| by Richard Ebeling*
On July 9th, Nobel economist and New York Times columnist, Paul Krugman, gave his read on the recently unearthed letters between J. M. Keynes and F. A. Hayek in the London Times in October 1932, which have been posted and discussed on ThinkMarkets. (and in the Wall Street Journal). Krugman insists that Hayek is worse than he thought and that Keynes was better than he imagined. He attacks Hayek for insisting that the best cure for recovering from the Great Depression would be to free up markets both domestically and internationally, and to rein in government spending. This, Hayek said, would create the political and fiscal environment that would foster a positive private sector return to a job generating rebalancing of supply and demand, and a sustainable investment climate. Not surprisingly, Krugman instead, hails Keynes as the advocate of fiscal stimulus that would “prime the pump” through deficit spending and government sponsored job creation. He thinks it is all a great tragedy that the same battle has to be fought all over again for sound Keynesian policies, nearly eighty years after the exchange of these letters. But what, instead, is Krugman missing? Most reputable economic historians have come to consider the high tariff policy of the United States in the early 1930s to have led to retaliation by other countries — a general “beggar-thy-neighbor” tit-for-tat — that only made the depression even worse, internationally, than it needed to be. A growing number of economics historians have taken second looks at the domestic policies under first Herbert Hoover and then Franklin Roosevelt, and come to the conclusion that Hoover’s “high-wage” policy in an attempt to artificially maintain “purchasing power” and then the economy-wide rigidities during Roosevelt’s first New Deal under the NRA and AAA controls (which resembled aspects of the Italian fascist corporativist state), all worked to keep price-wage and supply-demand relationships out of balance. This, too, prolonged any process back to sustainable profitability in the private sector for a return to fuller employment. And, in addition, the growing budget deficits and rising national debt (by the historical standards of that time) all generated uncertainty surrounding future tax burdens in a political environment in which the administration’s rhetoric out of Washington, D.C. was all covered with a strong anti-business tone, which served to inhibit any private sector confidence for investment and job creation. And, finally, all the public works projects and “job stimulus” spending actually failed to bring an end to high unemployment through the 1930s. Unemployment was still in the significant double digits in 1937 and 1938. Plus, many of the accounts written at that time — by people “on the ground” — emphasize that a very large part of such spending was guided by local and state political favoritism and party loyalty expenditures to reinforce and buy the reelection of the Democratic Party. On the other hand, the types of policies that were being advocated by economists such as F. A. Hayek were pointing the way to a renewed, sustainable and balanced restoration of supply and demand, and cost-price relationships that would have resulted in a return to prosperity and normal employment patterns. If the advice of economists like Hayek and his London School of Economics colleagues of that time had been followed, the Great Depression could have been far less severe, and much shorter in duration. I do agree with Dr. Krugman that it is unfortunate and a tragedy that this debate has to be fought once again. But the tragedy is that after the failures of Keynesian policies then and in the post-World War II period; after the reinforcement of anti-market rigidities that retarded and delayed a rebalancing of the economy in the 1930s; and after all the big government “experiments” and extensions of political power over the market place that only caused anti-investment and anti-recovery uncertainty in the private sector during those New Deal days; after the reintroduction of neo-mercantilist trade policies that undermined the global market; and after the huge fiscal irresponsibility that undermined financial confidence in the country in the 1930s business community . . . I fear that Dr. Krugman is one of those “practical men of affairs” who is the slave of a defunct economist named John Maynard Keynes. He is hearing Keynes’ voice in the air, and is distilling his frenzy from an academic Cambridge scribbler from a few decades past. *Professor of Economics, Northwood University. |
ThinkMarkets 
You mention how unemployment was still in the double digits by the end of the 30s, therefore, FDR’s policies didn’t help. However, it was Hoover’s policy of doing nothing that put unemployment at 25% by the time FDR took office. By 1938, unemployment was down to 14%, and it only went up again because he started listening to his Republican friends in Congress who took control a year before and cut spending. You are playing fast and loose with the facts, aren’t you?
When you get sick and take medicine, do you expect to feel better in 10 minutes?
Matthew,
Let me draw your attention to the following:
“Among the most harmful of the counterproductive policies implemented during the Great Contraction was the Smoot-Hawley Act in 1930, which lifted import taxes to an all-time high and set in motion a tariff war, a trade-constricting sequence of action and reaction around the trading world. In late 1929 President Hoover urged employers to maintain real wage rates despite the plummeting demand for their products. Many of the largest employers did so in 1930 and into 1931 and, as a result, unemployment increased much faster than it otherwise would have. The Revenue Act of 1932, which became fully effective in 1933, raised taxes by a greater percentage than any previous peacetime tax act, administering a stunning blow to already-struggling households and businesses.”
