Wednesday, July 3, 2013

Davies’s Top Three Myths about the Great Depression and the New Deal: A Critique

This video by the historian Stephen Davies is part of Steve Horwitz’s online course called “Making Sense of the Great Depression.” Steve Horwitz seems to be an Austrian in the GMU tradition, so it will be interesting to see if his approach to the Great Depression is different from that of Rothbard.

I’ll be very interested to look at the Austrian perspective on the Great Depression in the videos from this course, and I’ll also provide a detailed critique of the Austrian arguments here on my blog.

Let us divide the statements in this video into the right and wrong:

I. What is right?
(1) It is certainly true that war, to the extent that it creates war materiel that is destroyed and diverts real resources to such war production (instead of to production of consumer goods), destroys wealth.

(2) It is true that Herbert Hoover engaged in a number of interventions during 1929 to 1933, and did not, strictly speaking, do nothing. Hoover rejected extreme liquidationism, and attempted to fight the onset of the Great Depression with a number of limited and weak interventions.
II. What is wrong?
(1) Just because war is destructive and war production generally destroys wealth, it does not follow that all investment or employment during WWII was destructive. For example, the American government’s investment in aircraft during WWII helped to created a great deal of new technology and the capital goods to produce new and better generations of aircraft after the war ended. Many new technologies were invented during the war that were useful in the peacetime economy after the war ended and in the production of consumer goods.

The income of many people increased significantly during the way, allowing both businesses and households to clear private debt and save the money that fuelled the recovery after 1945.

(2) Just because it is true that Hoover did not do nothing, it does not follow that he did enough in terms of government interventions to prevent the severity of the depression or to end it quickly.

The proper and academic Keynesian critique of Hoover is not that he did nothing, but that he did not do enough and that his interventions were too mild, weak or ineffective.

(3) We are told from 0.27–0.31 that Hoover was an “extremely interventionist president”. I dispute that statement.

“Extremely interventionist” relative to what? Hoover was not “extremely interventionist” relative to the interventions that became commonplace in Western mixed economies after 1933 and certainly after 1945. Hoover was relatively non-interventionist in relation to the mixed economies of the post-1945 period.

It does make sense to say that Hoover was relatively “interventionist” compared to the economic system and presidents that preceded him, but even here the comparison is not necessarily “extreme.”

Take Hoover’s lowering of interest rates and open market operations, which I have examined here.

The Federal Reserve banks had regularly lowered rates and engaged in substantial bond buying programs in response to 1920s recessions before 1929. The Fed cut rates in 1921, 1924 and 1926–1927 to fight recessions, and cut rates and bought bonds in 1924 and 1926–1927.

For example, from July 1929 to late 1931, Federal Reserve holdings of US Treasuries securities increased about fivefold, over a period of about two years. Austrian critics might complain that this was an unprecedented “evil” monetary intervention.

But it was not. In the year from 1923–1924 during a recession, Federal Reserve holdings increased from $91 million in October 1923 to $585 million by October 1924. That was a six-fold increase over about a year, much more radical than the 1929–1931 program and in a shorter time too.

(4) It is claimed that “in most parts of the world the Great Depression” was over by much earlier and more quickly than in the United States.

Nobody denies that the Great Depression was highly variable in its length and severity throughout the world, nor that it ended more quickly in some countries.

We can see the real GDP loss and the duration of the Great Depression for 22 Western nations, ranked from the most severe to the least severe real output loss, here:
Nation | Real GDP loss | Years of Contraction
(1) Canada | -29.59% | 1929–1933
(2) US | -28.52% | 1929–1933
(3) Austria | -22.45% | 1929–1933
(4) Poland | -20.70% | 1930–1933
(5) Czechoslovakia | -18.19% | 1930–1935
(6) Germany | -16.11% | 1929–1932
(7) France | -14.65% | 1930–1932
(8) New Zealand | -14.63% | 1930–1932
(9) Yugoslavia | -13.69% | 1930–1932
(10) Bulgaria | -12.72% | 1934–1935
(11) Netherlands | -9.46% | 1930–1934
(12) Hungary | -9.36% | 1930–1932
(13) Switzerland | -8.02% | 1930–1932
(14) Belgium | -7.89% | 1929–1932
(15) Norway | -7.75% | 1931
(16) Sweden | -6.20% | 1931–1932
(17) UK | -5.80% | 1930–1931
(18) Australia | -5.78% | 1929–1930
(19) Romania | -5.57% | 1932
(20) Italy | -5.47% | 1930–1931
(21) Romania | -4.57% | 1929
(22) Finland | -3.97% | 1930–1932
(23) US | -3.97% | 1938
(24) Denmark | -2.62% | 1932
(25) Australia | -2.57% | 1932
(26) Bulgaria | -1.91% | 1929
The worst depressions were in Canada and the US, with Austria, Poland, Czechoslovakia, Germany, France and New Zealand following.

But, since different nations were affected in different ways and had different economic strengths and weaknesses, and took different policy responses, it makes little sense to invoke one nation whose depression ended early and compare it with the US, without a careful analysis of the extent of the depression and the policy response in both countries.

And there is another important issue here: is the “Great Depression” being defined as
(1) the actual period of real output collapse only, or

(2) the period of real output collapse and the recovery with high unemployment and insufficient growth to restore full employment which followed?
Stephen Davies asserts that in the UK the Great Depression “was over by 1933” (at 0.59–1.05). But in what sense?

