Great Depression: defending capitalism against anti-market myths, part I
Gerard Jackson
Steve, an American critic, has taken me to task over my attacks on interventionism in the American economy. He takes the usual interventionist line that the free market is responsible for America's economic ills, that it caused the Great Depression and that it was Roosevelt who restored prosperity.
He began by arguing that because the "entire South was destroyed after the Civil War, and economic growth is always fastest when you start from nothing," this inflated America's growth figures. But economic growth does not "always come fastest when you come from nothing."
There is no economic law or ‘rule of thumb’ to suggest otherwise. After all, the real name for growth is capital accumulation. (Austrian capital theory is something of which critics of the market are painfully ignorant.) In a free market the ‘rate of growth’ is basically determined by the level of savings, which in turn is determined by the social rate of time preference.
He then claimed that “massive immigration” and a doubling of the population between 1860 and 1990 “was responsible for a large part of this period's faster economic growth. This was also a time of scientific and technological change: electricity, the light bulb, the gas engine, the telegraph, the telephone, etc. These economic changes overshadowed any government policy of the time.’
Now population growth in itself does cannot increase per capita output, unless the previous population level was sub-optimal. I believe this was the case in England before the Black Death struck in 1348. Therefore population per se does not and cannot generate growth, i.e., capital accumulation.
If this were so we would expect countries like India to have outperformed countries with lower population rates. In fact, India’s economic performance from 1948 to the ‘90s was dreadful, thanks to the kind of policies interventionists are continuously preaching. (Things have taken a turn for the better since pro-market reforms were implemented).
As for technology, to be effective technology must be applied though investment. In other words, investment embodies technology. The reality is that savings fuels economies and entrepreneurship drives them.
From 1860 to 1890, the U.S. population doubled and from 1890 to 1920 it jumped by 62 per cent, after which growth was slowed. Now if population growth was the engine of economic growth then real wages would grow disproportionally as population grew. What we find, however, is something very different. From 1855-95 there was an annual increase in real wages of 1.27 per cent but the period 1896-1916 saw the annual increase in wages slow to 0.55 per cent.*
This latter period was marked by massive in immigration from Europe averaging about one million annually. The period 1917-55 saw the annual increase in wages rise to 2.47 per cent. Though we must be careful of averages and bear in mind the fact that they can hide fluctuations, there is no doubt that the correlation between rising real wages and population growth does not support the population-growth hypothesis.
This does not mean population increases always slow or depress wages, only that real wage rates must fall if population outstrips capital accumulation.
Steve considers the above “preposterous” because I “include the Roaring Twenties, the Great Depression, the economic explosion of World War II, and the Great Boom of the 50s,” asserting that “wild swings” render the figures meaningless, despite the fact that I stated quite clearly that statistics hide fluctuations.
This, however, should not be allowed to distract us from the fact that they also reveal long-term trends, and the long-term trend is what I am talking about. (How anyone can criticise me for using these figures while ignoring, for example, the Phelps Brown-Hopkins Index beats me. This index covers the prices of English consumerables from 1264-1983? Now that’s what I call a trend.)
Steve states that the “Roaring 20s saw overall economic growth, but income inequality reached record levels. The richest 1 percent would own 40 percent of America's wealth by the end of the decade. Meanwhile, the real disposable per capita income of the lower 93 percent of the non-farm population fell 4 percent over the decade.”
Now he seems to be suggesting that the vast majority of American consumers suffered a fall in disposable income during the 1920s and this was due to 1 per cent of the population owning 40 per cent of the country's wealth
If Steve were right the mass of Americans would have suffered a gradual fall in consumption during the ‘20s. Facts, however, tell another tale. During this period millions of ordinary Americans were able to acquire, for the first time in their lives, insurance; about 11 million Americans got their own homes and savings quadrupled. In 1914 1,258,062 cars were registered in the States; by 1929 it had risen to 26,501,443 — 83.4 per cent of world production!
This made European car ownership pathetic in comparison. Spending on radios leapt from $10,648,000 in 1920 to a staggering $411,637,000 in 1929. During the same period spending on other electrical appliances jumped from about $800,000,000 to $2.4 billion. These figures mock Steve’s assertion about falling incomes. (On the other hand, maybe the Astor, Rockefeller and Vanderbilt families did a lot of consuming).
Moreover, his insinuation that there was something destructive and unusual about the pattern of wealth fares no better than his view on consumption. That 1 per cent of the population owned about 40 per cent of the wealth is true. It is equally true that ". . . In 1983, the richest 1 per cent of U.S. households owned about 39 per cent of the wealth in the country. In 1989 they owned about 36 per cent" (Wall Street Journal, 14 June 1995) — and it was not much different in 1900.
Looking at wealth over time rather than at a point in time, as leftists like Steve tend to do, reveals that the pattern of wealth in America has been remarkably stable during this century, regardless of how wealth is measured. In any case, there is nothing unique about striking differences in wealth.
It has been estimated that in 1890 about 86 per cent of the country's wealth was owned by 10 per cent of the population (Benjamin Schwarz, New York Times, 19 December 1995).
