Arnold Kling  

Did the New Deal Fail?

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Cato's Jim Powell makes the case against the New Deal. Among the material Powell cites:


Richard K. Vedder and Lowell E. Gallaway, in their 1997 study Out of Work, estimated that by 1940 unemployment was eight points higher than it would have been in the absence of higher payroll costs imposed by New Deal policies.

Brad DeLong wrote a negative review of the Vedder-Gallaway book. It would be rash to accept their estimates uncritically.

On the other hand, I have never seen an economist lay out a case that the New Deal succeeded. There is no disputing Powell's point that "the 1937 peak for per capita output was lower than the previous peak in 1929. And the 1937 peak was followed by a crash."

The crash of 1937 bankrupted my grandfather's business. Nonetheless, our family became Democrats because of Franklin Roosevelt.

For Discussion. It seems to me that people who lived through the Depression tend to attribute all of the economic problems from 1933-1940 to Herbert Hoover, while giving Roosevelt credit for "doing something." If that is their thinking, is it justified?


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COMMENTS (22 to date)
Brad Hutchings writes:

No point even making the argument... If they lived through the era, chances are they are much less likely to now examine it rationally than they are to give up their drivers' licenses when they can't see well enough to safely operate a vehicle on the road (or the sidewalk).

This is one argument I don't engage in with my grandparents (80-ish). I gladly tell my Dad (56) that he needs to have another plan than social security because if payroll taxes increase so that the old can sit around and tell us how great the Kennedys were while the rest of us slave, I'll be glad to give anyone credit for "doing something" about social security (e.g. ending it). So long as my parents are OK, I don't have a problem taking everyone else's in the boomer generation social security away because they were naive, I mean stupid, to believe it would be there in the first place.

-Brad

Eric Krieg writes:

With all that is known about economics today, is there ANY question that the New Deal was a failure economically?

This is so mostly because the Depression was caused by REALLY bad monetary policy. Didn't the money supply contract by something like 25% from '29 to ??

If the Depression was a monetary phenomenon, then almost by definition the New Deal was a big waste of time.

Eric Krieg writes:

Arnold, who was the Fed chairman in 1929? Why wasn't he held in the same regard as Hoover?

Eric asked:

>who was the Fed chairman in 1929? Why wasn't he held in the same regard as Hoover?

I think the person most parallel to the current Fed chairman would have been the governor of the Reseve Board, Roy Young. However, the structure of the Fed was different in the 1920s, with more distributed, less centralized power.

Some interesting Fed history pertinent to this question can be found online in Allan Meltzer's article, "Lessons from the Early History of the Federal Reserve," at

http://www.gsia.cmu.edu/afs/andrew/gsia/meltzer/Munich.PDF

and in Friedman and Schwartz's memorable chapter on "The Great Contraction" in their _A Monetary History of the United States._

Patrick R. Sullivan writes:

Cole and Ohanian make the case for the counterproductivity of the New Deal here:

http://minneapolisfed.org/research/qr/qr2311.pdf

Abstract

Can neoclassical theory account for the Great Depression in the United States—
both the downturn in output between 1929 and 1933 and the recovery between
1934 and 1939? Yes and no. Given the large real and monetary shocks to the U.S.
economy during 1929–33, neoclassical theory does predict a long, deep downturn.
However, theory predicts a much different recovery from this downturn than
actually occurred. Given the period’s sharp increases in total factor productivity
and the money supply and the elimination of deflation and bank failures, theory
predicts an extremely rapid recovery that returns output to trend around 1936. In
sharp contrast, real output remained between 25 and 30 percent below trend
through the late 1930s. We conclude that a new shock is needed to account for the
Depression’s weak recovery. A likely culprit is New Deal policies toward monopoly
and the distribution of income.

Greg writes:

I think FDR's record as a war time leader and the fact that he died in office carries a lot of weight with the generation that lived through the depression. It would be difficult for them to square FDR's poor economic policies with his war time leadership.

I don't know if that justifies that generation's thinking, but I can understand it.

Boonton writes:

Perhaps a bit less scientific but more interesting method of looking at the issue is how much of the New Deal has survived? While national economic planning seems to have finally been discredited (although in the 80's there were still many who thought Japan was proving such policies correct) the bulk of the New Deal remains firmly established not only in the US but in most successful, Democratic, nations.

I have also seen it argued that economic shocks after the New Deal have been less dramatic and shorter lived than before. My instincts tell me its probably healthier for the economy to grow at a steady pace than go thru a series of dramatic booms and busts. Just like a doctor will tell you its probably better to be 200 lbs than to cycle back and forth between 150 and 250 endlessly.

