TCS Daily


The Great Displacement

By Arnold Kling - October 14, 2003 12:00 AM

"The high rates of investment in street, highway, water, and sewer capital literally helped pave the way for the postwar suburbanization boom."
-- Alexander J. Field, "The Most Technologically Progressive Decade," American Economic Review, September 2003

 

If I were in charge of the high school curriculum, I would have one semester of a history course devoted entirely to the 1930's. Students would be required to read from The Gathering Storm by Winston Churchill and from Reflections on the Great Depression by Randall E. Parker.

 

I keep coming across parallels between the 1930's and the present day. An impassioned pacifism swept the western intelligentsia. In England in February of 1933, the Oxford Union passed a resolution declaring that "this House will in no circumstances fight for its King and Country." Similar petitions were popular on elite college campuses in the United States. Meanwhile, of course, 1933 was the year that Adolf Hitler consolidated his power in Germany.

 

Myths of the Great Depression

 

Parker's book is a collection of interviews with famous economists who lived through the Great Depression. Thus, it combines first-hand memories with professional expertise.

 

The economists span the ideological spectrum, but they are surprisingly in agreement on many important points. For example, as Parker notes in his overview, "all of the individuals interviewed, most to a greater extent, attribute the ending of the Depression to the onset of World War II."

 

The economists agree that the New Deal mixed some harmful programs, such as the National Recovery Administration (a central planning board with the objectives of restricting industrial output and raising prices) and the Agricultural Adjustment Act (which pursued the goal of raising farm prices using policies that included destroying crops) with some successful financial reforms. Milton Friedman, a conservative who opposed the expansion of government under the New Deal, nonetheless praises "the series of monetary measures that Roosevelt took, including the bank holiday, the going off gold, the program to purchase gold, the silver purchase program." James Tobin, whom many regard as the foremost exponent of liberal Keynesian economics, nonetheless says that "When I got to college I began to realize that the NRA and the AAA were very bad ideas... Roosevelt was very lucky to get out from under the NRA." (The NRA was declared unconstitutional by the Supreme Court.)

 

A number of myths that are popular in conventional histories of the Depression are punctured in Parker's book. For example, the Wikipedia echoes many textbooks in saying, "A fundamental misdistribution of purchasing power, the greatly unequal distribution of wealth throughout the 1920s, was a factor contributing to the depression." None of the economists interviewed by Parker cites this so-called causal factor.

 

Another myth is that the New Deal rescued the country from the Great Depression. The economists agree that the economy expanded from 1933 to 1937, but this expansion was tepid in relation to the collapse that had taken place. In 1937, with unemployment still at double-digit levels, the economy contracted once again. National output finally regained its 1929 level in 1941, which may explain why the economists are unanimous in attributing recovery to the Second World War.

 

A Parallel with Today's Economy

 

The current recession (or recent recession if you believe the NBER chronology rather than mine) is unlike earlier post war recessions. In a widely-cited article, Federal Reserve economists Erica L. Groshen and Simon Potter describe the difference as "the predominance of permanent job losses over temporary layoffs and the relocation of jobs from one industry to another."

 

In the typical "inventory recession" of the postwar period, excess inventories led to temporary layoffs of workers, who were re-called back to their same jobs once stockpiles had been brought down to normal levels. Our current labor market instead is dominated by permanent job losses. Productivity has been soaring at unprecedented rates of 5 to 6 percent, which means that GDP growth of 2 or 3 percent is insufficient to require the available labor resources.

 

Today's labor market could be described in terms of progress and displacement. In some sectors, notably manufacturing, productivity is growing faster than demand, creating excess labor. Eventually, workers will find their way to other industries, in which demand is growing faster than productivity (in my article, I suggested home health care as an example). However, this process requires a number of adjustments -- wage changes, worker retraining, worker relocation, etc. -- that take a while to work out. Above all, we no longer have an irrationally exuberant stock market creating the impression that everyone can be productively employed doing business development for a dotcom. People have to find real jobs, which is more difficult.

 

What I had not realized until I read Alexander Field's article is that the Great Depression was also an era of high productivity growth. Field argues that the 1930's were also a period in which technological innovations were being exploited to increase productive efficiency.

 

The Depression certainly was an era of displacement. In fact I have borrowed the very term "displacement" from the late economic historian Charles Kindleberger, author of Manias, Panics, and Crashes and one of the eminent economists interviewed by Parker. Kindleberger's theory of manias, such as the Tulip Mania, the South Sea Bubble, or the Internet craze, is that they are triggered by a major change in the economic or geopolitical environment. The change creates new opportunities and sudden wealth, leading to greed and overspeculation. Kindleberger views the 1929 stock market boom and subsequent crash as a classic example of this theory. The geopolitical realignment following World War I, and the rapid growth of industries in automobiles and electronic communications, created displacement.

 

The development of motorized transportation must have affected every sector of the economy in the second quarter of this century. It permitted efficient farms located away from population centers to replace inefficient farms located close to cities and towns. It allowed people to enjoy the comfort and relative low cost of living in the suburbs while continuing to work in central cities. It allowed factories to relocate out of expensive central cities and into outlying areas and smaller towns.

 

Until World War II, however, the labor released by the progress of the 1930's was unemployed. The war brought full employment. After the war, to the surprise of most economists, the economy did not sink back into another recession. Instead, overall demand was high enough to absorb the nation's work force.

 

Have We Learned Our Lessons?

 

If today's economy shares some characteristics with that of the 1930's, then perhaps we should be worried. Will the economy pull out of its current slump, or will we suffer another long, stubborn period of high unemployment?

 

So far, we are doing much better than in the 1930's, and I am optimistic that we will continue to do so. First of all, monetary and fiscal policy are much more expansionary today than they were then. In fact, monetary policy in the Great Depression was so bad that most economists regard the contraction in the money supply as the primary cause of the severity of that episode. Fiscal policy, in spite of Roosevelt's willingness to experiment and Keynes' advocacy of deficit spending, was feeble or even perverse by modern standards. Current policies certainly deserve a higher grade.

 

Another reason that I am optimistic is that we are less likely to try some of the more dubious experiments of the New Deal, such as the central planning of the National Recovery Act. Thus, if Harold L. Cole and Lee E. Ohanian are correct in attributing the slow recovery of the 1930's to the adverse impacts of the New Deal, then we are likely to be spared a similar fate.

 

Among economists, at least some of us have been worried about a repeat of the Great Depression since the days when the dotcom bubble was at its height. As one of the worriers, I believe that our handling of the crisis has been better than expected, although not perfect. If you go back and read this essay, you will see that my predictions for economic policy were overly pessimistic. Today, my hope is that the worst is behind us.
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