Arnold Kling  

The Great Depression as a Recalculation

Price Discrimination: Illegal ... Book 1, Book 2...

In an interview, Bruce Greenwald says,

Basically, in the Depression a huge sector of the economy that everyone had always regarded as central, died. And it dies for an almost virtuous reason.

That sector of course is agriculture.

Because productivity in agriculture had been growing faster than demand, we needed to shift resources out of agriculture. The Great Depression did this, rather painfully. I would add that the advent of the internal combustion engine greatly re-organized economic life. Because you could move agricultural produce and other goods around by truck, you did not need central cities surrounded by farms. The farms that used to surround big cities were now converted either to suburbs or wilderness.

How were people re-employed after the Great Depression? Greenwald says,

The reason why World War II got us out of the Depression, and the reason that Argentina suffered because it didn't participate, is that it is actually industrial policy that gets everybody off the farms.

...One of the great concerns at the end of WWII was that everyone thought we were going to go back to the Great Depression. In Argentina, of course, that happened. In the US and everyplace else, everyone was surprised and relieved. But the reason is that you've gotten everyone off the farms and into the cities. It was through both the war industries and in the army.

Greenwald goes on to say that the same thing is happening today in manufacturing--productivity has been growing faster than demand. This is a problem for the United States, but we have a fair amount of the restructuring behind us. Japan, China, and Germany are the most vulnerable economies right now.

He sees these manufacturing countries as dependent on U.S. trade deficits.

The problem from the perspective of the US is that if we are importing 9% more of our GDP than we are exporting, it is very difficult to sustain full employment. You basically have to have a zero saving rate or a bubble in the internet or housing. But you have to have some substitute demand.

...The long-term solution is you have to get people out of manufacturing - and governments have to cooperate in this effort - and get them into industries like health care...

The services people have to buy are lots of health care, custodial services for old people, college education and graduate education, and housing. They are big lumpy expenditures, and the government has to help finance them.

i was with Greenwald until the last sentence. I do not see why a market economy cannot generate demand for those services. The transition would be easier if (a) we did not tell workers in declining industries to expect to get their jobs back and (b) we did not limit access to employment in education and health care through licensing, accreditation, unionization, etc.

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COMMENTS (8 to date)
JPIrving writes:

I dont know if I buy it. Why did unemployment jump after the Smoot-Hawley tariff rather than slowly rise as demand for farm labor slowly shifted in? It is not as though the tractor and pickup truck simply dropped from the sky onto every farm, it must have taken years and years for the disemploying effects of these technologies to be fully felt. I think the Higgs or Sowell explanations of the depression and subsequent recovery in '46 are more convincing.

Maybe there is a farming recalc effect but certainly the FED and Hoover/FDR have the leading roles?

David Pearson writes:

The data unfortunately do not support his hypothesis. Bianco Research has published data on the breakdown of job losses over the past five recessions. What it shows is that previous recessionary job losses were concentrated in goods-producing sectors: around 95% of job losses in the 70's and 80's recessions; and around 85% in the last two recessions.

The 2009 recession is quite different. Fully 50% of job losses have occurred in the service sector. This, obviously, would imply that the "recalculation" is happening in services. Why should this be? Perhaps its not a function of improving productivity, but in a build-up of discretionary services that were supported by rising consumer debt.

Logic would tell us that, having shrunk to less that 20% of employment, the "Great Recaculation" would not be about ridding ourselves of manufacturing jobs. Moreover, given the resulting chronic weakness in the dollar, it stands to reason that manufacturing employment might actually RISE relative to service employment before the adjustment is over.

fundamentalist writes:

There are a lot of tangled up issues in the article that are hard to unwrap. While productivity increases in ag were good, they weren't the main cause of excess ag production; state interference was. The ag crisis began with the end of WWI. The guv had encouraged excessive ag production during the war because he feared food shortages in Europe. Spurred by ridiculously low interest rates, farmers borrowed vast somes and dramatically expanded production. But the war ended suddenly and Europe's ag sector rebounded quickly. As a result, food prices plummeted and farmers couldn't repay loans. I know because my great-grandfather lost his farm in the 20's for that reason. Killing 400,000 farm boys in WWII helped solve the problem.

Today, the shrinkage of manufacturing in the US is due to high taxes, regulation and continuing price inflation, all of which destroy manufacturing. And the demand for health care and education is driven by state policies of subsidizing those industries through Medicare, medicaid and studen loans. In addition, the state has allowed or abetted industries in setting up medieval guilds that require PhD degrees to sweep streets.