Robert Higgs, “The Great Contraction”
http://www.independent.org/newsroom/article.asp?id=1975
Sometimes pictures help:
http://mises.org/daily/4350
Note well that Pigou & Keynes & Robbins & Hayek were thinking only about the special problems of Britain — most of them many years old — involving WWI debt and inflation, the pathology of the Churchill deflation of 1925, massive British union power, and all sorts of special concerns involving the unique problems of the British Empire and the emerging British interventiomist state.
When you are engaging Krugman it’s clear from his self-confessed surprise that you must be aware that this man knows almost nothing of thr economic history involved hear, and just as little about the intellectual hisotry. Krugman has self-confessed that he can’t bring himself to read any prose economics written before his time in grad school, which helps to explain Krugman’s self-confessed ignorance of Keynes economics outside of the GT.
We shouldn’t make the common mistake of thinking that Keynes or Hayek thought much or cared much or really knew much about the American situation
Krugman has replied tomthis on his blog.
Note that Krugman is ignorant of the fact that Smoot-Hawley is directly linked to the rash of bank failures in the Midwest in the eraly 1930s.
One must always keep i. mind that Krugman is no student of economic history or the history of economic ideas — and that he is arguing out of his hat and outside his domain of competence (which seems smaller every time he opens his mouth).
Thomas Rustici explains how Smoot-Hawley took down the banks here:
http://www.econtalk.org/archives/2010/01/rustici_on_smoo.html
Lee Ohanian of UCLA has done good work on the Great Depression. He has companion papers. First, who caused the GD? Hoover. Who prolonged it? Roosevelt.
It was Roosevelt’s folly to follow Hoover’s interventionist policies (hardly “do nothing”) and double down. Much as Obama has followed the policies of the spendthrift Bush, and then doubled down.
FDRs Treasury Secretary Morganthau pointed out the futiltiy of the New Deal. At the end of the decade, unemployment was where it was at the beginning of FDRs administration. As Morganthau lamented, they had accomplished nothing except to accumulate a large debt. Ditto Obama.
When FDR began rebuilding the Navy in 1938, he began the recovery of GDP. To avoid a Republican takeover in 1940 and 42, he abandoned the New Deal. Putting millions of men in the military solved the unemployment problem. GDP grew, but that was war prosperity, which is not prosperity at all. As Higgs has documented, consumption did not revive until the war ended.
The Republcians took over in 1946 and forced AUSTERITY. That brought the economy out of recession.
Eisenhower won in 1952 promisng to end the Korean War. He then began cutting defense, which he knew was a drag on the economy. Turman broke protocal and attacked his successor for being weak on defense. Truman wanted a war economy and iintervetionism. Ike knew a strong economy was the basis for strong defense (following Robert Taft).
Everett Dirksen defeated the then Senate Majority Leader in 1952. Barry Goldwater was elected to the Senate. Eisenhower was moderate at home and abroad. He rebuked the proto-neoconservatives who wanted nuclear confrontation. He would not take over France’s colonial Empire.
Jerry O’Driscoll are you serious ?
“Putting millions of men in the military solved the unemployment problem. GDP grew, but that was war prosperity, which is not prosperity at all. As Higgs has documented, consumption did not revive until the war ended.”
You never thought we could go at war against tings like illiteracy, cancer, pollution, traffic jam … or we can have a government spending on marginally better weapons such as faster public transportation infrastructure or incentives to stay longer in school. Those would increase well been and productivity. That is called a “stimulus package” with long term effects, just like WW2 left us with an increased production capacity but not the excess capacity of the then useless arms production.
“The Republcians took over in 1946 and forced AUSTERITY. That brought the economy out of recession.”
Or that could not be the war economy transitioning to the consumption society. What do I know, a soldier is surly a good assembly line worker and a tank plant can just switch to cars over night.
Rizzo, I know better. The Smoot-Hawley act had a minimal impact once the Great Depression was already in full swing.
The Smoot-Hawley act raised tariffs on 60% of imports, and imports only accounted for 6% of our GDP.
The Great Depression resulted in a 31% drop in total GDP and 25% unemploymnt.
You’re still telling me this little tariff act is to blame? Do the math, Rizzo.
Neither Hayek nor I claimed that the Smoot-Hawley tariff caused the Great Depression. In fact, Hayek had a very specific theory based on monetary distortions. However, by 1932 there was a WORLD-WIDE increase in tariffs, capital controls, exchange controls all resulting in significant restrictions on international trade. This was by no means the only bad policy followed by Hoover and other governments. Hayek listed elimination of these new restrictions as one thing governments could do to encourage recovery. He was concerned that governments were adding still more distortions to an already monetarily-distorted economy. And furthermore he was writing in Britain, not the in US. By 1932, the British government had made a mess of things for about a decade including the ill-advised return to gold at pre-war parity.
