The Great Depression
The years since the United States became an industrial economy have seen one Great Depression, that of 1929-1941. Whether assessed by the relative shortfall of production from trend or by the duration of slack production, the Great Depression was of an order of magnitude larger than any others. Thus this essay breaks chronological order and considers it first.
It is straightforward to narrate the slide of the United States into the depression. The 1920s saw a boom as firms invested in capacity and consumers bought durable goods on credit in quantity for the first time. The boom was the result of optimism: businesspeople and economists believed that the newly born Federal Reserve would stabilize the economy and that the pace of technological progress guaranteed rising living standards and expanding markets. The Federal Reserve's attempt in 1928 and 1929 to raise interest rates to discourage stock speculation brought on an initial recession. Caught by surprise, firms cut back their own plans for further purchase of producer durable goods, and firms making producer durables cut back production; out-of work consumers--and those who feared they might soon be out of work--cut back purchases of consumer durables, and firms making consumer durables faced falling demand as well.
Businesspeople, economists, and politicians--most memorably Secretary of the Treasury Andrew Mellon--expected the recession of 1929-1930 to be self-limiting. Earlier recessions had come to an end when the gap between actual and trend production was as large as in 1930. They expected workers with idle hands and capitalists with idle machines to try to undersell their still at-work peers. Prices would fall. When prices fell enough, entrepreneurs would gamble that even with slack demand production would be profitable at the new, lower wages. Production would then resume.
Instead, falls in prices during the depression set in motion further contractions in production, which triggered additional falls in prices. With prices falling at 10 percent per year, investors calculated that they would earn less profit investing now than if they delayed investment until the next year when their dollars would stretch 10 percent further. Banking panics and the collapse of the world monetary system cast doubt on the value of everyone's credit and reinforced the belief that now was a time to watch and wait. The slide into the depression--with increasing unemployment, falling production, and falling prices--continued throughout President Herbert Hoover's term (1929-1933).
There is no fully satisfactory explanation of why the depression happened when it did. If such depressions were always a possibility in an unregulated capitalist economy, why weren't there many great depressions in the years before World War II? Milton Friedman and Anna Schwartz argued that the Great Depression was the consequence of an incredible and unlikely sequence of blunders in monetary policy. But those controlling economic policy during the early 1930s saw themselves as following the same gold-standard rules of conduct that had been followed before. Why hadn't obedience to the rules of conduct led to similar blunders earlier?
At its nadir, the depression paired individual rationality with collective insanity. Workers were idle because firms would not hire them to work their machines; firms would not hire workers to work machines because they saw no market for goods; and there was no market for goods because workers had no income to spend. George Orwell's powerful account of the depression in Britain, The Road to Wigan Pier, speaks of watching "several hundred men risk their lives and several hundred women scrabble in the mud for hours ... searching eagerly for tiny chips of coal" in slagheaps so they could heat their homes. For them, this arduously gained "free" coal was "more important almost than food." And all around them the machinery they had previously used to mine in five minutes more than they could gather in a day stood idle.
Workers who kept their jobs--even with reduced hours--and financiers whose money was invested in bonds prospered during the depression. Their incomes in dollars dropped, but prices dropped even more: the baskets of goods they could buy increased. Farmers, workers who lost their jobs, and entrepreneurs who had bet their money on continued prosperity were the big losers of the depression. Production was a third less than normal and the distribution of income shifted toward those who kept steady employment or who had invested their wealth conservatively. As a result, at the nadir the standard of living of losers taken all together was perhaps half of what it had been in 1929.
No large-scale social insurance programs compensated the losers from the depression during Hoover's term. In contrast to Europe, the United States had no effective system of unemployment insurance to cushion job loss. The federal government's only significant action before the New Deal was the veterans' bonus--granted over Hoover's objection. State governments, with limited abilities to tax, could not come close to finding the resources to significantly cushion the decline in living standards of the unemployed.
Recovery began with the inauguration of Franklin D. Roosevelt. The two initial planks of the New Deal--the abandonment of the gold standard with a concomitant attempt to force the dollar price of gold and other commodities up, and the National Industrial Recovery Act (later declared unconstitutional) with its explicit aim of keeping competition from pushing wages and prices down--broke the expectation of further deflation. The end of deflation caused a mini-industrial boom. Output slowly increased and unemployment slowly decreased throughout the New Deal.
Although the shift in expectations brought about by the announcement of the New Deal deserves credit for breaking the downward slide, it may be the case--such arguments are still controversial--that the New Deal hindered the recovery as well. New Deal spending was by and large not deficit spending: each dollar Harry Hopkins funneled into relief was matched by a dollar removed from private-sector pockets by taxation, causing little if any rise in aggregate demand. The alliance of the New Deal with organized labor may have led to policies biased toward maintaining the real incomes of those still employed, perhaps at the expense of the unemployed in the late 1930s.
Social democracy came to America in the New Deal. The fact that the Great Depression was the impetus for the leftward shift had an impact on the form of the post-World War II American welfare state. In Europe social democracy had an egalitarian bent: it was to level the income distribution as well as insure citizens against the market. In America the major programs--Social Security and unemployment insurance--were built up as insurance in which individuals on average got what they paid for. They were not tools to shift the distribution of income. And the prolabor framework set up by the National Labor Relations Board was of most use to relatively skilled and well-paid workers with secure job attachments who could use the legal machinery to share in their industries' profits; it was of less use to the ill-paid without secure attachment.