Also the Great Depression hit many nations around the world. Has anyone looked at a cross border comparision of different policies?

lgude writes:

My father studied economics at Columbia in New York in the thirties - graduated in '35. Some of his teachers were involved in FDR's 'brain trust' I believe. Although I never studied economics formally, probably half the dinner table conversation growing up was about economics and passionate. He was Keynesian; admired and knew Gailbraith. Yet he always said that the New Deal didn't actually get the economy going again but that it took the war to really break the depression. He also said that when FDR was elected in '32 that emotionally for himself and many others it was like the sun had come out from behind storm clouds...there was hope again. He also felt that without that hope there would have been a revolution. So I think that what has been said in general about people who lived through it has some truth - that they were too emotionally involved to be objective, but I think it is also fair to say others like my father had both involvement and objectivity. My father argued that Keynes' 'middle way' worked in the end in modulating the boom bust of unregulated capitalism - he felt strongly that it saved capitalism in America. I believe he was including the post war period in his thinking here..not that it worked in the 30s, but that eventually it produced a vibrant and more controlable economy. He was also aware of and talked about all the increased economic reporting, monitary policy and various approaches to fine tuning of the economy. For example as to why better reporting was important, I recall he used to point out that freight car loadings dropped off in the spring of '29 and it took about 6 months for the market to reflect the slowdown. (I think that may be in Gailbraith's Crash of '29)He has been dead since '72. Gailbrath was still alive the last I knew and I think that his reminiscences of what things were like then - I have heard him interviewd sometime in the past 5 years - are worth listening to even if his economic ideas may seem out of date. I'd probably fight with my dad too if here were alive!

Stu707 writes:

My mother’s family went from wealth to poverty during the depression. Yet they became Democrats and passionate admirers of FDR. My uncle who was able to finish law school on the proceeds of my grandmother’s pawned jewels told me that FDR was the man who saved capitalism. Fascism and Communism were in the air in the ‘30s. Whatever the actual economic effects of FDR’s policies, the political theater of the New Deal made people think something dramatic was being done to improve the national economy.

Tom Dougherty writes:

Cole and Ohanian http://minneapolisfed.org/research/qr/qr2311.pdf present data on real wages for the total economy. From 1929 to 1933, real wages fall by 9% at a time when unemployment increases from 3.2% to 25.2%. Vedder and Gallaway in their book “Out of Work” argue that the real wage should be adjusted for changes in labor productivity, which they call the adjusted real wage. If labor productivity decreases then the marginal revenue product for each worker is decreasing. So, if you get the same real wage but you produce less revenue, your real wage per unit of revenue product increases. This is what happened from 1929 to 1933. The real wage falls, but labor productivity falls even faster, causing the adjusted real wage to rise. From 1933 to 1939 there is a big jump in labor productivity, real wages also rise but at a slower pace than labor productivity causing the adjusted real wage to fall.

Dividing the real wage by the labor product, I come up with the adjusted real wage. As the adjusted real wage rises, unemployment tends to rises and as the adjusted real wage falls, unemployment tends to fall.

Year….L.Prd…..R.Wage….AdjRW…..Unempl....
1929….100..……...100...….100.0…...3.2
1930….95.9.……..99.1..….103.3……8.9...
1931….95.4.……..98.6……103.4.….16.3...
1932….90.7.……..97..…....106.9……24.1.
1933…87.9……....91……...103.5…..25.2...
1934....96.7……...95.5.…....98.8…....22.....
1935….98.4.…….94.8.…....96.3.…..20.3.
1936....101.6…….97.3.…....95.8…...17...
1937…100.7….....97.6……..96.9..…14.3...
1938…102.4…….98.9.…….96.6…..19.1...
1939…104.6…….99.9.…….95.5.….17.2.

Eric Krieg writes:

The question is still open, why was 1930 different than 1920? There was a big depression in 1920, too. But the country didn't change direction, towards the semi-socialist, cartel model that was the New Deal. We stayed the capitalist course in 1920. Why not 1930?

One answer is that Hoover himself believed in Socialism, and he actually started some New Deal like programs, in addition to tarriffs and tax increases, that made things much, much worse.

Boonton writes:

I think we're being a bit loose with the terms here. The US did not become socialist in the 1930's. In fact, if Roosvelt were to have proposed that the Federal Gov't of the Reagan era (say 1985) be ported into 1930 the radicalness of such a change would have made him look like Lenin.

Eric Krieg writes:

>>I think we're being a bit loose with the terms here. The US did not become socialist in the 1930's.

Boonton writes:

My point is simply that the gov't involvement with the economy in the 1930's probably was only a fraction of the gov'ts invovlement with the economy in the 60's, 70's, & 80's. If 'socialization' turned a recession in 1929 & 1930 into a prolonged depression then not only should we still be in it it should be even worse today than it was in the 1930's!

Eric Krieg writes:

B, were you alive in the 1970s? It was a pretty dismal time, especially economically. It was dismal mostly because of government interference in the economy, much of it left over from the New Deal.

