Great Depression

The Great Depression was the most severe worldwide economic downturn to date; it started in late 1929 in the U.S. and persisted in some countries, to the end of the 1930s. The depression was felt most markedly in the United States, Germany and other industrial countries, as well as raw materials producers such as Australia.

See

• Great Depression, U.S.
• Great Depression, Canada

Causes of Depression

Scholars have not agreed on the exact causes and their relative importance. The search for causes is closely connected to the question of how to avoid a future depression, so the political and policy viewpoints of scholars are mixed into the analysis of historic events eight decades ago. Current theories may be broadly classified into two main points of view. First, there is orthodox classical economics, monetarist, Keynesian, Austrian Economics and neoclassical economic theory, which focuses on the macroeconomics of the money supply, including production and consumption. Second, there are structural theories, including those of institutional economics, that point to underconsumption and overinvestment (economic bubble), or to malfeasance by bankers and industrialists, or to failures of government.

There are multiple issues—what set off the first downturn in 1929, what were the structural weaknesses and specific events that turned it into a major depression, and how did the downturn spread from country to country.

In terms of the 1929 small downturn, historians emphasize structural factors and the stock market crash, while economists point to Britain's decision to return to the Gold Standard at pre-World War I parities ($4.86 per Pound). Although most analysts believe the Wall Street Crash of 1929 was the immediate cause triggering the Great Depression, there are other, deeper causes that explain the crisis. The vast economic cost of World War I weakened the ability of the world to respond to a major crisis.

The New York Stock Market crash

Economists dispute how much weight to give the Wall Street Crash of 1929; most say it played some role. It clearly changed sentiment about and expectations of the future, shifting the outlook from very positive to negative, with a dampening effect on investment and entrepreneurship. In the long run, the market did not recover; it began almost continuously to head downwards until 1933, producing the greatest long-term market declines by any measure and erasing billions in assets.

Debt

Macroeconomists, such as Ben Bernanke, have revived the debt-deflation view of the Great Depression originated by Arthur Cecil Pigou and Irving Fisher. In the 1920s, in the U.S. the widespread use of the home mortgage and credit purchases of automobiles and furniture boosted spending but created consumer debt. People who were deeply in debt when a price deflation occurred were in serious trouble—even if they kept their jobs—and risked default. They drastically cut current spending to keep up time payments, thus lowering demand for new products. Furthermore the debts grew, because prices and incomes fell 20-50%, but the debts remained at the same dollar amount. With future profits looking poor, capital investment slowed or completely ceased. In the face of bad loans and worsening future prospects, banks became more conservative in lending. They built up their capital reserves, which intensified the deflationary pressures. The vicious cycle developed and the downward spiral accelerated. This kind of self-aggravating process may have turned a 1930 recession into a 1933 depression. For Irving Fisher, the only economist to predict, in 1928, that a "recession" was right around the corner, thought the depression was preventable:

I believe some of the crash was inevitable because of over-indebtedness, but the depression was not inevitable. The reason is that the deflation which went with the over-indebtedness was not necessary. We can always control the price level. Irving Fisher

Trade Decline and the U.S. Smoot-Hawley Tariff Act

Many economists at the time argued that the sharp decline in international trade after 1930 helped to worsen the depression, especially for countries dependent on foreign trade. Most historians and economists assign the American Smoot-Hawley Tariff Act of 1930 part of the blame for worsening the depression by reducing international trade and causing retaliation. Foreign trade was a small part of overall economic activity in the United States; it was a much larger factor in most other countries. The average rate of duties on dutiable imports for 1921-1925 was 26% but under the new tariff it jumped to 50% in 1931-1935.

In dollar terms, American exports declined from about $5.2 billion in 1929 to $1.7 billion in 1933; but prices also fell, so the physical volume of exports only fell in half. Hardest hit were farm commodities such as wheat, cotton, tobacco, and lumber. Many American farms had been heavily mortgaged as farmers bought overpriced land in the bubble of 1919-20, and defaulted.

U.S. Federal Reserve and money supply

Monetarists, including Milton Friedman and Ben Bernanke, stress the negative role of the American Federal Reserve System in not acting properly to prevent a small depression from turning into a large one. The money supply to fall by one-third from 1930 to 1931. With significantly less money to go around, businessmen could not get new loans and could not even get their old loans renewed, forcing many to stop investing. This interpretation blames the Federal Reserve not for causing the depression but for not taking aggressive action to restore the money supply. The Fed was not controlled by President Hoover or the U.S. Treasury; it was primarily controlled by member banks and businessmen and it was to these groups that the Fed listened most attentively regarding policies to follow. This monetarist approach certainly explains why the depression was agravated, but does not shed any light on why it began, in first place. Friedman argues that the downward turn in the economy starting with the stock market crash would have been just another recession. In general, he blames widespread runs on small local banks.

