Did Capitalism cause the Great Depression?

Answer 1

The causes of the depression are generally acknowledged to be a complex question.

School textbooks like my 1980s The World this Century: Working With Evidence say the Depression was caused by the rise in profits surpassing that of wages to such an extent that commodity stocks increased beyond what the public could buy ("Had wages kept pace with profits between 1923 and 1929 this situation might never have arisen. Profits rose by 72% whereas wages rose by only 8%"). The World this Century also mentions the invention of hire puchase as increasing sales of consumer durables in the short term, but causing problems for workers who could not pay off their debts in the long term.

Radical Trotskyists like Socialist Alternative, the International Socialist Organisation and the Democratic Socialist Party argue that the Depression is a reflection of the boom/bust cycle inherent in a system of private ownership and profit, which they oppose to a system of ownership by the producers (ie. workers) themselves. Trotskyists argue that bosses wil always seek to take more from workers and that this leads eventually to a reduction in the level of profit, due to production beyond what workers can buy. They argue that there are mechanisms to restructure most forms of capitalism in crisis, but that crisis is inherent in capitalism.

Austrians like Human Events and the Mises Institute, in contrast, argue that capitalism did not in any way cause the Great Depression. Defining capitalism as strict laissez-faire, they believe that a boom/bust cycle is not inherent in a free market because a free market will always judge what are viable investments better than any alternative. Austrians believe the creation of the Federal Reserve (in 1913) led to easy credit making naturally unprofitable investments seemingly profitable and creating a "phantom" boom in the 1920s which had to be corrected.

Before I leave this point, there are many other explanations of the Great Depression. Some historians have argued it to be caused by the deflation necessary to get the United Kingdom back on the gold standard after it had moved away from that system in the urgent call for a larger money supply during World War I. Monetarist or Chicago School economists, whilst free-market like the Austrian School, argue quite differently about bank policy.

Alternatively, recent scholarly works by economists like Amity Shlaes in her book: The Forgotten Man suggest that the uncertainty created by government actions were almost totally to blame for the failures that led to and extended the Great Depression. These failures were sevenfold:

1) The Stock Market Crash:

The economy did very well during the 1920's. Calvin Coolidge's "hands-off" policy towards the economy resulted in massive growth and prosperity. Unfortunately, this led to a lot of people who had no idea what they were doing pouring money in to the market. Naturally, this drove stock prices up. As the prices rose, more and more people became convinced they could get rich by pouring their money in to the market as well, and did so.

Impact: Many people took a very big financial hit, and banks and investors who were not careful collapsed or went bankrupt. People became very nervous about investing, banks and financial institutions. This contributed to bank runs (Point #3)

2) Smoot-Hawley

Herbert Hoover was a big believer in tariffs (a tax on imported goods.) He was convinced that this tariff would help American products compete and make America more self-sufficient. He was wrong. He helped push one of the largest tariffs in history through Congress, and almost every nation on Earth immediately imposed a retaliatory tariff on the United States. Our exports dropped precipitously overnight.

Impact: We could not export our way out of the Depression.

3) The Money Supply:

When the economy is in trouble, the Federal Reserve generally makes money more available so that it will be easier for people to get a loan to start or expand a business. This is called a counter-cyclical policy. As the GDP drops, the Fed prints more money. As the economy grows, they buy money back, and take it out of circulation. Hoover pursued a pro-cyclical monetary policy. What does this mean? When the economy was in trouble, he restricted the money supply. This made it extremely difficult for banks to loan any money to anybody, or to keep a decent reserve on -hand. Any difficulty for the bank could result in a "run," a large number of people lining up to withdraw all of their money from the bank. Since banks only hold a small portion of their customer's money in the bank at any given time, many banks collapsed. Since the money supply was restricted, wages began to fall, and people found themselves unable to repay loans or mortgages.

Impact: Instability in the banking system, numerous bank runs and deflation.

4) Attacks on Short Sellers: Both Hoover and FDR attacked short-sellers as unpatriotic. Short-sellers bet on the price of a given stock dropping. One of the fundamentals of any market is that you have to be able to bet on the price going both ways, or a given stock will never find its proper price level. Because of the attacks on short-sellers, this activity virtually stopped, and nobody was certain whether the price levels on the market were accurate or not.

Impact: Risk has a cost, and the stock market did not rebound very quickly because of all of the people who were wondering when or if it would hit bottom.

5) Taxes: FDR raised taxes dramatically everywhere he could. President Coolidge lowered them, and people realized they could keep more of what they earned. Not surprisingly, they worked harder and produced a boom. FDR raised them, and people stopped working as hard. Moreover, FDR talked about raising several other taxes, creating fear that people would be able to keep even less of what they earned. Naturally, people cut back the amount of new business investment and work that they did.

Impact: The uncertainty caused by FDR's tax policy resulted in fewer new businesses, and fewer hours worked by professionals.

6) Regulatory Burden:

Regulations cost money. If you know in-advance what regulations you are going to face in a given business, you can plan for the future. If you have no idea what is coming tomorrow, you are likely to avoid expanding your business, or simply to shut it down. FDR and his cronies regulated the heck out of anything they chose, and they frequently chose at random. Many of the regulations were massive expansions of government power that went well-beyond anything the government had ever done before, so people had no idea what to expect.

Impact: Paralysis for some businesses, death for others.

7) Unions:

FDR was a big believer in unions. He passes several very influential laws that made unions far-more powerful, and far-more easy to organize. These unions resulted in great jobs for a few people, but far-fewer jobs overall. They also reduced the efficiency of the businesses that had to deal with them, meaning they had trouble competing and their prices had to rise.

Impact: Many fewer jobs created, and many uncompetitive businesses.