What is also striking but seldom, if ever, mentioned is how wages as a proportion of national income moved from 1900 onwards. In 1909 wages plus salaries were 54.4 per cent of national income; by 1929 they had risen 65.1 per cent (Brookings Institution 1934) — when, as Steve stressed, 1 per cent of the population owned about 40 per cent of the wealth.
(Anyway, the wealth figures are misleading because they exclude all forms of wealth, i.e., assets, that the "average" American owns: these include cars, homes, IRAs, pensions, etc. Therefore the figures only include the kind of wealth likely to be held by the rich: stocks, bonds, investments in real estate and the like. Moreover, figures from the 1980s show that the middle class actually made the largest per centage gains in net wealth. The main point there is that everyone got wealthier.)
Let us now take a look at wages in the 1920s: according to the Conference Board Index there was an increase in average hourly earnings of 12 per cent during this decade. This is not surprising given that capital investment was rising by 6.4 per cent a year while manufacturing productivity rose by 43 per cent between 1919 and 1929.
However, averages do hide differences between groups. There was little or no increase in earnings in boot and shoe manufacturing, earnings in furniture production rose by 6 per cent and less than 3 per cent in meat packing.
Now Austrian economic theory predicts that the greatest rises would take place in the higher stages of production. And that is exactly what happened. Earnings in the Chemical industry were up by 22 per cent; machines and machine tools, 12 per cent; lumber, 19 per cent and iron and steel, 25 per cent.
The above figures completely demolish the thesis that the depression was brought on by falling real wages caused by the rich getting richer. The real black spot was monetary expansion misleadingly labelled “stabilisation policy.” This policy based on credit expansion prevented the fruits of increasing productivity from being more widely spread through falling prices.
It also misdirected production which caused gross malinvestments. Once the monetary expansion was halted the malinvestments appeared as idle resources, just as they did in the 1920-21 depression. Again, just as the Austrians predicted — but not Keynes who enthusiastically supported the stabilisation policy.
Steve continued with the claim that "during the Great Depression, everyone’s income fell as GDP declined by a third . . .They [wages] fell on Hoover’s watch, and started rising on Roosevelt’s." This statement is a real beauty. Real average hourly earnings (RAHE) actually rose through "Hoover’s watch" just as they did through Roosevelt’s. However, disposal incomes fell through both “watches.”
With June 1929=100 we find that RAHE stood at 100.7 in June 1929, 99.8 in December, rising to 102.7 by June 1930 and to 105.3 in December 1930. June 1931 saw them peak at 111 falling to 108.3 by March 1933. Yet this period saw real payrolls fall by more than 60 per cent, real weekly earnings by about 30 per cent, factory employment fell by 42 per cent, unemployment rose to 25 per cent and production crashed.
This was the dreadful price of deliberately resisting vital wage and cost adjustments. Yet Hoover’s Secretary of the Treasury, Andrew Mellon, boasted in May 1931 “. . . that the all important factor is purchasing power, and purchasing power . . . is dependent to a great extent on the standard of living . . . that standard of living must be maintained at all costs.”
Unemployment then stood at 16 per cent. In his 1932 Presidential campaign Hoover stated: “. . . For the first time in the history of depression, dividends, profits, and the cost of living, have been reduced before wages have suffered . . . . They were maintained until the cost of living has decreased and profits had practically vanished. They are now the highest real wages in the world . . .”
And this was when unemployment was at an unprecedented 24 per cent.
So far we have established that: (1) the pattern of wealth had nothing to do with the depression, (2) real wage rates rose during Hoover’s “watch”, along with unemployment, (3) maintaining money wages rates caused an unprecedented fall in payrolls, (4) that the purchasing-power-of-wages theory was an economic and social disaster.
Part II follows next week.
*The wage figures are from the Tucker series converted to hourly rates and adjusted for the cost of living.
BrookesNews.Com
Monday 31 January 2005
I received a lot of flak on this article, some of it quite venomous. In response I am simply going to repeat what I have said elsewhere.
These critics claim that WWII proved that Keynes was right. No it didn’t. During the 1930s real wage rates were kept in excess of productivity. This is why unemployment was so high. Those countries that allowed real wage rates to adjust to the level of productivity would have seen their unemployment levels fall. And this is what I believe is what happened.
When WW II started so did rapid monetary expansion. This swept away the job-destroying effects of Roosevelt’s industrial codes and cut real wage rates. The result was that a mass of “withheld capacity” was let loose against the Axis Powers. In other words, the enormous pent up demand that the Hoover-Roosevelt policies had created in the form of idle labour and capital was released. (On this subject see William H. Hutt’s The Keynesian Episode, LibertyPress, 1979).
The immediate post-war experience of the US also refutes Keynes. The war-time economy saw a considerable increase in productive capacity, much of which would have been redirected to meet peace-time needs. Fortunately, the war-time inflation created this situation. Keynesians thought otherwise.
Between 1945 and 1947 the US government slashed Federal spending from an annual $95 billion to $36 billion per year — a $59 billion cut. This was a staggering 62 per cent reduction. Instead of the economy spiralling into a deep and prolonged depression with 8 million unemployed, as predicted by Keynesians, though not Keynes, prices, wage rates and employment increased after a the economy had made a brief adjustment to peace-time needs.
I rest my case.
Gerard Jackson is Brookes' economics editor