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EH.NET BOOK REVIEW
Published by EH.NET (September 1998)
Michael D. Bordo, Claudia Goldin, and Eugene N. White, editors, _The
Defining Moment: The Great Depression and the American Economy in the
Twentieth Century_. An NBER Project Report. Chicago: The University of
Chicago Press, 1998. xvi + 474 pp. $60.00 (cloth). ISBN: 0-226-06589-8
(cloth), 0-226-06589-8 (paper).
Reviewed for EH.NET by Louis P. Cain, Departments of Economics, Loyola
University of Chicago and Northwestern University. <[log in to unmask]>
The "moment" is the Great Depression; what is being "defined" is public
policy. The editors have assembled twelve papers from a distinguished cast
of authors who are closely associated with their subject. The papers
discuss almost all of the programs that persisted from the First and,
particularly, the Second New Deals, but few of those that did not. In
their introduction, the editors discuss that this is potentially a
controversial hypothesis, but most of the papers simply explain why they
agree or disagree with the proposition, and some do find this was NOT a
"defining moment." Whether each reader ultimately accepts or rejects the
hypothesis may be little more than a matter of definition.
In any event, each of the papers makes a substantial contribution to our
understanding of the depression. Most will be widely cited. Many readers,
including undergraduates, will want to consult the volume for more than one
paper. Thus, in the interest of disclosure, a thumbnail sketch of each of
the papers is appropriate. These brief synopses emphasize the relation of
each paper to the volume's general theme. Each contains much more.
The collection is divided into four sections of three papers each. The
first is entitled "The Birth of Activist Macroeconomic Policy." Charles
Calomiris and David Wheelock ask whether the substantial changes in the
monetary environment of the 1930s had lasting effects? Those familiar with
Wheelock's work will not be surprised to note they find little change in
the thinking of the Federal Reserve System. One effect of the New Deal
banking laws was to shift power from the Fed toward the Treasury, a shift
they feel imparted an inflationary bias, especially when conjoined with the
more activist approach to policy that was undertaken concurrently. The
most important legacy of the depression was the departure from gold
creating "the permanent absence of a 'nominal anchor' for the dollar" (63).
The Bretton Woods dollar system allowed the Fed to "stumble" into the
inflation of the 1960s, and the continued absence of something like the
gold standard "provides an enduring legacy of uncertainty" (63) as to
monetary policy in the long run.
Brad De Long notes that the U.S. did not have a fiscal policy in the
contemporary sense of the term before the Great Depression. It borrowed
heavily during periods of war and tried to redeem the debt as quickly as
possible during periods of peace. Government deficits in peacetime were
rare until the 1930s, when they proved unavoidable despite the fiscal
conservatism of both Hoover and FDR. Yet, even before Keynes, there was an
understanding that "deficits in time of recession helped alleviate the
downturn" (83). After the second World War, a fiscal policy consensus
emerged that De Long characterizes as: "set tax rates and expenditure plans
so that the high-employment budget would be in surplus, but do not take any
steps to neutralize automatic stabilizers set in motion by recession" (84).
That consensus proved hard to maintain: "The U.S. government simply lacks
the knowledge to design and the institutional capacity to exercise
discretionary fiscal policy in response to any macroeconomic cycle of
shorter duration that the Great Depression itself" (82). What has
persisted is the willingness to adopt a fiscal policy stance that imposes a
cost -- perhaps higher than necessary (higher inflation, lower saving and
productivity) -- to insure that there is no return to Depression-era
conditions.
Deposit insurance, the topic of Eugene White's essay, was a result of the
Depression and is generally considered to be one of its great successes.
Banks became a scapegoat, and the restrictions placed on the banking
business diverted part of what they once did to other parts of the
financial sector. Banking became smaller than it might have been. Deposit
insurance was an attempt to insure the banking system did not fail again.
