precursor of the New Deal mentality -- of pressuring businesses to keep nominal wages fixed.

Really, read the entire column.

The last thing I would like to leave the reader with is the following graph that I stumbled upon (click to enlarge):

Source: housingbubblebust.com

Assuming that this graph is accurate, it tells an interesting story. While many people would look at this and think that it is further evidence that FDR ended the Depression, look a bit more closely. According to the graph the Depression actually reached its nadir in about the third quarter of 1932. Roosevelt, however, didn't even take office until March 1933, at which time the economy had already begun to recover before he had lifted a finger.

Massive government spending didn't work then and it won't work now.