We are making some of the same economic policy mistakes today that caused the Great Depression of the 1930s.
The Japanese Disease
There is a proxy battle going on in the media and blogosphere between a Nobel winning economist and a writer on economics about the most important issue we face about the economic crisis: will government fiscal stimulus work? The argument is phrased around the idea that it worked for the Great Depression and it will work now.
It didn’t work then and it won’t work now.
On one side is Nobel economics laureate, NYU Professor Paul Krugman who has the New York Times on his side–he writes a column for them. On the other side is Amity Schlaes, a writer about economics, and the author of The Forgotten Man, a new history of the Great Depression.
By proxy, I mean that the war is being fought not only by TV appearances and articles published by both parties, but by their supporters through blogs, news articles, and letters to the editor. The fight seems to be mainly from the Krugman side. Schlaes is characterized as being a lightweight, tendentious, sloppy, a tool of the right wing, and, because of Krugman’s stature, that it’s not even a fair fight. She’s being smeared. And by smearing her, ridicule is given to the idea that FDR didn’t save us from the Depression.
The liberal argument is that FDR saved us from the Great Depression by, among other things, fiscal stimulus. By stimulus these advocates mean massive government deficit spending to “kick start” the economy. Damn the cost and the consequences. The metaphor is “let’s save the patient first; then we can talk about the rest.” Most economists today adopt this Keynesian concept, including economists advising Bush and Obama.
Schlaes, and many others, argue that such stimulus didn’t get us out of the Great Depression. Schlaes illustrates in her book how Hoover and Roosevelt took a garden variety market crash and recession and made it a decade-long depression. Furthermore, there’s no evidence that massive government spending will work. Many argue that it will make it worse.
Schlaes, in her well written and documented book argues successfully that Hoover’s and FDR’s policies didn’t end the Depression. FDR doubled federal spending, yet, despite his massive intervention, by 1938 unemployment shot back up to almost 20%. FDR’s hatred of business and his power grab led to a mishmash of policies that were admittedly experimental. His government-run industries, oppressive regulation, anti-competitive cartels, central planning, erratic tax policy, and war against businesses and businessmen, kept everyone off base as he consolidated his power. It destroyed business, profits, and incentive, and caused massive unemployment and poverty.
Most of the argument that fiscal stimulus works comes from economist J. M. Keynes. Krugman is a leading Keynesian proponent. They have yet to provide any evidence of that. Krugman says:
“F.D.R. did not, in fact, manage to engineer a full economic recovery during his first two terms. This failure is often cited as evidence against Keynesian economics, which says that increased public spending can get a stalled economy moving. But the definitive study of fiscal policy in the ’30s, by the M.I.T. economist E. Cary Brown, reached a very different conclusion: fiscal stimulus was unsuccessful ‘not because it does not work, but because it was not tried.’”
While he’s right about FDR’s failures, he offers no credible evidence of efficacy of massive deficit spending. He’s just engaging in polemics to sway his audience. Perhaps as Nobel laureate he believes his pronouncements are the final word on a subject. Brown in this 1956 paper said FDR’s fiscal stimulus didn’t work. Brown offers no empirical evidence for his conclusion that if there had been more spending it would have worked. If this is the “definitive” empirical work on the subject, their argument is bogus. Apologists for failed policy always say the policy wasn’t implemented the right way.
However there is very good evidence that such policies don’t work. The Great Depression aside, there is the “Japanese disease.” The Japanese descended into recession in 1991 after an inflationary real estate bubble burst and, despite massive deficit spending on infrastructure, the propping up of banks and insurance companies, and a nearly zero “fed funds” rate, their economy languished for 10 years. Sound familiar?
The stakes are too high to let this go unchallenged. We can’t assume that just because these leaders are in the majority they are right. There are many economists who believe the programs now being pursued by the Bush Administration and proposed by Obama are very wrong. Just because “everyone” believes the fairy tale doesn’t make it true.
The cures now being proposed by our political and economic leaders have enormous consequences for all of us if they get it wrong. The most likely scenario will ultimately be the Japanese disease: recession and economic stagnation.
Considering the immense damage already done to the economy as a result of the actions of our economic and political leaders, why should we listen to them now?