Paul Krugman argues:
What’s less well known is the extent to which the public drew the wrong conclusions from the recession that followed: far from calling for a resumption of New Deal programs, voters lost faith in fiscal expansion.
Having just finished Amity Shlaes’ The Forgotten Man this weekend, I can say that while their attitude may confuse Krugman in 2010, Americans in 1937-8 had seen fiscal expansion’s failure first-hand. Unemployment was still in the teens, compared to 3% in 1927, and the Dow was still far below where it had been ten years earlier. Over the 1930s GDP per capita had gone from being a third higher than Great Britain’s to roughly equal (the Economist blamed “institutional obstructions to the free flow of capital”). The undistributed profits tax was stifling investment, FDR was outlawing holding companies (saying he wanted a “death sentence” for them), and the TVA was deliberately driving private competitors out of business. Even Keynes had written to FDR complaining the government’s hand was too heavy.
Meanwhile, the Russian economic triumph FDR’s programs were modelled on had begun to take on a very bad odor — Stalin’s paranoid, barbaric show trials of Russian heroes he perceived as threats to his rule were upsetting even his supporters in America. And the planners in Germany and Italy were turning out to be even worse.
Government spending had not even brought the economy back to pre-Depression levels, let alone delivered the economic growth proponents had promised, and everyone could see the ugliness unrestrained government was capable of. The mystery is that anyone alive in 1938 thought yet more government was the answer.
The other argument Krugman makes is that WW II was a giant fiscal stimulus that produced prosperity, and therefore another one today will do the same. To the extent this is true of the war effort, though, all that extra GDP really “produced” was death and destruction in Europe, financed by war bonds that would not have been sold in normal circumstances. This is truly the broken windows fallacy writ large — the overall effect of the war spending was to devastate the world economy out of all proportion to any benefit to the United States. Does anyone really doubt we’d have been better off overall if WWII had never happened?
While Krugman argues the war “boom” created long-term prosperity, it’s much more likely the economy was finally experiencing a natural, long-delayed rebound as the onerous yoke of FDR’s experiments was gradually eased, the economy reflated due to capital flight from Europe, trade resumed under the Bretton Woods agreement, and businesses went back to creating productivity improvements and innovative products and services.
If there’s one lesson to be learned from the 20th century it’s that you cannot centrally plan long-term prosperity. Massive government intervention can sometimes produce illusory short-term growth in GDP, but only at the cost of creating inefficiencies and misallocating resources in ways that willl hinder long-term growth.
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4 responses to “A Deficit Of Understanding”
Another related reason for the American boom in the prosperity of the average factory worker in the 1950s is that the rest of the world had been kind enough to blow up their factories (or let us blow them up). This rather limited the amount of competition for American industrial workers.
Unfortunately, teachers and political candidates have orated for decades now that that prosperity was the result of strong labor unions and because American factory workers are really, really special.
Massive government intervention can sometimes produce illusory short-term growth in GDP, but only at the cost of creating inefficiencies and misallocating resources in ways that will hinder long-term growth.
Yes, and the Federal Reserve which is little more than a monetary arm of government has done that twice recently. The dot-com bubble was Greenspan’s first accommodation, and the housing bubble his final folly. As a student of the Depression, he advocated throwing money into the economy at the first sign of a correction. He gave a lecture years ago quoting from Benjamin Anderson’s Economics And The Public Welfare to the effect that THE cause of the extended Depression was the tight money policy of the Fed. Bernanke seems to have the same ideas. If one were betting on their next move, it would be the attempt to create another bubble. How they will go about this is anyone’s guess.
Well, the housing bubble was certainly a government creation, though it probably had more to do with fiscal and regulatory policy than monetary. The dot-com bubble was just the usual irrational exuberance we see from a transformative technology — the same thing happened with electricity when it was introduced.
You don’t think keeping interest rates artificially low helped funnel investment money into both of those areas?
The Fed Funds Rate dropped from 10% in the late 80’s down to 3% by 1994, and from over 6% in 2000 down to 1% in 2004. No connection?
And Greenspan didn’t make TV ads for Apple, and didn’t encourage homeowners to cash out equity. Right.