Great Depression

The Great Depression was an economic downturn which started in 1929 and lasted through most of the 1930s. It was centered in North America and Europe, but had devastating effects around the world, particularly in industrialized countries and producers of raw materials. Cities all around the world were hit hard, especially those based on heavy industry. Unemployment and homelessness soared. Construction was virtually halted in many countries. Farming and rural areas suffered as prices for crops fell by 40–60%.^[1] Mining and logging areas had perhaps the most striking blow because the demand fell sharply and there were few employment alternatives. The Great Depression ended at different times in different countries; for subsequent history see Home front during World War II.

Dorothea Lange's *Migrant Mother* depicts destitute pea pickers in California, centering on Florence Owens Thompson, a mother of seven children, age 32, in Nipomo, California, March 1936.

Causes

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, all which focus on the macroeconomic effects of 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. Another theory revolves around the surplus of products and the fact that many Americans were not purchasing but saving.

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 (such as Peter Temin and Barry Eichengreen) point to Britain's decision to return to the Gold Standard at pre-World War I parities ($4.86 Pound).

Debt

Macroeconomists, including the current chairman of the U.S. Federal Reserve Bank 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, they risked default. They drastically cut current spending to keep up time payments, thus lowering demand for new products.

Furthermore, the debt became heavier, 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.

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. [1] The average ad valorem rate of duties on dutiable imports for 1921–1925 was 25.9% 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. According to this theory, the collapse of farm exports caused many American farmers to default on their loans leading to the bank runs on small rural banks that characterized the early years of the Great Depression.

U.S. Federal Reserve and money supply

Monetarists, including the late Milton Friedman and Benjamin Bernanke, stress the negative role of the American Federal Reserve System in failing to reverse the cascading bank failures. They do not argue the federal reserve caused the depression, but rather that different policies might have stopped the downward slide. By not acting the Federal reserve allowed the money supply to drop by one-third from 1930 to 1931. In A Monetary History of the United States, Friedman argued that the downward turn in the economy starting with the stock market crash would have been just another recession. The problem was that some large, public bank failures, particularly the Bank of the United States, produced widespread runs on local banks, and that the Federal Reserve sat idly by while banks fell. He claimed that if the Federal Reserve had acted by providing emergency lending to these key banks or simply bought government bonds on the open market to provide liquidity and increase the quantity of money after the key banks fell, all the rest of the banks would not have fallen after the large ones did, the money supply would not have fallen to the extent and at the speed that it did. ^[2] 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 (the Fed), especially the New York branch, which was owned and controlled by Wall Street bankers for inaction.The Fed was not controlled by President Herbert Hoover nor 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.^[3]

Huntly force issues

File:Greatdepression2.jpg

Texas panhandle, 1938

A recent theory based on institutional analysis focuses on the terms of employment for the labor force. For example, in the American agricultural sector farm prices fell about 50% as did farmer income while farm employment and output both rose by about 6% between 1929 and 1933 ^{[citation needed]}. That outcome was more in line with the predictions of Say's Law that states that supply and demand balance at full employment provided that labor (and other costs) remain flexible.

Since farmers had only a residual claim on the revenue they received, the unit cost of a farmer's labor was automatically flexible. Prices were thus free to fall, and they fell far enough to match the roughly 50% drop in national income. Thus, agricultural markets cleared at full employment.

Industry, however, depended on hired labor paid contractually agreed pay rates. Any hired factor, land, labor, or capital has a prior claim on enterprise revenue which makes for rigid costs and hence limits the flexibility of prices. Thus, industrial prices were flexible only to the extent of profits, which were free to fall. They did, to the extent that corporate profits vanished by 1933.

At the time this difference in the behavior of farm and industrial prices was attributed to the fact that farmers were subject to auction markets of perfect competition while the industrial sector was dominated by large oligopolies. They thus had some control over prices. Gardiner Means argued that corporations could "administer prices," "to protect profit margins."

That argument, however, fails to explain why corporate profits vanished. It also raises the question of why, wherever input prices such as oil, wheat, or cotton fell sharply, output prices reflected the drop in costs, and final output fell correspondingly less.