If one defines the “Great Depression” in sense (1), then the Great Depression occurred from 1930–1931 in the UK and from 1929–1933 in the US.

But, in sense 2, the Great Depression continued in both the UK and the US (and in many other nations) until the late 1930s.

Crucially, the UK did not recover to full employment by 1933 at all, as we can see here in the UK unemployment statistics:
Year | UK Unemployment Rate
1928 | 8.2%
1929 | 8.0%
1930 | 12.3%
1931 | 16.4%
1932 | 17.0%
1933 | 15.4%
1934 | 12.9%
1935 | 12.0%
1936 | 10.2%
1937 | 8.5%
1938 | 10.1%
1939 | 8.5%
(Boyer and Hatton 2002: 667).
Even in 1936, UK unemployment was still at 10.2%.

While the UK left the gold standard and devalued its currency quickly, which allowed some degree of export-led growth, its unemployment was still shockingly high in the 1930s without significant fiscal stimulus.

Stephen Davies asserts that the Great Depression in the US went on for more than a decade and in fact got worse by 1937. Without further clarification, this is misleading, because the US experienced a significant recovery from 1933 to 1936, and then Roosevelt turned to contractionay fiscal and monetary policy in 1937 and 1938 (the opposite of Keynesian fiscal policy!), and this caused the recession of 1937–1938 during which unemployment increased.

A final point is this: what nations emerged quickly from the depression in sense (2) to have a strong recovery where unemployment fell to low levels?

Those nations that recovered rapidly and successfully from the Great Depression defined as a severe real output collapse and its aftermath in sense (2) were New Zealand, Germany and Japan. They did so by large-scale fiscal stimulus. The US recovery was aided by its moderate fiscal expansion, but its stimulus was not nearly enough to drive the economy to full employment.

More on the fiscal expansion in New Zealand, Germany and Japan is given in these posts:
“Keynesian Stimulus in New Zealand: 1936–1938,” September 23, 2011.

“Takahashi Korekiyo and Fiscal Stimulus in Japan in the 1930s,” August 27, 2011.

“Fiscal Stimulus in Germany 1933–1936,” September 3, 2011.
It is also notable that some Scandinavian nations left the gold standard quickly, devalued their currencies, stabilised their banking systems, implemented loose monetary policy, and perhaps some degree of fiscal stimulus to escape the worst ravages of the depression (although the question whether the Scandinavian countries pursued fiscal expansion and how strongly is disputed by some economists).

Further Reading
“More Fake History of the Great Depression,” September 28, 2012.

“The Great Depression in 22 Western Nations: Real GDP Data,” March 1, 2013.

“UK Unemployment, 1870–1999,” February 25, 2013.

Boyer, George R. and Timothy J. Hatton. 2002. “New Estimates of British Unemployment, 1870–1913,” The Journal of Economic History 62.3: 643–667.


  1. "For example, the American government’s investment in aircraft during WWII helped to created a great deal of new technology and the capital goods to produce new and better generations of aircraft after the war ended. Many new technologies were invented during the war that were useful in the peacetime economy after the war ended and in the production of consumer goods."

    Suggest you look at Alex Field's book A Great Leap Forward on productivity growth during the Great Depression. The logic of his argument is that war production was so effective because of the productivity growth up to 1941 not because of the stimulus of the war programme itself. However Field also argues that government intervention for the road building programme was crucial to that productivity growth.

  2. I don't know if anyone has researched this, but the war also gave the U.S. Government a gold mine of data on the health and intellectual abilities of the male population the armed forces processed through the draft. The poor physical condition of many of the recruits who grew up during the Depression alarmed the government and led to programs to improve the nutrition and health of the nation's children; while the IQ testing gave some idea of how many men from lower socioeconomic backgrounds had the cognitive abilities to benefit from higher education. This knowledge might have played a role in the inclusion of subsidies for college education in the G.I. Bill.

    I know my father, a poor Oklahoma farm boy, benefited from the G.I. Bill. The Air Corps drafted him after he turned 18 in 1945, looked at his IQ test results, and trained him as a cryptographer, which says something about his cognitive abilities at the time. After the demobilization, he used his G.I. Bill benefits to go to the University of Oklahoma and earn a pharmacy degree. He wouldn't have gotten a college education otherwise and he might have wasted his life as a manual laborer.

    1. Yes, the social and economic consequences of the G.I. Bill were profound, not just in a personal sense (as you have just demonstrated with these interesting facts about your father), but also for the whole economy and society.

      It's likely that the G.I. Bill stopped unemployment from soaring too after 1945, as many of the demobilised went and pursued higher education.

  3. What utter tripe.

    'by definition, military production does not create wealth. Wars destroy wealth rather than create it.'

    Sure, buddy. The US and UK would've done much bettter to allow the Axis powers complete victory, and we'd all be better off on net somehow. Containment of Soviet power? Total waste across the board. We'd all be better off if Korea and Japan were abandoned to the soviet orbit. The wealth destroying occupations of these countries wrecked their economies along with that of the US. Seems legit.

    Not to mention that by a similar logic, police and court systems are also not 'wealth creating'. I suppose we'd be better off without them as well.