But it was in the 1970s that the tide turned, and the New Deal was rolled back. Airline, trucking, and rail freight deregulation were the opening salvos.

Now, why were the 1940s, 50s, and 60s not depression years? The war and its aftermath. We took out two big competitors when we defeated Germany and Japan, and created captive markets for a time. And the English shot themselves in the foot with their Labour government's nationalization of industry.

It's no coincidence that the rise of the Germans and Japanese as global competitors coincided with the US economic malaise of the 1970s. After we lost our global monopoly status, the inefficiencies of the New Deal that we were still straddled with caused big problems.

Lgude writes:

In answer to Boonton's request for cross border policy comarisons specifically I would like to float an idea that comes out of my thinking about the hostility toward the US since 9/11 in the Social Democratic world. I'm an American who lives in a Social Democracy - Australia - where the US is seen as the imperial bastion of capitalism and neo colonialism and therefore deserving of what happened on 9/11. As I tried to deal with this attitude in my friends I began to see that economically there was actually far less difference than supposed between the way the Social Democratic systems operated and the American system. In the broadest of terms I think what happened is that both the Keynesian approach and the Social Democratic approach arrived at workable, no highly sucessful, versions of what I think of as regulated capitalism. I don't think people knew what was going to work in the 30s. Everything was up for grabs and certainly 'coerced central planning' (ie Communism or Fascism) looked to many like the logical way forward. But when the smoke cleared it was the Keynsian based regulated capitalism in America and Marxist based Social Democratic Deviationism in Europe that suceeded. The deviation is critical. Besides deviating by being democratic, Social Democracy retained the private sector. They regulate it more heavily than the US, but they have a productive private sector to tax. Both China and India have converted in thier own way to regulated capitalism. Generally, I think where you find effective regulated capitalism you find prosperity, but I don't think that Social Democrats understand Americans and vice versa. A lot of it has to do with social justice being the core value of the former and freedom the core value of the latter. But it also has to do with the Marxist base of social democracy which regards capitalism with deep suspicion, while the US regards Marxism and anything reminscent of it as dubious or worse. So my main point here is that both systems have arrived at very similar places by very different routes and tend to view each other through the lens of thier own ideology and not recognise how similar thier systems really are. I've lived in both and there are real and important differences but what 9/11 has shown me is that people miss the similarities and focus on the differences and fail to properly guage the differences between our common western economic and social culture - its sucesses and problems - and say that of the Talban or the Baathists. I know this is much more global than a 'cross border copmparison of policy' that Boonton asked for. I hope it is a general appreciation of what emerged from the Depression that could - with refinement and elaboration - be a basis for the comparison of specific policies. Agree or diagree I'd appreciate some feedback - my Social Democratic friends never seem interested in discussing these ideas. :-)

Vivek Oberoi writes:

I wanted to write to about press coverage about social security and the low birth rates in the West, particularly Europe. For most part, the coverage has been about the consequences of the low birth rate on the welfare state, not the causes—almost as if it were some great mystery. Or a problem that Europeans can’t do anything about and just have to live with. But it isn’t, is it? Or am I missing something?

The one big cause for low birth rate is Western Europe is almost certainly social security. Correct me if I am wrong, but economic theory tells us that people invest in children as a means of securing the old age. This arrangement is held together by a social contract. I am aware that the social contract argument is controversial; but it makes sense to me. Social Security distorts incentives to have kids by guaranteeing people a decent standard of living after they retire. Why invest the money, time and effort to raise your own kids when you can just as well live off your neighbour’s brood. The classic free rider problem.

The little discussion that I have read about the causes of lower fertility is mostly about women delaying or forgoing pregnancy because they have entered the workforce. True, but that is the symptom not the cause of the problem. Policies like better child-care benefits and other incentives only cure the symptom, not the problem. I believe France has done better in this respect than other countries in Western Europe, and their birth rates are consequently higher than, say, Italy or Spain. However, the generous welfare state ensures that birth rates are still well below replacement levels.

The other argument explaining low birth rates is that the cost of raising children has gone up tremendously is the last few decades and prospective parents are scared off by the thought of incurring such a heavy investment. I have two problems with this argument. Firstly, if the cost of raising kids has gone then surely, so has the return. If you invest a lot of money and send your kid to Harvard, then he has a better shot at making tons of money at an investment bank (well maybe not any longer). Secondly, if the cost of raising kids were so much higher than the return, why would so many people still choose to become parents? I accept this argument might be subtler than I am making it out to be, though.

In the press coverage I have read, the sharp fall in birth rates in Eastern Europe is being blamed on the decline in the post-communist economy. It is claimed that, people are unwilling to make investments in children. I am unwilling to accept this too. While life is hard in post-communist (though not universally terrible) Europe, it is just as hard, if not harder in other parts of the world. Surely the uncertainty and quality of life in sub-Saharan Africa and the Middle East is comparable to Eastern Europe. Yet, they have very high birth rates. And the low birth rates in Eastern Europe actually pre date the events of 1989-90. Birth rates were below replacement level well before communism imploded. Social security, in communist countries, could be an explanation here too.