White attempts to estimate bank failures under the assumption that deposit
insurance was not adopted. He finds that a stronger, larger banking system
would have resulted in lower failure rates and higher recovery rates.
Thus, it is possible the FDIC increased bank losses. A more important
outcome is that the FDIC changed the distribution of losses. The cost of
those losses is now "distributed to all depositors and hidden in the premia
levied on banks" (119). Thus, even if losses increased, they were unseen
by individual depositors, with the result that a marginal institution
remains extremely popular.
The second part, "Expanding Government," begins with a paper by
Hugh Rockoff on the expansion of the government sector, largely as a
result of a large number of new federal programs. As Rockoff notes,
"it is easy to see that there was an ideological shift ... it is harder to
see what produced it" (125). This ingenious article looks back at
the publications of economists in the 1920s and earlier and finds there
were champions for almost all of the New Deal programs. Curiously, one
of the programs economists did not endorse, one measure that FDR did
not champion, was deposit insurance. When the Depression came and
the economic doctors were called, microeconomists had what they
considered successful prescriptions. Some part of that must have been
conditioned by the role of the government in World War I. But another
part is something that Rockoff does not discuss, and it surely is one
of the factors producing an ideological change within the profession.
Even before the Great Depression, the competitive paradigm
was under attack. The merger movement at the turn of the century called
into question the assumptions of constant returns to scale and easy entry
and exit. The emergence of a consumer society called into question the
assumption of homogeneous products. Robinson and Chamberlin's
models are independent of the Depression, and what impact they would
have had in the absence of the Depression is unclear. It is clear that
FDR came into the White House with a mandate to do something, and the
economic doctors had a long list of things to try, things that had been
used successfully elsewhere.
John Wallis and Wallace Oates argue persuasively that the New Deal had a
profound effect on the nature of American federalism through its use of a
little used fiscal instrument -- intergovernmental grants. Before the
Depression, different levels of government operated with a much greater
degree of independence than they would thereafter. Intergovernmental
grants created the necessity for cooperation that has characterized the
fiscal federalism ever since; "fiscal centralization and administrative
decentralization" (170). They argue that the new structure was conducive
to the growth of government. Like Rockoff, they note the growth of the
federal government did not come at the expense of state and local
governments; both grew. They show how this new pattern was "the result of
the struggle between state and national governments, and also between the
president and Congress, for control over these programs" (178). How much
of this has to do with a states rights' bias in the legislative and
judicial branches, and how much with the depression itself, is uncertain.
Gary Libecap examines the regulatory laws effecting agriculture between
1884 and 1970 and the budgetary expenditures that were derived from those
laws between 1905 and 1970. His contention is that "the New Deal increased
the amount and breadth of agricultural regulation in the economy and ...
shifted it from providing public goods and transfers to controlling
supplies and directing government purchases to raise prices" (182).
Acreage restrictions and government purchases were the most apparent of
what he terms, "unprecedented, peacetime government intervention into
agricultural markets" (216). Abstracting from those policies, Libecap asks
what agricultural policy might have been in the absence of the Depression.
He believes it would have been more like it had been, but that is the
result of an exercise in which he subtracts laws passed after 1939 with a
direct link to "key New Deal statutes." One wonders how many any of those
statutes would have been passed in any event; some represent ideas that
predate the depression.
In the first paper of Section III, "Insuring Households and Workers,"
Katherine Baicker, Claudia Goldin, and Lawrence Katz note that there are
three differences between the system of unemployment compensation in the
U.S. and elsewhere: experience rating, a federal-state structure, and
limitations on benefit duration. The question they address is how that
system would have been different had it not been created during the New
Deal. There is an implicit assumption the U.S. ultimately would have
adopted some form of unemployment compensation in the absence of the
Depression. To how many other New Deal programs is this assumption
relevant? The authors point to the federal-state structure as the key
difference. Their counterfactual system is strictly a federal system with
no experience rating, a system consistent with the administration's
recommendation. We got the system we did because, "The federal-state
structure and the manner in which the states were induced to adopt their
own UI legislation assured passage of the act and guaranteed its
constitutionality" (261). They criticize the system for not having
"changed with the times," but that is no surprise after reading Wallis and
Oates.