Capitalism to blame

The revolutionary left saw the Great Depression as the beginning of capitalism's final collapse. The idea mobilized the far left for action, but they failed to take power in any major country in the 1929-32 period.

New Deal and "big business"

Roosevelt primarily blamed the excesses of "big business", specially speculators and financiers, for causing an unstable bubble-like economy. At the end of September 1932, as the economic and financial crisis deepened and even more banks failed, with many citizens losing their savings, F.D.R. said:

Every man has a right to his own property, which means a right to be assured, to the fullest extent attainable, in the safety of his savings.... If, in accord with this principle, we must restrict the operations of the speculator, the manipulator, even the financier, I believe we must accept the restriction as needful, not to hamper individualism, but to protect it."

(...)I believe, that the individual should have full liberty of action to make the most of himself; but I do not believe, that in the name of that sacred word, a few powerful interests should be permitted to make industrial cannon fodder of the lives of half of the population of the United States. Franklin Delano Rooselvelt, presidential campaign, Ohio, August 1932

When Franklin D. Roosevelt was finally inaugurated on Saturday, March 4, 1933, the United States was ruined. Almost all banking activities had ceased; the financial system was disintegrating; industrial production had collapsed; agriculture barely existed any more; many of the 12.8 million unemployed (this figure was not only in absolute numbers, but also relative—officially it stood at 25%—much higher than in Germany then) were wandering around homeless, hungry, even starving. A mood of utter despair had gripped the country.

Coming to the heart of the New Deal, F.D.R. announced "strict supervision of all banking and credits and investments” and “an end to speculation with other people’s money." On March 6, 1933 he shut down all of the banks in the nation and forced Congress to pass the Emergency Banking Act which gave the government the opportunity to inspect the health of all banks. The Federal Deposit Insurance Corporation (FDIC) was formed by Congress to insure deposits up to $5000. These measures reestablished American faith in banks. Americans were no longer scared that they would lose all of their savings in a bank failure. Roosevelt expanded this emergency legislation: Commercial banks were strictly separated from investment houses, so by law they could not “speculate with other people’s money.” This effort culminated in the famous Glass-Steagall Act of June 1933, which not only established sound banking practices, but also greatly weakened Wall Street’s grip over U.S. financial policy. Historians distinguish between the "First New Deal" of 1933, which had something for almost every group, and the "Second New Deal" (1935–36), which introduced class conflict, especially between business and labor unions.

Concretely, Roosevelt attacked the depression problem on two levels: First, emergency measures, such as social relief programs and make-work programs of all kinds, urgently needed to prevent millions of Americans from literally starving, and give them work—any work. Secondly, on a strategic level, were those measures to reconstruct and develop the country’s totally ruined infrastructure. Dozens of alphabet agencies (AAA, CCC, CWA, FHA , FDIC, NRA, NRLA, PWA, TVA , SEC, SSA , WPA, etc.) were created as a result of the New Deal. F.D.R. reduced unemployment by over 5 million in his first term—and reconstruct the country by physically changing its economy.

Great Infrastructure Projects

The best of big "hard" infrastructure projects being carried out under the New Deal examples are the results of the Public Works Administration (PWA) , a former U.S. government agency established by Congress as the Federal Administration of Public Works, pursuant to the National Industrial Recovery Act, and the almost legendary Tennessee Valley Authority (TVA) , both of which, President Roosevelt ran, more or less directly. The PWA became, with its "multiplier-effect" and first two-year budget of $3.3 billion (then an enormous sum), the driving force of America’s biggest construction effort up to that date. By June 1934 the agency had distributed its entire fund to 13,266 federal projects and 2,407 non-federal projects. For every worker on a PWA project, almost two additional workers were employed indirectly. The PWA accomplished the electrification of rural America, the building of canals, tunnels, bridges, highways, streets, sewage systems, and housing areas, as well as hospitals, schools, and universities; every year it used up roughly half of the concrete and one-third of the steel of the entire nation. The development of the huge Tennessee River basin in the South by the TVA was a model for what a modern nation could accomplish. By stopping the yearly floods of the Tennessee River and making it navigable, an entire area of almost the size of England could be opened up for development. Franklin Delano Roosevelt was the first President who attacked this problem from a higher level.