So why haven’t birth rates recovered with the disappearance of the welfare state in Eastern Europe? Perhaps because “humans are, as cognitive psychology teaches us, really bad at changing their minds. They are really good at finding ways to explain away and ignore new information.” Or that Eastern European couples have little faith the social contract, which ensures that kids look after their old parents.

Ofcourse, the solution to the problem could be immigration, or getting rid of social security. It’s a choice that the Europeans will have to make.

So at the end, I have one question and one comment.

Do you guys think I am on the right track?

In light of the nature vs. nurture debate, I thought that this was ringing proof, if any were needed, that genes are not puppeteers, which control our personality. Environment matters just as much. A government program can influence whether or not we choose to transmit our genes to the next generation—the most basic impulse for any living thing.

David Thomson writes:

“Do you guys think I am on the right track?”

I thank God that my German ancestors immigrated to the United States. Today's’ Old Europeans are morally and intellectually corrupt. Their culture has been severely damaged by socialism. Children are a heavy responsibility and therefore would interfere with their lazy and indulgent lifestyles. This is also why the Old Europeans shy away from warfare even when its necessary to preserve justice and liberty. We should never forget that America saved the day during the Balkan's tragedy. Also, where are these selfish folks when the Iraqi people so desperately need their assistance?

France and Germany (and even the Canadians) can barely be called our allies. It would be far more accurate to describe them as backstopping enemies that are unlikely to declare war on us. Socialism is an evil intellectual virus that destroys the backbone and decent instincts of a culture. It may take decades, if ever, before the Old Europeans are able to regain their self respect.

Do I seem unduly harsh? Oh well, at least nobody can accuse me of racism! I have thought about these matter for a long time---and I’m convinced that my comments are carefully nuanced and not even slightly exaggerated.

Boonton writes:

"It's no coincidence that the rise of the Germans and Japanese as global competitors coincided with the US economic malaise of the 1970s. After we lost our global monopoly status, the inefficiencies of the New Deal that we were still straddled with caused big problems."

Eric misses the original point; considering that the scope of gov't in the 1980's still far exceeded the New Deal era of the 30's, why did the 80's look so much better than the 30's? Ditto for the 70's and all the other decades.

Eric seems to be dangerously close to asserting the discredit theory of mercantilism. That theory asserted that well off neighbors & trading partners were a threat to your economy. It also asserted that the foundation of economic growth was increased exports & limited imports.

I think it's odd to think that we can afford universal healthcare, social security etc. only if the EU & Japan are in ruins but if they are doing fine (or even just ok) we have to kick grandma out of the nursing home! Standard economic theory says the US is better off with rich neighbors like Canada, Europe, Japan etc. than a world of poor nations.

David Thomson writes:

“...why did the 80's look so much better than the 30's? Ditto for the 70's and all the other decades.”

Our economic values are so strong that we were able to succeed in spite of the obstacles caused by the New Deal.

Eric doesn’t need me to defend his views. Nonetheless, I adamantly believe that you are taking him out of context. Nobody possessing a lick of sense argues that economically weaker foreign countries enrich our own nation. Zero sum economic nostrums are only for idiots.

Boonton writes:

"Our economic values are so strong that we were able to succeed in spite of the obstacles caused by the New Deal. "

This sounds nice but I really have no idea what it means. Did the New Deal turn a recession into a Depression or did a Depression cause the New Deal?

If the New Deal caused the Great Depression then how to explain the 40's thru today is a serious question. By most objective measurements the economic intervention of the New Deal was smaller than it was in any of those future periods. If the New Deal caused the Depression then we should still be in it.

Eric at least tried to answer that question but his answer seems unlikely to be accurate IMO. That 1970's are not a 'delayed reaction' to the policies of the 1930's. More to the point, except for some 'industrial planning' the New Deal was never rolled back. Never. Even people often associated with 'rolling back the New Deal' never actually did it. The closest Reagan ever came was a one time suspension of the cost of living adjustment on social security. Bush is supporting an expansion of the New Deal with a new prescription entitlement.

Roger Febuary writes:

Well...... i dont think we can really judge if it was a faliure now, all that matters is it got people working i dont hink we can just sit around and twiddle our thumbs and slowly but surely come up with answer.
we where not part of that time we dont know what it was like to get a job back then, the biggest point is it ESTABLISHED strong unions. workers untill then (even now) s=where harressed and where violently suppressed. so the only thing that really matters is that it established some thing that didnt further the gap BETWEEN THE RICH AND THE POOR.

if you would like to further this please e-mail me i would love to hear back

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