While most people look to the labor legislation of the 1930s as "a defining
moment," Richard Freeman argues that to be defining an event must "lock in
certain outcomes that persist ... when, given a blank slate, society could
have developed something very different" (287). This test creates two
interesting dichotomies in Freeman's story. The first concerns the
framework versus the results. The legal framework for private sector labor
relations has persisted, and Freeman considers that framework to be
"outmoded." On the other hand, the unionization attendant to the adoption
of that framework "looks more like a diversion from American
'exceptionalism' ... than a critical turning point in labor relations"
(287). The density of private sector unions today is similar to what it
was just after the turn of this century; the voice of those unions in
national political discourse is barely audible. The second dichotomy
concerns private versus public unions. State regulation of the latter has
resulted in a relatively stable environment in which collective bargaining
proceeds with less confrontation, but that may be because public sector
managers are not as accountable to the taxpayers as private sector managers
are to the company's profits. In sum, Freeman acknowledges that the
framework in which labor relations takes places was defined during the
Depression, but that was not a "defining moment" for labor relations.
In their study of the creation and evolution of social security, Jeffrey
Miron and David Weil do not examine the role the Great Depression might
have played in the program's adoption. Their emphasis is on the evolution
of the program since its inception. They find that "in a mechanical sense,
there has been a surprising degree of continuity in social security since
the end of the Great Depression" (320). That is, there has been little
change in what each of the parts does; it is clear the balance between them
has changed and that change has had an impact on the economy. As the
population has aged, the balance between the old-age assistance component,
the basic response to the depression, and the old-age and survivors
insurance component has transformed what was an insurance program
benefiting few to a transfer program benefiting many.
Doug Irwin's paper on trade policy begins the final section, "International
Perspectives." Irwin shows that, during the 1930s, the locus of control of
trade policy passed from the legislative to the executive
branch of government largely as a result of "the depression as an
_international_ phenomenon" (326). Smoot-Hawley marked the end of
the old approach. By the end of the 1930s, the average tariff rate had
decreased from over 50% to less than 40%. In another ten years it would
be below 15%. While part of this change is attributable to trade policy,
part should be attributable to fiscal policy (a return to the days of the
Underwood tariff) as the federal income tax came to play a much larger
role, especially in the 1940s. Similarly, the Reciprocal Trade Agreements
Act was passed during the depression, but it was not "institutionalized"
until after World War II. When, during the war, Republicans moved to
seek congressional approval and to protect domestic firms competing
with imports, it was clear that the policy changes of the 1930s would
persist. Then, after the war, "the new economic and political position of
the United States in the world ... made a return to Smoot-Hawley
virtually unthinkable" (350).
The paper by Maurice Obstfeld and Alan Taylor is in many ways the most
expansive in the volume. They begin by investigating more than a century
of data on capital mobility, then propose a framework in which both the
downtrend initiated by the Great Depression and the uptrend of recent years
can be understood. The framework is a policy "trilemma" faced by all
national policymakers: "the chosen macroeconomic policy regime can include
at most two elements of the 'inconsistent trinity' of (i) full freedom of
cross-border capital movements, (ii) a fixed exchange rate, and (iii) an
independent monetary policy oriented toward domestic objectives" (354). To
the authors, the Great Depression was caused by subordinating the third
element to the second. Under the classic gold standard, monetary policy
was concerned with exchange rate stability, not domestic employment, and
capital mobility was facilitated. The abandonment of gold led to a system
"based on capital account restrictions and pegged but adjustable exchange
rates, one whose very success ultimately led to increasingly unmanageable
speculative flows and floating dollar exchange rates...." (397).
