How Government Prolonged the Depression

The Carnival of Latin America & the Caribbean will be up later this morning, but don’t miss this at the Wall Street Journal: It is completely pertinent now that we’re about to have the catastrophic “stimulus bill, of which Less Than 25 Percent is Actually Stimulus

How Government Prolonged the Depression
Policies that decreased competition in product and labor markets were especially destructive.

So what stopped a blockbuster recovery from ever starting? The New Deal. Some New Deal policies certainly benefited the economy by establishing a basic social safety net through Social Security and unemployment benefits, and by stabilizing the financial system through deposit insurance and the Securities Exchange Commission. But others violated the most basic economic principles by suppressing competition, and setting prices and wages in many sectors well above their normal levels. All told, these antimarket policies choked off powerful recovery forces that would have plausibly returned the economy back to trend by the mid-1930s.

The most damaging policies were those at the heart of the recovery plan, including The National Industrial Recovery Act (NIRA), which tossed aside the nation’s antitrust acts and permitted industries to collusively raise prices provided that they shared their newfound monopoly rents with workers by substantially raising wages well above underlying productivity growth. The NIRA covered over 500 industries, ranging from autos and steel, to ladies hosiery and poultry production. Each industry created a code of “fair competition” which spelled out what producers could and could not do, and which were designed to eliminate “excessive competition” that FDR believed to be the source of the Depression.

These codes distorted the economy by artificially raising wages and prices, restricting output, and reducing productive capacity by placing quotas on industry investment in new plants and equipment. Following government approval of each industry code, industry prices and wages increased substantially, while prices and wages in sectors that weren’t covered by the NIRA, such as agriculture, did not. We have calculated that manufacturing wages were as much as 25% above the level that would have prevailed without the New Deal. And while the artificially high wages created by the NIRA benefited the few that were fortunate to have a job in those industries, they significantly depressed production and employment, as the growth in wage costs far exceeded productivity growth.

These policies continued even after the NIRA was declared unconstitutional in 1935. There was no antitrust activity after the NIRA, despite overwhelming FTC evidence of price-fixing and production limits in many industries, and the National Labor Relations Act of 1935 gave unions substantial collective-bargaining power. While not permitted under federal law, the sit-down strike, in which workers were occupied factories and shut down production, was tolerated by governors in a number of states and was used with great success against major employers, including General Motors in 1937.

The downturn of 1937-38 was preceded by large wage hikes that pushed wages well above their NIRA levels, following the Supreme Court’s 1937 decision that upheld the constitutionality of the National Labor Relations Act. These wage hikes led to further job loss, particularly in manufacturing. The “recession in a depression” thus was not the result of a reversal of New Deal policies, as argued by some, but rather a deepening of New Deal polices that raised wages even further above their competitive levels, and which further prevented the normal forces of supply and demand from restoring full employment. Our research indicates that New Deal labor and industrial policies prolonged the Depression by seven years.

By the late 1930s, New Deal policies did begin to reverse, which coincided with the beginning of the recovery. In a 1938 speech, FDR acknowledged that the American economy had become a “concealed cartel system like Europe,” which led the Justice Department to reinitiate antitrust prosecution. And union bargaining power was significantly reduced, first by the Supreme Court’s ruling that the sit-down strike was illegal, and further reduced during World War II by the National War Labor Board (NWLB), in which large union wage settlements were limited by the NWLB to cost-of-living increases. The wartime economic boom reflected not only the enormous resource drain of military spending, but also the erosion of New Deal labor and industrial policies.

Go read the whole article.

James Pethokoukis links to Robert Brusca

The CBO has scored the HOUSE plan and has found that of the House plan’s $819 bln of spending and tax cuts only 21% will have impact in 2009 and by the end of 2010 only 64% of the plan will have had its impact on the deficit.

“Stimulus”? Not for the economy.


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6 Responses to “How Government Prolonged the Depression”

  1. Stacey Derbinshire Says:

    I found your blog on google and read a few of your other posts. I just added you to my Google News Reader. Keep up the good work. Look forward to reading more from you in the future.

  2. John Says:

    Yep the New Deal was a huge failure that’s why FDR was re-elected four times and is considered our second or third greatest president. I’m mystified why conservatives have chosed to try to discredit FDR yet again. They’ve been trying for seventy years and it hasn’t worked yet but what it does do is reinforce an image of a party that is detached from reality. It’s as counterproductive as Bush and McCain claiming 9 months ago that the “fundamentals of the economy were strong.” The only people it’s convincing is about 30% of the electorate, the rest think were nuts.

  3. Dave Says:

    What? Nine months ago the fundamentals of the economy were strong! The stock market didn’t head south until Obama started surging in the poles, and then again the day it was confirmed that he was indeed elected. The greatest problem with our economy isn’t the fundamentals but fear, the fear that Obama will make good on his promises to implement the New Deal II.

  4. foutsc Says:

    John: Nice talking points, but you fail to address the issue at hand: Did FDR’s policies prolong the great depression? There is some convincing studies that say yes.

    Why did FDR get reelected three times? Because he was a great leader and people were scared. This is not about demonizing FDR, its about learning from the past and drawing the right lessons from it.

  5. Steve J. Says:

    its about learning from the past and drawing the right lessons from it.

    The New Deal was a great success –
    Click on the “here” links in this post –

  6. Pat Patterson Says:

    All the graph tends to show is that deficits stayed, as a percentage of GDP, nearly the same. And since most consumer goods were rationed the rise GDP was almost exclusively war related and had virtually nothing to do with any New Deal programs. But at the end of the war the US had a debt of 140% of GDP the highest figure ever and which immediately pushed the US back into a a period of flat growth and subtly rising inflation until monetary policy was tightened after 1952. Some of the more cynical historians have pointed out that the real solution to the Great Depression was in the US demanding payment in gold not scrip or even currency from the UK, the USSR and a big chunk of the gold bars that the Free French fled with after the Fall of France.

    I’ve noticed this particular web site being touted lately as proof the New Deal worked by reliance on graphs that appear with no explanation as to what exactly was measured. Plus this site never links to the page where the data comes from. That doesn’t mean the data is bogus but becomes immediately suspect if one has to scroll through hundreds of pages.