Thursday, January 8, 2009

FDR's New Deal Made the Depression Worse

We hear over and over again how today's economy is the next "Great Depression.” Nancy Pelosi and President elect Barack Obama continue to call for an economic stimulus package to save America from an economic collapse. President elect Obama addressed the nation on January 8th claiming this crisis could "linger for years," and only the government can solve an economic crisis of this magnitude. Today's economic woes are a far cry from the 1930's Great Depression. However, the solution by our government remains the same. Can the federal government stimulate and save our economy? If it worked for The Great Depression, shouldn't it work for today's lagging economy? The truth is it did not work in the 1930's; and our government not only prolonged the Depression, but actually made the economy worse.

One great myth is that Herbert Hoover tried the classical approach by staying out, and the economy only became worse as a result. Nothing could be further from the truth. Herbert Hoover raised taxes on the top marginal rate as well as tariffs. The top marginal rate was raised from 24 to 63 percent. The tariff hike became known as the "Smoot Hawley Tariff" and was the largest tariff hike in U.S. history. Excessive tariffs severely impacted imports and exports. This robbed the American consumer of low cost imports. Consumers were forced to pay higher prices as a result of fewer products on the market to satisfy demand as well as higher labor costs of American made goods. Declining exports resulted in fewer overseas consumers purchasing their products which hurt businesses. It was Hoover who started the Reconstruction Finance Corporation (RFC). These actions prove that Hoover's approach was in no way indicative of laissez-faire economics. Hoover's policies failed and paved the way for Franklin Roosevelt's big government expansion called "The New Deal".

Franklin Roosevelt's (FDR) New Deal contained an expansion of existing Hoover policies. Three years after Hoover raised the top marginal rate, FDR raised the top marginal rate from 63 to 79 percent. Entrepreneurs were not going to make many investments in a lagging economy to give ¾ back to the government in the slight chance they would make a profit. FDR enacted Hoover's idea of the RFC which was supposed to give low rate loans to struggling companies. Our government decided which troubled companies would get the loans and which ones would not. What ended up happening in many cases was government bureaucrats gave low rate loans to their friends and supporters regardless of whether they were in need.

In addition to raising the top marginal rate, FDR also enacted tax increases on inheritance, corporate income, and excess profit taxes. Social Security excise taxes on payroll also affected business expansion and hiring. Excise taxes were levied on all kinds of different products. Alcohol, cigarettes, matches, candy, gum, margarine, fruit juice, soft drinks, cars, tires (including wheelchair tires), telephone calls, movie tickets, playing cards, electricity, and radios are examples of the products that had excise taxes put on them. These excise taxes were often paid by middle and lower income people - the very people The New Deal was supposed to help.

Perhaps the worst program was the "National Industrial Recovery Act" (NIRA). This program forced manufacturing companies to pay wages that were above market levels. This put an additional load on already struggling companies which made it more expensive to hire and keep employees. This also affected the consumer who was forced to pay higher prices for goods and services. The "Agricultural Adjustment Act" paid subsidies to farmers to produce fewer crops, which was supposed to raise the value of crops and save the farming industry. This resulted in fewer crops produced so less crop workers were hired. As a result, the struggling American had to pay higher prices for food. The "National Labor Relations Act" gave unions more power in workplaces. This led to countless strikes, less production, and fewer jobs. It has been estimated there were as many as 14 million strike days in 1936 and 28 million strike days in 1937.

A study was conducted by UCLA economists Harold Cole and Lee Ohanian in 2004 based on 1929 data provided by the Conference Board and the Bureau of Labor Statistics. The study concluded that the New Deal prolonged The Great Depression by about seven years. Prices across 19 industries averaged 23 percent higher while gross domestic product (GDP) was 27 percent below where it would have been without the New Deal. Cole and Ohanian estimate the NIRA account for 60 percent of the weak recovery. They claim without the NIRA the Depression would have ended in 1936 instead of 1943, only to be saved by World War II. After two years the US Supreme Court repealed the NIRA because it was considered unconstitutional. That did not stop the FDR administration from ignoring certain industries once protected by NIRA who continued to collude and price fix for another four years. Cole concluded the study by saying "…recovery would have been very rapid had the government not intervened."

The average unemployment rate in the 1930s was over 17 percent. It reached it's height in 1933 with a peak of almost 25 percent. One may ask how FDR was able to serve four terms if these policies were so bad. One theory, according to Jim Powell, author of the book "How Roosevelt and His New Deal Prolonged the Great Depression," could be due to the fact that most of the New Deal programs were spent in political swing states in the West and the East where incomes were 60 percent higher than in the South. The Southern states were among the poorest states in the union at the time and received the least amount of money for New Deal programs. One can conclude that it appeared though FDR may have bought his four terms in office by distributing more Federal dollars where it would most benefit his political career.

FDR is continuously touted as the model for liberal fiscal policy, and we can clearly see the New Deal was an expensive and miserable failure. With the Democrats in full control today, we will certainly hear more about how the government has to get involved to deal with this economic crisis. This economy, while in a recession, does not come close to the problems we were facing in the 1930s. However, our government has only scratched the surface on how they can save us from ourselves and further deepen the current crisis. If our government does enough, it very well could create an economy that would be worse than anything we have ever seen before.


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