The gold standard plays an equally prominent role in the paper by Michael
Bordo and Barry Eichengreen. To address the question of what the Great
Depression meant for the international monetary system, they examine a
counterfactual world without the Great Depression -- but with World War II
and the Cold War. They assume the gold standard would have persisted
through the 1930s, been suspended during the war, and resumed in the early
1950s. Under these assumptions, "the depression interrupted but did not
permanently alter the development of international monetary arrangements"
(446). The system that did develop in the U.S. was very different than the
hypothesized one, but the factors that ultimately led to the collapse of
the Bretton Woods arrangements would have caused the collapse of the gold
standard -- and possibly at an earlier date. Those factors include "the
failure of the flow supply of gold to match the buoyant growth of the world
economy and hence of government's demand for international reserves" (447).
This, in turn, led to questions about U.S. official foreign liabilities and
the gold convertibility of the dollar. Bordo and Eichengreen believe that,
in these circumstances, a floating system would have resulted leaving us
with more or less what we have today. If one accepts the "ifs" in their
argument, the institutional structure that emerged in the wake of the Great
Depression postponed the transition.
This is a remarkable thought on which to end this volume. Calomiris and
Wheelock discuss the Fed's recent emphasis on price stability as a
short-run policy concern as a "throwback." Obstfeld and Taylor discuss the
deregulation and recent growth of the financial sector as creating a
barrier to the reimposition of capital controls. Both discussions concern
long-run adjustments the economy has made as a result of the abandonment of
gold, but both would have taken place had there been no Great Depression if
Bordo and Eichengreen are correct.
The editors point to four common themes supporting the "defining moment"
hypothesis (6). "First, skepticism about the efficacy of government
intervention withered as the public adopted the attitude that the
government could 'get the job done' if the free market did not." It is
unquestionably the case that there was a loss of faith in the tenets of the
competitive model. While this faith was wavering among social scientists
well before the depression, the general bewilderment of the 1930s created a
search for someone who was willing to try anything. To paraphrase the late
John Hughes, before the Great Depression the federal government only knew
how to spend money on rivers, harbors, and post offices. As Rockoff
documents, there were a number of other projects waiting in the wings.
"Second, many innovations introduced by the New Deal were forms of social
insurance." While much of the First New Deal took the form of World War I
programs modified for peacetime use, many of the Second New Deal programs
were aimed at ameliorating specific types of suffering, particularly those
where successful experiments had been tried elsewhere. Some undoubtedly
would have been adopted eventually; the depression meant they started
earlier than otherwise would have been the case.
"Third, the character of federalism moved from 'coordinate' to
'cooperative' with extensive intergovernmental grants, giving greater
influence to centralized government." This change in form, it is argued,
was necessary to get them through Congress and the Supreme Court, but that
is not necessarily a result of the Great Depression; the states rights'
bias was present much earlier.
"Last, the conduct of economic policy ... changed to give more weight to
employment targets and less to a stable price level and exchange rate."
These changes in turn imparted what several authors refer to as a bias in
favor of inflation, but, in a simple Phillips curve world, what developed
was a bias against a return to the conditions of the 1930s. To put it as
simply as possible, those who lived through the Great Depression defined
for policy-makers then and for their grandchildren today that all possible
steps should be taken to avoid repeating the trauma.
Louis P. Cain
Departments of Economics
Loyola University of Chicago and
Northwestern University
Louis Cain and the late Jonathan Hughes are the authors of _American
Economic History_ published by Addison Wesley. Cain's article with
Dennis Meritt, Jr., "The Growing Commercialization of Zoos and Aquariums,"
appeared in the _Journal of Policy Analysis and Management_, Spring 1998.
His article with Elyce Rotella, "Urbanization, Sanitation, and Mortality
in the Progressive Era, 1899-1929," will appear in Gerard Kearns, W.
Robert Lee, Marie C. Nelson, and John Rogers, editors, _Improving the
Public Health: Essays in Medical History_.
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