Organized Crime

CHAPTER47 Macroeconomists Discover Economics and Debunk the New Deal (Again)

It took several decades but macroeconomic model builders, who consider themselves to be the elite of the economics profession, have finally discovered freshman-level principles of economics and have used that discovery to finally debunk FDR’s New Deal. (Beginning in the 1930s Austrian School economists like Henry Hazlitt recognized the truth about the New Deal: It made the Great Depression deeper and longer lasting.)

This new realization on the part of the economics profession’s elite came about in the form of an article in the August 2004 Journal of Political Economy, one of the top-tier academic journals in the profession. The article was entitled “New Deal Policies and the Persistence of the Great Depression: A General Equilibrium Analysis,” by UCLA economists Harold L. Cole and Lee E. Ohanian. “Real gross domestic product per adult,” they wrote, “which was 39 percent below trend at the trough of the Depression in 1933, remained 27 percent below trend in 1939.” And, “Similarly, private hours worked were 27 percent below trend in 1933 and remained 21 percent below trend in 1939.” In other words, the New Deal never even came close to ending the Great Depression, contrary to several generations of government propaganda taught to every American public school child.

Cole and Ohanian—and the rest of the macroeconomic model-building club—seem surprised if not shocked by this realization. But this should be no surprise to anyone who has studied the reality of the Great Depression (as opposed to studying mathematical models of depressions). U.S. Census Bureau statistics show that the official unemployment rate was still 17.2 percent in 1939 despite seven years of “saving capitalism from itself” by the FDR regime. Per capita GDP was lower in 1939 than in 1929 ($847 vs. $857), as were personal consumption expenditures ($67.6 billion vs. $78.9 billion), according to Census Bureau data. In addition, net private business investment was minus $3.1 billion from 1930 to 1940.

Because “mainstream” macroeconomic models are so befuddling and nonsensical, even the elite of the economics profession seem bewildered by their belated discrovery of the truth about the New Deal. Cole and Ohanian label as “striking” the fact that the recovery from the Great Depression during the FDR regime was “very weak” (a dramatic understatement). It is “striking” to them because “these data contrast sharply with neoclassical theory . . .” That is, they have spent their entire professional careers spinning out journal article after journal article based on fanciful mathematical “models” that often have no association whatsoever with economic reality. After doing that for several decades and receiving numerous awards and honors from their fellow physics enviers in the economics profession, they finally got around to looking around outside to try to discover a few facts about the economic world. Lo and behold, they discovered what the Austrian economists had known for seventy years—New Deal interventionism made the Great Depression worse.

The “neoclassical” theory of depressions is admittedly useless according to Cole and Ohanian, who expressed shock over their discovery of its uselessness. It also employs an absolutely comical version of the English language. It may be thought of as a Frankenstein Monster theory of depressions. As explained by Cole and Ohanian, “The weak recovery [from the Great Depression] is puzzling because the large negative shocks that some economists believe caused the 1929–33 downturn—including monetary shocks, productivity shocks, and banking shocks—became positive after 1933.” Thus, according to the “neoclassical” theory, the economy during a depression is somewhat like a prostate Frankenstein Monster, with economists playing the part of mad scientist recommending that the beast be “shocked” back to life with bursts of deficit spending by government. Or if shocking the beast back to life doesn’t work, perhaps he can be injected with a syrum that can do the trick. Such as “injections” of government spending or easy credit that may cause the economy to come “roaring” back, to use the language of neoclassical macroeconomic model builders.

“The monetary base increased more than 100 percent between 1933 and 1939,” the authors write, making the case that such a “monetary shock” should have returned the economy to normalcy. They invoke the authority of well-known macroeconomists Robert Lucas and Leonard Rapping, who once proclaimed that “positive monetary shocks should have produced a strong recovery, with employment returning to its normal levels by 1936.” But of course it did not.