But a more compelling rebuttal comes from Japan, which did not suffer from the Great Depression. Japan's real economy grew by about 6% from 1929 to 1933 and Japan's industrial economy was far more concentrated than the United States economy. In fact four firms controlled Japan's industrial sector: Mitsui, Mitsubishi Heavy Industries, Sumitomo, and Yasuda. Japan was hit by a serious recession in 1930 but quickly recovered by slashing prices (by about 40%) ^{[citation needed]}. Japan could cut prices because it did not depend on "hired labor" except for part timers and seasonal overload work. The bulk of the industrial labor force were regarded as "members of an extended family". As such, workers got about 30% of their income from a semi-annual bonus that would rise or fall with enterprise performance. In addition, the Japanese government devalued the yen by about 50%. Therefore, while world trade in total went into a sharp slump, Japanese exports boomed and Japanese industry prospered. At the same time Say's Law appeared inoperable in the United States to explain unemployment where labor sought work at any wage, including in exchange for only food, but with little effect.

The conclusion of this institutional school of thought with the case of Japan is that Say's Law worked as advertised during the Great Depression. Where costs were rigid, prices fell little and so output plunged. Where costs were flexible, prices plunged and output held stable. Yet, the conclusion from the historical example of American labor, is to suggest Say's Law was not in effect.

Business

President Franklin D. Roosevelt, elected in 1932, primarily blamed the excesses of big business for causing an unstable bubble-like economy. The problem was that business had too much power, and the New Deal was intended to remedy that by empowering labor unions and farmers (which it did) and by raising taxes on corporate profits (which they tried and failed). Regulation of the economy was a favorite remedy. Most of the New Deal regulations were abolished or scaled back in 1975–1985 in a bipartisan wave of deregulation. However the Securities and Exchange Commission, which regulates Wall Street, won widespread support and continues to this day.

Insufficient government deficit spending

The British economist John Maynard Keynes argued that the lower aggregate expenditures in the economy contributed to a multiple decline in income, well below full employment. In this situation, the economy may reach perfect balance, but at a cost of high unemployment. Keynesian economists were increasingly calling for government to take up the slack by increasing government spending.

Effects

Australia

Australia's extreme dependence on agricultural and industrial exports, meant that it was one of the hardest-hit countries in the Western world, amongst the likes of Canada and Germany. Falling export demand and commodity prices placed massive downward pressures on wages. Further, unemployment reached a record high of 29% in 1932, with incidents of civil unrest becoming common. After 1932, an increase in wool and meat prices led to a gradual recovery.

Great Britain

Canada

Canada is sometimes considered to be the country hardest hit by the Great Depression. The economy fell further than that of any nation other than the United States, and it took far longer to recover. However, unlike in the U.S., there were no bank failures in Canada.

East Asia

France

Germany

Germany's Weimar Republic was hard hit by the depression. Unemployment soared, especially in larger cities, and the political system veered toward extremism. Hitler's Nazi Party came to power in January 1933.

Latin America

South Africa

Responses in the United States

Initial reaction in the United States

Secretary of the Treasury Andrew Mellon advised President Hoover that a shock treatment would be the best response: "Liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate.... [That] will purge the rottenness out of the system. High costs of living and high living will come down. People will work harder, live a more moral life. Values will be adjusted, and enterprising people will pick up the wrecks from less competent people." (Hoover Memoirs 3:9). Hoover rejected this advice.

Hoover did not believe that the government should directly aid the people, but insisted instead on "voluntary cooperation" between business and government. Hoover believed that the stock market crash was a regular hiccup in the capitalistic cycle, and that it need not affect the greater economy. Hoover asked large business leaders to voluntarily "take a hit" for the greater good of the nation. Business leaders agreed initially, but in practice no business wanted to put its neck out and risk complete failure for the good of the economy. Hoover also promoted a centralized bank—led by business, not the government, like the eventual FDIC—that would hold money in reserve to secure against bank runs. Once again, business agreed that it was a good idea, but they were incapable of coordinating such an organization on their own. Hoover's "voluntary cooperation" failed, but his policies during his tenure proved that the government needed to take an active role in the economy if it was to recover from this depression.