A free market would reallocate demand away from education and healthcare toward manufactured goods.

Boonton writes:

Except didn't the roaring 20's largely leave farmers behind? 'Recalculation' implies some sort of previous mistake on the part of the economy that is now painfully corrected. But the 20's did saw agriculture as the way of the past as manufacturing expanded rapidly.

Likewise the 2000's saw many ideas about the next 'big thing' but domestic manufacturing wasn't one of them. OK maybe Amazon wasn't going to employ 20% of the workforce in 2006 but find me one person who thought GM was!

spencer writes:

Beautiful theory,

except from 1930 to 1934 farm employment only fell 3.4% while nonfarm employment fell 10.4%, or about three times as much on a proportional basis.

farm employment rose rose from 23.4% of total
employment in 1930 to 24.7% in 1934.

Never confused by the facts are you.

Source: historical statistics of the US.

Milton Recht writes:

Bruce (by the way, he is far more intelligent and knowledgeable than I am) is talking about sector changes in employment. Whether or not his example of agriculture is correct, during times of economic retrenchments, some industries suffer more and reduce employment more than others. When the economy rebounds, the new economic growth does not entirely reverse an industry's previous employment and production declines and undo a particular industry's employment losses. The employment and production growth occur in different areas due to changes in demand, changes in production efficiency and capital investment that affect the need for labor.

Bruce and Arnold do not mention that there are also changes that occur within sectors. There is a constant churning of labor in the economy, which can result in significant changes in the characteristics of the labor force within an industry. As companies let employees go, companies hire new employees with different attributes.

In times of increasing unemployment and a slowing economy, there is an excess of employee applicants for jobs. Employers could lower salaries and benefits in response to the excess of available workers. Most of the time, it appears that wages and benefits do not decline (sticky wages). Instead, employers raise the requirements for their open positions. They are able to hire workers with more education and more experience at or slightly above the previous wage paid for the position, but at a lower wage than they would have paid before the economic slowdown. During recessions, there are often complaints of workers being overqualified and underutilized for positions they have, but it allows some companies to use the newly available unused talent within their business to achieve competitive advantages. During the Depression, some jobs added a high school degree as a new requirement.

As employers accumulate more experienced, more skilled, and more educated workers, the employers expand, restructure and modify jobs to increase efficiencies. Additionally, companies can use the workers' experience and unused skills to expand their institutional knowledge, focus on other aspects of the industry and reduce a competitor's advantage. The internal changes to the talent pool within an existing industry allow it to respond to competitive changes proactively, dynamically and flexibly.

It was the internal industry and employee skill changes during the recession that allowed industries to grow post WWII.

One could argue that the rigidities of job definitions, job responsibilities, and hiring and firing rules caused by the unionization of the US auto industry prevented the auto industry from making the necessary internal structural job modifications, increase workers' experience and gain institutional skills in times of previous economic recessions and auto sales slowdowns. The inability of the auto industry to avail itself of cheap talent, without reducing wages, during recessionary times hindered its competitiveness and allowed new competitors to take away significant market share.

Niccolo writes:

So wait? Why does war bring down unemployment?

I didn't think it had anything to do with shifting policy. I thought it was more about it being easier to kill a fifth of the population than to have to find them new jobs.

Boonton writes:

War brings down unemployment because it generates massive demand that mops up a lot of unemployment. Yes it does 'remove' people from the economy to fight in the army, but I don't think that alone reduces unemployment (the drafted people take their demand out of the economy too, spending their pay in London pubs rather than New York bars).

Stimulus skeptics should look carefully at WWII. Suppose the US didn't have a nasty Germany and Japan to fight. IMO, it could have achieved the same return to growth by undertaking a massive fiscal stimulus....say doing the Interstate highway system 15-20 years earlier, massive investments in TV, doing the space program early and so on. The result would have been an even better post WWII record. Even though a lot of that spending would have ended up wasted, a lot more would have remained behind providing useful capital for economic growth. In reality war is wasteful because it destroys lives and the capital it does produce (ships, tanks etc.) are useful for little besides war.

An interesting counter factual would be an alternative history where WWII was not necessary. How would culture have been different with the addition of the hundreds of thousands of men who died young? Would antisemitism be taboo today if the Holocaust never happened? What would the economy look like? Would computers have arrived early due to that investment or would they have arrived late since their seed was the war effort?

Sci-fi aside, if stimulus spending is counter productive then it should be easy to point to a massive problem with WWII which can be viewed economically as massive stimulus spending. Were the 1950s and 60's poorer because of WWII? Not compared to an alternative stimulus spending but compared to none?

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