Railroad Cycles and Earlier Depressions
The years between the Civil War and the 1890s saw the great railway booms. In 1870 and 1871 U.S. railroad construction reached its first post-Civil War peak. The number of miles of operated railroad in the United States, then around fifty thousand, grew at about 12 percent per year. The construction of six thousand miles of railroad track each year employed perhaps one-tenth of America's nonfarm paid labor force and half of the production of America's metal industries. But four years later, railroad construction had collapsed. In 1875, operated railroad mileage grew at only 3 percent. Railroad construction employed less than 3 percent of America's nonfarm paid labor force and required perhaps 15 percent of the production of America's metal industries.
It is hard to attribute such spasms of construction to independent disturbances in finance: railroad finance was then more or less the sole business of Wall Street. By default such depressions appear to have been driven by waves of optimism about future growth followed by recognition of overbuilding and contraction until the economy had grown enough that it seemed that shipping by rail was a railroad's and not a farmer's market.
Such waves must have been difficult to absorb. Each wave required an expansion of capacity in iron and steel for rails, timber for ties, equipment for locomotives and cars, furniture to equip the cars to carry passengers on the new lines, and so on--and most important the redirection of 1 million workers to railroad construction. As the wave passed, suppliers and workers would have to find new markets and new jobs. The dislocation generated may well have been extreme and severe. But we know little about how it was accomplished or about what workers who built railroads in 1871 were doing in 1875.
Before the railroad cycles our quantitative knowledge is even more limited. Our inability to track workers from job to job, coupled with the agricultural nature of American life then, leaves us unsure of the quantitative rhythm of the economy in earlier years. Was the presidency of Martin Van Buren marked by a deep depression, with widespread unemployment and lowered living standards? Or was it a mere deflation--a lowering of prices without consequence for working Americans whose nominal wages were matched by reduced prices--that impoverished only the vocal and politically influential class of merchant-entrepreneurs? My guess is that pre-Civil War depressions were closer to the second, but I am far from sure.
Financial Panics and Depressions, 1890-1930
The fifty years before the Great Depression saw no depression of remotely similar magnitude. Whether those that did occur were worse than they have been since World War II remains disputed; given our limited quantitative knowledge, it is likely to remain so. That depressions before 1929 were more painful is, however, clear. Those who lost their jobs had no welfare state to cushion them. Individual states had sketches of a future welfare system, but such embryonic systems did not have the resources to cope with episodes of widespread unemployment. Extended families, friends, and local benevolent associations must have provided support for those who lost their jobs, so that, for the most part, they were fed and housed. American cities during depressions at the turn of the century were centers of poverty and want, but apparently not of mass near-starvation.
Depressions before 1929 by and large had different causes from post-World War II depressions. The 1921 recession aside, there was no Federal Reserve to risk high unemployment to reduce inflation. The typical pre-1929 depression had its origin in the United States' gold standard links with the London-centered world economy. The panic of 1907 and depression of 1908 followed a recession in Great Britain during which the Bank of England raised interest rates to pull gold to London, leaving the United States short of currency to be paid out to farmers and middlemen during the shipment of the fall harvest to the East.
The gold standard appears also in the depression of the 1890s. The possibility that "free silver" might sweep American politics made investors and financiers uneasy. Relative to what they would earn if they kept their cash, investments, and capital in London, a free-silver victory and subsequent devaluation might well have cost them a third of their wealth as measured by the international yardstick of the gold standard. Perhaps the free-silver movement was powerful enough to cause capital flight, investment shortfall, and depression, but not strong enough to secure devaluation and monetary expansion to reduce the debt burdens of farmers and create a booming labor market for urban workers. The United States thus got the worst of both worlds: it suffered the disadvantages of being on the gold standard without reaping the gold-standard advantage of keeping financiers confident and investing.
Post-World War II Depressions
The Great Depression did create a new orthodoxy in politics: the government was now considered responsible for maintaining a high level of production. Government deficits in recessions were seen as signs that the government was boosting demand to avoid another Great Depression. Confidence in this commitment to maintain spending helped, perhaps as much as the commitment itself, to keep the post-World War II era free of great depressions. Instead, the bias of the government seemed to be to risk an acceleration in inflation rather than to take even a tiny chance of severe depression. Over the decades, this pro-inflation bias intensified and became generally anticipated.
As a result, the United States in the postwar years experienced only three minidepressions--the slowdown in growth during the second Eisenhower administration, the opec shock (1974-1975), and the Paul Volcker depression (1979-1982). All were deliberately caused by governments that momentarily gave priority to reducing inflation at the cost of unemployment, but even such governments were unwilling to push contraction too far. Postwar America coped with these minidepressions relatively well in the sense of providing comparatively generous unemployment insurance and income support to the "deserving unemployed"--those who had previously held secure, higher-wage jobs. It did less well at supporting those unemployed who had not previously been in the middle-class circle.
Milton Friedman and Anna J. Schwartz, A Monetary History of the United States (1963); Herbert Stein, The Fiscal Revolution in America (1969); Peter Temin, Lessons from the Great Depression (1989).
J. Bradford De Long
See also Coxey's Army; Government and the Economy; New Deal; Unemployment; Welfare and Public Relief.
