Arnold Kling  

Phelps on the Great Displacement

A Case for Paternalism?... The Employment Situation...

Edmund S. Phelps looks at one of my favorite topics: parallels between the current economy and the Great Depression.

Each boom was caused by the advent of a new general-purpose technology -- commercially available electric power in the '20s, the information and communication technologies in the '90s. By mid-decade there were high and rising expectations of profits to be earned in the decade ahead from applications of the new technology. In the boom years these expectations fueled a wave of preparatory investing -- much of it in infrastructure and employee training. The force of the expectations may be roughly gauged by the take-off of share prices. Take the S&P Composite stock price index adjusted for inflation -- the "real S&P." From pre-boom 1924 it rose 20% by 1925 and 104% by 1928; from the pre-boom 1996 level it rose 30% by 1997 and 98% by 1998.

...Recovery from the Depression faced stiff headwinds from the cost-savings and spin-off innovations made possible by the '20s investments in the new general technology. The '30s, after all, marked the rise of the great industrial laboratories that so impressed Schumpeter.

...The technological developments and overseas tensions that slowed and limited the '30s recovery have clear parallels in the economy's present situation. The 350,000 employees sent into the jobless pool every week is a significant hurdle on the way to getting unemployment back to the pre-boom rate of 1995-96 (5.5%), let alone the 5% level envisaged by some.

For Discussion. Phelps argues that employment is a function of the difference between stock market appreciation and productivity growth. Is this a good model for explaining movements in employment?

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CATEGORIES: Macroeconomics

COMMENTS (12 to date)
randy writes:

I think one of the keys to understanding the Great Depression is to contrast the US experience with other similar countries. Why did the depression last so long in the US, despite the relatively rapid recovery of productivity in the US, and the relatively rapid recovery of employment in other countries?

Now turn to Cole and Ohanian ...

Steve writes:

->Why did the depression last so long in the US, despite the relatively rapid recovery of productivity in the US

Don Lloyd writes:


"...Until someone gives me a better explanation, that is what I'm sticking to. I'd like to hear other opinions"

Economic recovery was made impossible by government support of prices of various kinds, but, in particular, wages. Despite grossly changed economic conditions, wages were not allowed to fall. If the government made it impossible today to pay or accept less than $100 per hour for labor, you would have some idea on the effects of such a policy on employment and production.

Regards, Don

Cap'n Arbyte writes:

See Rothbard's _America's Great Depression_ for the argument that tremendous credit expansion made possible by the Federal Reserve caused the whole problem (the boom and the bust) in the first place. Also contains an exposition of the Austrian business cycle theory in the first few pages:

The book unfortunately ends around 1933 so doesn't talk about the recovery period.

We Austrians are a funny bunch, we actually like the gold standard and think the villain's role was played by fractional-reserve banking. Then later, by the reluctance to allow prices (particularly labor prices) to fall, as Don said.

Incidentally, Austrians agree that deficit spending can get things moving again... but we think that's an unwise move, because it just allows a bad condition (the poor investments of the boom) to continue. Misidentifies the process of healing as the disease itself, and all that.

While there may be similarities between the 20's/30's and the 90's/00's, there are also many differences.

1) We have a much better understanding of how monetary policy works today.

2) We have a more enlightened presidential administration that understands the consequences of taxation (of course, they don't seem to understand the consequences of spending, but at least they are half way there)

For more background on points 1 and 2, I recommend FDR's Folly, a new book by Jim Powell from Cato. Fascinating analysis of the horrible effects of FDR's many supposedly 'helpful' policies.

3) The 30's was the peak of the movement towards and belief in centralization, a time when the president of the American Chamber of Commerce (!) foresaw all corporations inevitably combining into one. Centralization breeds inflexibility. To the extent that government was not maintaining prices and wages (and aggresively backing unions), corporate centralization could only further hinder appropriate adjustment.

Brink Lindsey's book Against the Dead Hand gives a great history of the dogma of centralization over the century.

4) While the industrial economy did require an amount of centralization to function (although I think it could have functioned with much less), the information economy does not. It is tremendously easier to start a new business today than it was in the 1930's.

The 'international tensions' is a big wild card. Another serious terrorist attack in the US and we would pretty likely see a big economic downturn.

Eric Krieg writes:

>>2) We have a more enlightened presidential administration that understands the consequences of taxation (of course, they don't seem to understand the consequences of spending, but at least they are half way there)

Do YOU understand the "consequences" of spending?

For instance, can you tell me what the unemployment rate and the federal deficit would be if spending had been held to 2000 levels?

Dubya has implemented the PERFECT fiscal policy for a recession if the goal is to minmize unemployment. ANY other scenario (less spending, less tax cuts, or even tax increases) would have most likely resulted in MUCH, MUCH, MUCH more unemployment.

Lawrance George Lux writes:

The Great Depression was a failure of Consumer Demand, and Business and Government made it worse. I hold Don Lloyd in esteem, but it was exactly the opposite effect: Government and Business insisted on slashing Wages. Government invoked Subsistence payments for Welfare, and Work programs implemented insisted on minimal Wage. Business slashed their Wage payments, and it completely dryed up the source of Consumer Demand. It took WWII to convince Business and Government to pay Consuming levels of Wages. lgl

Don Lloyd writes:


Nominal wages didn't fall far enough and real wages actually increased. Of course, the level of wages is of little importance if there are no jobs. A recovery depends on an economic re-arrangement that allows private businesses to earn profits. Absent this, it makes no difference what the government chooses to call its welfare payments.

Regards, Don

>Dubya has implemented the PERFECT fiscal policy for a recession if the goal is to minmize unemployment.

It did seem to work out well, I'm not opposed to deficit spending in a recession per se. But a new unfunded $7T mandate (the medicare drug bill)? This has nothing to do with stimulating anything except votes.

Eric Krieg writes:


I couldn't agree with you more about Medicare. I think that there should be a drug benefit, but such a benefit should be made revenue neutral by reforming Medicare.

But the fact that the bill doesn't reform Medicare as much as it should have is not Dubya's fault.

And no one other than a dyed in the wool Austrian should give Dubya a hard time about the LEVEL of spending. Were it not for all that spending, the recession would have been MUCH worse.

Lawrance George Lux writes:

I take the Macro view of Wages, where Layoffs and Firings are considered Wage reduction. There was heavy involvement in the Stock Market prior to the Crash of 1929. Business people took a bath in the Market, and the Warehouses were full, so they laid off Workers. We are talking the same thing here, though you would claim actual Real Wages rose; they did so only for Sector elements.

Stephan and Eric,
There never should have been a Prescription bill in the first place, the only thing which will bring down Drug prices is competition for Sales. The law passed stops this very thing. Evaluation of the Law presents a real contradictory picture for Elderly; the law only provides for Health Care industries, prohibits bulk purchasing negotiation by the Government, and insists Seniors actually pay for the cost of the Drugs through a fully-funded Insurance-sharing scheme. lgl

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