As Murray Rothbard showed in his book, America’s Great Depression, it was the easy money policies of the late 1920s that caused a bubble in the economy that eventually burst, causing the Great Depression. The only wise thing to have done was to have allowed the liquidation of hundreds of overcapitalized businesses to occur, cut taxes and spending, and deregulate. Instead, the Fed increased the money supply by 100 percent in a failed attempt to create another bubble while the president and Congress implemented an explosion of government interventionism. That was the first time in American history that a depression was responded to with government interventionism rather than governmental retrenchment, and the result was a seventeen-year long Great Depression, the worst in history.

Cole and Ohanian apparently decided that the classroom lessons they had been teaching their undergraduate UCLA students were not just useless model-building exercises after all, but can sometimes be used to explain real-world economic events. In particular, they recalled that elementary microeconomics teaches that cartels are groups of businesses that attempt to artificially prop up prices by collectively agreeing to restrict supply on the market. They also recognized what Austrians recognized from the very beginning of the New Deal in 1933—that the “First New Deal” (1933–35) was an attempt to cartelize all of manufacturing and agriculture with government-imposed output restrictions and price codes that fixed prices above free-market levels.

“New Deal cartelization policies are a key factor behind the weak recovery,” they wrote, “accounting for about 60 percent of the difference between actual output and trend output.” Translating from economese, this means that if government enforces restrictions on the production of goods and services in the economy, there will be fewer people employed producing goods and services in the economy. Thus, the New Deal “cartelization” policies caused unemployment to be higher than it otherwise would have been. It is truly astounding that it took the “mainstream” of the economics profession seven decades to come to this simplistic realization.

Unlike Austrian economists, who have a tradition of being widely read in economics, history, philosophy, and other disciplines, the “mainstream” of the economics profession is incredibly narrow minded, with your typical academic economist specializing in some trivial aspect of a trivial mathematical model-building exercise. His “knowledge” of economics tends to be only the last couple of years worth of articles in the very top journals on his trivialized specialty. He rarely, if ever, reads an entire book, let alone write one. In this regard the most disappointing thing about the Cole-Ohanian discovery is that they do not even cite the pioneering research on the subject, namely, the book Out of Work: Unemployment and Government in Twentieth-Century America by Richard Vedder and Lowell Gallaway, first published in 1993. Vedder and Gallaway arrived at all the same conclusions that Cole and Ohanian arrived at but in much greater detail and in a much more informed way. They estimated that because of New Deal interventionism, by 1940 the unemployment rate was eight percentage points higher than it would otherwise have been and concluded that “The Great Depression was very significantly prolonged in both its duration and its magnitude by the impact of the New Deal programs.” In addition to the cartelization policies of the First New Deal, Vedder and Gallaway explain how the “Second New Deal” made labor much more expensive to employers with minimum wage laws, laws that empowered labor unions, and payroll taxes for unemployment insurance and Social Security. Since the law of demand has never been repealed, it is obvious that government policies that force the price of labor up will lead to a reduction in the number of laborers employed as it prices the less productive members of the workforce out of jobs. It is sloppy scholarship, at best, for Cole and Ohanian to not even mention the Vedder/Gallaway book, and scandalous at worst.

Cole and Ohanian reach essentially the same conclusions as Vedder and Gallaway did, but expressed them in the convoluted language of the “top” economic journals, as opposed to the plain English that can be found in Out of Work. They concluded that

New Deal labor and industrial policies did not lift the economy out of the Depression. . . . Instead, the joint policies of increasing labor’s bargaining power and linking collusion with paying high wages prevented a normal recovery by creating rents and an inefficient insider-outsider friction that raised wages significantly and restricted employment . . . . the abandonment of these policies coincided with the strong economic recovery of the 1940s.

This last sentence is also a theme of the work of another Austrian-inspired economist, Robert Higgs, who is also ignored by Cole and Ohanian. At least the “mainstream” of the economics profession is finally beginning to realize what the Austrians have always known—that government interventionism is what caused the Great Depression, and it was post-war capitalism that cured it.