The projects to develop the "hard" infrastructure of the country were flanked by measures to improve its "soft" counterpart: important social measures, which for the first time in U.S. history, established the concept of a minimum wage, created insurance for the unemployed, sick and old, established decent health care, and abolished child labor. The Works Progress Administration (later Work Projects Administration, abbreviated WPA), was created on May 6, 1935 by Presidential order (Congress funded it annually but did not set it up). It was the largest and most comprehensive New Deal agency, employing millions of people and affecting every locality. The crowning achievement of these measures was the Social Security Act of 1935. This law was overturned by the Supreme Court, so that Roosevelt had to pass it in another form the Wagner Act of 1935, the "Bill of Rights" of American labor. Many of the New Deal regulations were abolished or scaled back in 1975-1985 in a bipartisan neoliberal wave of deregulation. However various of them, such as the Federal Housing Administration (FHA) , the Social Security Administration (SSA) , the Tennessee Valley Authority (TVA) , the Federal Deposit Insurance Corporation (FDIC) , the Securities and Exchange Commission (SEC) and the so called Glass-Steagall Act sections of the original Banking Act of June 1933, (sections 16, 20, 21 and 32), which regulates Wall Street, won widespread support and continue to this day.

Deficit Spending needed

The British economist John Maynard Keynes argued that the low aggregate demand in the economy caused a multiple decline in income, keeping the economy in an equilibrium well below full employment. In this situation, the economy may reach perfect balance, but at a cost of a high unemployment. Keynesian economists were increasingly calling for government to take up the slack by increasing government spending. Although Keynes's specific policy prescriptions at the time were vague (Perelman 1989) , his basic approach was to let business be free to do as it would choose, while creating a macroeconomic climate in which investment would be brisk or, using Keyne's own words - which became famous - creating a macroeconomic environment capable of awakening the "animal spirits" of entrepreneurs. Animal spitirts are a particular sort of confidence, "naive optimism"; "the thought of ultimate loss which often overtakes pioneers, as experience undoubtedly tells us and them, is put aside as a healthy man puts aside the expectation of death".John Maynard Keynes

New Deal in the United States

From 1932 onward Roosevelt argued that a restructuring of the economy—a "reform" would be needed to prevent another depression. New Deal programs sought to stimulate demand and provide work and relief for the impoverished through increased government spending, by:

• reforming the financial system, especially the banks and Wall Street. The Securities Act of 1933 comprehensively regulated the securities industry. This was followed by the Securities Exchange Act of 1934 which created the Securities and Exchange Commission. (Though amended, the key provisions of both Acts are still in force as of 2006). Federal insurance of bank deposits was provided by the FDIC (still operating as of 2006), and the Glass-Steagal Act (which remained in effect for 50 years).
• instituting regulations which ended what was called "cut-throat competition" which kept forcing down prices and profits for everyone. (The NRA—which ended in 1935).
• setting minimum prices and wages and competitive conditions in all industries (NRA)
• encouraging unions that would raise wages, to increase the purchasing power of the working class (NRA)
• cutting farm production so as to raise prices and make it possible to earn a living in farming (done by the AAA and successor farm programs)

The most controversial of the New Deal agencies was the National Recovery Administration (NRA) which ordered:

• businesses to work with government to set price codes;
• the NRA board to set labor codes and standards.

These reforms (together with relief and recover measures) are called by historians the First New Deal. It was centered around the use of an alphabet soup of agencies set up in 1933 and 1934, along with the use of previous agencies such as the Reconstruction Finance Corporation, to regulate and stimulate the economy. By 1935, the "Second New Deal" added Social Security, a national relief agency the Works Progress Administration (WPA), and, through the National Labor Relations Board a strong stimulus to the growth of labor unions. Unemployment fell by two-thirds in Roosevelt's first term (from 25% to 9%), but then remained stubbornly high until 1942.

In 1929, federal expenditures constituted only 3% of the GDP. Between 1933 and 1939, federal expenditure tripled, funded primarily by a growth in the national debt. The debt as proportion of GNP rose under Hoover from 20% to 40%. FDR kept it at 40% until the war began, when it soared to 128%. After the Recession of 1937, conservatives were able to form a bipartisan Conservative coalition that stopped further expansion of the New Deal, and, by 1943, had abolished all of the relief programs.

Recession of 1937 in the United States

In 1937, the American economy took an unexpected nosedive that continued through most of 1938. Production declined sharply, as did profits and employment. Unemployment jumped from 14.3% in 1937 to 19.0% in 1938. The administration reacted by launching a rhetorical campaign against monopoly power, which was cast as the cause of the new dip. The president appointed an aggressive new direction of the antitrust division of the Justice Department, but this effort lost its effectiveness once World War II, a far more pressing concern, began.