The tariff wars of the early 1930s, starting with Hawley-Smoot, had a significant affect, certainly, on the American agricultural sectors.
U.S. farm exports as a percentage of farm income fell from 16.7 percent in the late 1920s to 11.2 percent in the early 1930s, or a one-third decline. U.S exports of farm commodities fell by 68 percent between 1929 and 1933.
Did trade restrictions cause the Great Depression? No. Was it the primary or single cause for the intensity or duration? No. Was it a significant contributing factor in causing a falling off on production and employment in export and import sectors (including in the U.S., and especially agriculture)? Yes.
And it is difficult, based on the evidence that was understood at the time, and reevaluated since, to think otherwise.
Certainly, in those European countries in which foreign trade played a greater role in their national economies than, say, the U.S., trade protectionism and economic nationalism had major effects on their ability to recover from the Depression.
And in those countries in which they actively attempted to “stimulate” industrialization in predominantly agricultural economies, or “stimulate” farming development in predominantly industrial economies — behind their economic nationalistic trade barriers in the same of “self-sufficiency” — the result was a huge misallocation of resources into economically wasteful uses, and a heavy cost to the general population in the form of taxes or debt burden to subsidize this artificial restructuring of the division of labor with the domestic economy.
(On the latter point, see, Wilhelm Roepke, “International Economic Disintegration” (1942) pp. 111-187.)
Richard Ebeling
Yes, to reiterate, it’s not the Smoot-Hawley tariff by itself, but the global tariff war that ensued that deepened the global depression. The breakdown in the global trading system contributed to the outbreak of WWII.
Matthew J should check out Professor Rustici on Smoot-Hawley (the link is listed in a comment above).
Despite the small numbers you cite as percentage of total GDP, Rustici points out that, because agriculture is a regional industry, certain areas were absolutely devastated by these tariffs. This is revealed by micro-analysis of the agricultural regions. He then shows that banks focused in these regional agricultural zones (such as banks serving corn or wheat farmers in the midwest) were among the first to go belly-up immediately following Smoot-Hawley.
He takes a monetarist deflationary view of the Great Depression and points out that the money supply contractions caused by these regional failures may have had a disproportionate effect on total money supply (as these banks were linked with banks in other regions). These failures spread to other banks throughout the country.
My point is, one cannot write off Smoot-Hawley based on the smallness of a macro statistic when it, according to Rustici, was quite severe in certain areas. These troubles were magnified and spread through monetary forces.
Again and again I run across macroeconomists providing great blocks of aggregate data as arguments against the possibility of non-aggregated causes and consequences through relative prices, production structures, and the money and credit sector.
It’s pathetic, but that is the steel trap that controls what these “scientists” think and what problems they can imagine.
Zach C says,
“My point is, one cannot write off Smoot-Hawley based on the smallness of a macro statistic when it, according to Rustici, was quite severe in certain areas.”
Great article. I think that especially thanks to Ohanian (citing Rothbard) the myth of the laisser-fairist Hoover has been definetely debunked.
“The Republcians took over in 1946 and forced AUSTERITY. That brought the economy out of recession.”
Can you further elaborate on this point? What about other deflationary pressures, and how does this fit with Hayek’s idea to keep MV constant?
Here is a link to Michael Barone’s account of the politics of 1946. Monetary policy is a separate issue.
http://www.american.com/archive/2010/april/what-1946-can-tell-us-about-2010
Thanks Jerry.
All of us, all without exception, are sons -not merely followers- of defunct economists. You have yours, I have mine. Please stop to pretend that you and your defunct economists are more clever than other defunct economists. Economy is not a cockfighting or a hooligans quarrel (although sometimes it doesn’t seem quite different). It is about to understand complex human behaviours and social interactions. And human behaviours and social interactions are quite difficult to understand. There is not one plain truth about this, that, and everything. Just some few clues.
Click to access 07056.pdf
Keynes and Hayek were both right but they missed three important issues: (1)interest rate expectations are more important than their level, and they change the expected marginal efficiency of capital; (2) leverage is only a lethal risk when it increases beyond a level that makes open or disguised default an unavoidable prospect; and (3)while private investment only creates jobs if predominantly directed towards capital growth and not capital appreciation, public investment is only more useful than consumption if directed towards national productivity increasing spending (and not productivity reducing).
I addressed the first two in my blog: http://marques-mendes.blogspot.com/2010/07/is-keynes-wrong-or-outdated-on.html. In relation to the third, I would like to leave the following challenge to professional economists: which policy would create more jobs within 5 years – to reduce or to increase by one hour the daily working day of every American?