Sunday, 12 October 2008

FDR's policies prolonged the depression

In two recent posts, here and here, I made comment on the idea that "regime uncertainty" was one factor which prolonged the depression in the US. The basic idea being that private investors held back on investing since they were unsure as to whether or not they would receive the returns on any such investment. I have now came across a paper in which two economists at UCLA blame the delay in recovery on specific anti-competition and pro-labour measures that Roosevelt promoted and signed into law June 16, 1933. So New Deal policies could have delayed recovery via at least two routes, private investment and industrial policy.

After spending four years scrutinizing Franklin D. Roosevelt's record, the economists Harold L. Cole and Lee E. Ohanian conclude in their study that New Deal policies signed into law 75 years ago thwarted economic recovery for seven years. The study, "New Deal Policies and the Persistence of the Great Depression: A General Equilibrium Analysis", appeared in the Journal of Political Economy, 2004, vol. 112, no. 4, p.779-816.

In a news release on the paper Cole is quoted as saying
"President Roosevelt believed that excessive competition was responsible for the Depression by reducing prices and wages, and by extension reducing employment and demand for goods and services," [...] "So he came up with a recovery package that would be unimaginable today, allowing businesses in every industry to collude without the threat of antitrust prosecution and workers to demand salaries about 25 percent above where they ought to have been, given market forces. The economy was poised for a beautiful recovery, but that recovery was stalled by these misguided policies."
Ohanian and Cole use data collected in 1929 by the Conference Board and the Bureau of Labor Statistics. Using this they were able to calculate average prices and wages across a number of industries just prior to the start of the Great Depression. Then they worked out a counter factual of what would have happened if Roosevelt's policies not been put in place. By adjusting for annual increases in productivity, they were able to use the 1929 benchmark to work out what prices and wages would have been during every year of the Depression without Roosevelt's interventions. They then compared those figures with actual prices and wages as reflected in the Conference Board data.

One result they found was that in the three years following the implementation of Roosevelt's policies, wages in 11 key industries averaged 25 percent higher than they otherwise would have done. But unemployment was also 25 percent higher than it should have been, given gains in productivity.

Meanwhile, prices across 19 industries averaged 23 percent above where they should have been, given the state of the economy. With goods and services that much harder for consumers to afford, demand stalled and the gross national product floundered at 27 percent below where it otherwise might have been.

The news release quotes Ohanian as pointing out that
"High wages and high prices in an economic slump run contrary to everything we know about market forces in economic downturns." [...] "As we've seen in the past several years, salaries and prices fall when unemployment is high. By artificially inflating both, the New Deal policies short-circuited the market's self-correcting forces."
An important point noted by Cole and Ohanian is that under the National Industrial Recovery Act (NIRA), industries were exempted from antitrust prosecution if they agreed to enter into collective bargaining agreements that significantly raised wages. Because protection from antitrust prosecution all but ensured higher prices for goods and services, a wide range of industries agreed. In fact by 1934 more than 500 industries, which accounted for nearly 80 percent of private, non-agricultural employment, had entered into the collective bargaining agreements called for under NIRA.

According to Cole and Ohanian the NIRA and its aftermath account for 60 percent of the weak recovery. Without the policies, they contend that the Depression would have ended in 1936 instead of the year when they believe the slump actually ended: 1943.

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