New Deal in the United States

From 1933 onward, President Roosevelt argued that a restructuring of the economy—a "reform" would be needed to prevent another or prolong the current 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 2007). Federal insurance of bank deposits was provided by the FDIC (still operating as of 2007), 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 aspect 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%, 1933 to 1937), 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%. Roosevelt 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 Roosevelt administration reacted by launching a rhetorical campaign against monopoly power, which was cast as the cause of the depression, and appointing Thurman Arnold to act; Arnold's effectiveness ended once World War II began and corporate energies had to be directed to winning the war.

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 antitrust 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 battling 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 resumed only in 1946 (Higgs does not estimate the value to consumers of collective, intangible 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, the Keynesians (incorrectly) predicted a new depression would start after the war.

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' basic idea was simple: in order to keep people fully employed, governments have to run deficits when the economy is slowing because the private sector will not invest enough to increase production and reverse the recession.

As the Depression wore on, 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 ideas of the consumption function have been challenged, most notably in the 1950s by Milton Friedman and Franco Modigliani.

Gold standard

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

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, masking the effects of the Depression. Businessmen ignored the mounting national debt and heavy new taxes, redoubling their efforts for greater output to take advantage of generous government contracts. Most people worked overtime and gave 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 was the abandonment of classic economic liberal approaches, which Roosevelt replaced in the United States 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.^{[citation needed]}

Notes

^ Willard W. Cochrane. Farm Prices, Myth and Reality 1958. p. 15; League of Nations, World Economic Survey 1932-33 p. 43. .
^ *Krugman, Paul. "Who Was Milton Friedman?" New York Review of Books Vol 54#2 Feb. 15, 2007 online version
^ Ellis W. Hawley and Silvano A. Wueschner. Charting Twentieth-Century Monetary Policy: Herbert Hoover and Benjamin Strong, 1917-1927. 1999. Page 157.

References

For US specific references, please see complete listing in the Great Depression in the United States article.
Ambrosius, G. and W. Hibbard, 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
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)
Eichengreen, Barry. Golden fetters: The gold standard and the Great Depression, 1919-1939. 1992.
Barry Eichengreen and Marc Flandreau; The Gold Standard in Theory and History 1997 online version
Feinstein. Charles H. The European economy between the wars (1997)
Friedman, Milton and Anna Jacobson Schwartz. A Monetary History of the United States, 1867-1960 (1963), monetarist interpretation (heavily statistical)
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)
Madsen, Jakob B. "Trade Barriers and the Collapse of World Trade during the Great Depression"' Southern Economic Journal, Southern Economic Journal 2001, 67(4), 848-868 onlie at JSTOR and online version
Mundell, R. A. "A Reconsideration of the Twentieth Century' "The American Economic Review" Vol. 90, No. 3 (Jun., 2000), pp. 327–340 in JSTOR
Powell, Jim FDR's Folly: How Roosevelt and His New Deal Prolonged the Great Depression (2003)
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)

External links

Recession? Depression? What's the difference? (About.com)
An Overview of the Great Depression from EH.NET by Randall Parker.
Great Myths of the Great Depression by Lawrence Reed
Franklin D. Roosevelt Library & Museum for copyright-free photos of the period
Economic Depressions: Their Cause and Cure by Murray Rothbard (1969)
The Prophet of the Great Depression by Frank Shostak (October 4 2006)

[1] Willard W. Cochrane. Farm Prices, Myth and Reality 1958. p. 15; League of Nations, World Economic Survey 1932-33 p. 43. .

[2] *Krugman, Paul. "Who Was Milton Friedman?" New York Review of Books Vol 54#2 Feb. 15, 2007 online version

[3] Ellis W. Hawley and Silvano A. Wueschner. Charting Twentieth-Century Monetary Policy: Herbert Hoover and Benjamin Strong, 1917-1927. 1999. Page 157.

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