But the administration's other response to the 1937 deepening of the Great Depression had more tangible results. Ignoring the pleas of the Treasury Department, Roosevelt embarked on an antidote to the depression, reluctantly abandoning his efforts to balance the budget and launching a $5 billion spending program in the spring of 1938, an effort to increase mass purchasing power. Business-oriented observers explained the recession and recovery in very different terms from the Keynesians. They argued that the New Deal had been very hostile to business expansion in 1935-37, had encouraged massive strikes which had a negative impact on major industries such as automobiles, and had threatened massive anti-trust legal attacks on big corporations. All those threats diminished sharply after 1938. For example, the antitrust efforts fizzled out without major cases. The CIO and AFL unions started battling each other more than corporations, and tax policy became more favorable to long-term growth.

On the other hand, according to economist Robert Higgs, when looking only at the supply of consumer goods, significant GDP growth only resumed in 1946 (Higgs does not estimate the value to consumers of collective goods like victory in war) (Higgs 1992). To Keynesians, the war economy showed just how large the fiscal stimulus required to end the downturn of the Depression was, and it led, at the time, to fears that as soon as America demobilized, it would return to Depression conditions and industrial output would fall to its pre-war levels. That is, Keynesians predicted that a new depression would start after the war, unless some government measures were enacted to prevent it, such as the Marshall Plan in destroyed Europe.

Keynesian models

In the early 1930s, before John Maynard Keynes wrote The General Theory, he was advocating public works programs and deficits as a way to get the British economy out of the Depression. Although Keynes never mentions fiscal policy in The General Theory, and instead advocates the need to socialise investments, Keynes ushered in more of a theoretical revolution than a policy one. Keynes's basic idea was simple: in order to keep people fully employed, governments have to run deficits when the economy is slowing because, under unemployment, the private sector won't invest to increase production and reverse the recession.

As the Depression wore on, Franklin D. Roosevelt tried public works, farm subsidies and other devices to restart the economy, but he never completely gave up trying to balance the budget. According to the Keynesians he had to spend much more money; they were unable to say how much more. With fiscal policy, however, government could provide the needed Keynesian spending by decreasing taxes, increasing government spending, increasing individuals' incomes. As incomes increased, they would spend more. As they spent more, the multiplier effect would take over and expand the effect on the initial spending. The Keynesians did not estimate what the size of the multiplier was. Keynesian economists assumed that poor people would spend new incomes; in reality they saved much of the new money, that is they paid back debts owed to landlords, grocers and family. Keynesian initial ideas of the consumption function were harshly questioned in the 1950s by the monetarist Milton Friedman and have since been considerably refined by Franco Modigliani who, with help from the Hicks-Hansen IS-LM model, created the nucleus of the Neoclassical Synthesis of Keynesianism which was embraced and further developed by Paul Samuelson, James Tobin, Wassily Leontief an his pupil Robert Solow to became the mainstream economic thought until the early seventies.

Gold Standard

Britain departed from the gold standard in September 1931, allowing the pound sterling to float. As a result, the value of the pound dropped significantly and British exports became cheaper. In 1933, the United States followed suit and dropped the gold standard.

Madsen (2004) provides an econometric analysis from an international perspective on the consequences of inflexible wages and prices on the length and depth of the Great Depression beginning in 1929. In order to analyze the sources and consequences of the supply-side failure during the Great Depression, it is necessary to create a supply model consisting of price and wage settings in which, in addition to using instruments and alternative estimators, the sensitivity of the estimation results to different data sources, data coverage, instrument set, and restrictions imposed on the estimates are examined. The analysis indicates that inflexibility of prices in the manufacturing sector of the industrialized and semi-industrialized countries in the data set was the primary factor for the extent of the Great Depression.

Aldcroft (2004) notes the 1930s are often seen as a time of almost continuous currency disorder around the world, particularly between 1931 and 1933, when many countries went off the gold standard and allowed their currencies to float free. However, the wild fluctuations of the early years in the decade began to subside, and stability returned to the currency market due, in part, to the emergence of the sterling bloc; the name given to a group of countries that pegged their currencies to the value of the British pound. The arrangement worked well, in spite of there being no constitution or administrative regulations governing the operation of the system. The creation of the sterling bloc helped Britain to regain its position in international finance, accelerated its recovery from the Depression, and helped to stabilize international trade generally.

Rearmament and recovery

The massive rearmament policies to counter the threat from Nazi Germany helped stimulate the economies of many countries around the world. By 1937 unemployment in Britain had fallen to 1.5 million. The mobilization of manpower following the outbreak of war in 1939 finally ended unemployment.

In the United States, the massive war spending doubled the GNP, helping end the depression. Businessmen ignored the mounting national debt and heavy new taxes, redoubling their efforts for greater output as an expression of patriotism. Patriotism drove most people to voluntarily work overtime and give up leisure activities to make money after so many hard years. People accepted rationing and price controls for the first time as a way of expressing their support for the war effort. Cost-plus pricing in munitions contracts guaranteed that businesses would make a profit no matter how many mediocre workers they employed, no matter how inefficient the techniques they used. The demand was for a vast quantity of war supplies as soon as possible, regardless of cost. Businesses hired every person in sight, even driving sound trucks up and down city streets begging people to apply for jobs. New workers were needed to replace the 12 million working-age men serving in the military. These events magnified the role of the federal government in the national economy. In 1929, federal expenditures accounted for only 3% of GNP. Between 1933 and 1939, federal expenditure tripled, and Roosevelt's critics charged that he was turning America into a socialist state. However, spending on the New Deal was far smaller than on the war effort.

Political consequences

The crisis had many political consequences, among which the abandonment of classic economic liberal approaches, which Roosevelt replaced in the US with keynesian policies. It was a main factor in the implementation of social-democracy and planned economies in European countries after the war. It would not be until the 1970s and the beginning of monetarism that this keynesian approach was challenged, leading the way to neoliberalism.

Bibliography

• For 'titles on American history, see complete listing in the Great Depression, U.S. article.

• Aldcroft, Derek H. Europe's Third World: The European Periphery in the Interwar Years (2006) 217pp; ISBN: 0-7546-0599-X. excerpt and text search
• Ambrosius, G. and W. Hubbard, A Social and Economic History of Twentieth-Century Europe (1989)
• Bernanke, Ben S. "The Macroeconomics of the Great Depression: A Comparative Approach," Journal of Money, Credit & Banking, Vol. 27, 1995 online edition
• Brown, Ian. The Economies of Africa and Asia in the inter-war depression (1989)
• Davis, Joseph S., The World Between the Wars, 1919-39: An Economist's View (1974)
• Dimsdale, Nicholas H.; Horsewood, Nicholas; and Riel, Arthur Van. "Unemployment in Interwar Germany: an Analysis of the Labor Market, 1927-1936." Journal of Economic History 2006 66(3): 778-808. Issn: 0022-0507 * Feinstein. Charles H. The European economy between the wars (1997)
• Garraty, John A., The Great Depression: An Inquiry into the causes, course, and Consequences of the Worldwide Depression of the Nineteen-Thirties, as Seen by Contemporaries and in Light of History (1986)
• Garraty John A. Unemployment in History. (1978)
• Garside, William R. Capitalism in crisis: international responses to the Great Depression (1993)
• Haberler, Gottfried. The world economy, money, and the great depression 1919-1939 (1976)
• Hall Thomas E. and J. David Ferguson. The Great Depression: An International Disaster of Perverse Economic Policies (1998)
• Kaiser, David E. Economic diplomacy and the origins of the Second World War: Germany, Britain, France and Eastern Europe, 1930-1939 (1980)
• Kindleberger, Charles P. The World in Depression, 1929-1939 (1983)
• League of Nations, World Economic Survey 1932-33 (1934)
• Loh, Kah Seng. "New Winds in Economic History? A Look at Writings on the Great Depression in Southeast Asia." Crossroads 2006 17(2): 66-92. Issn: 0741-2037
• Madsen, Jakob B. "Trade Barriers and the Collapse of World Trade during the Great Depression"' Southern Economic Journal, Vol. 67, 200
• Madsen, Jakob B. "The Length and the Depth of the Great Depression: an International Comparison." Research in Economic History 2004 22: 239-288. Issn: 0363-3268
• Mundell, R. A. "A Reconsideration of the Twentieth Century' "The American Economic Review" Vol. 90, No. 3 (Jun., 2000), pp. 327-340 in JSTOR
• Paolera, Gerardo Della, and Alan M. Taylor. "Economic Recovery from the Argentine Great Depression: Institutions, Expectations, and the Change of Macroeconomic Regime," The Journal of Economic History Vol. 59, No. 3 (Sep., 1999), pp. 567-599 in JSTOR
• Romer, Christina D. "The Nation in Depression," The Journal of Economic Perspectives, Vol. 7, No. 2. (Spring, 1993), pp. 19-39. major survey by leading economist, with comparisons to other nations in JSTOR
• Rothermund, Dietmar. The Global Impact of the Great Depression (1996)
• Tipton, F. and R. Aldrich, An Economic and Social History of Europe, 1890–1939 (1987)
• Stein, Samantha. "Great Depression Women" (2006)

External links

• An Overview of the Great Depression from EH.NET by Randall Parker.