Great Depression

The Great Depression was the longest and deepest downturn in economic activity in the history of the modern industrial world. It was the unintended consequence of practices that were unquestioned at the time of its outset, and it has since prompted a critical examination of those practices that has had a profound influence upon both economic theory and the practice of economic management.

In the United States, where it began in 1929, there was a deep and prolonged decline in production and a damaging rise in unemployment. Businesses and banks closed, people lost their jobs, homes, and savings; and in the absence of welfare programmes, many depended on charity to survive. By 1933, American unemployment had risen to a poverty-inducing 25 per cent of the working population, and it did not fall below a debilitating 15 per cent until the outbreak of the second world war.

Beyond the United States, it affected most of world’s industrial countries, many of which also experienced severe and prolonged declines in economic activity with similar - though often less severe - effects upon unemployment and poverty.

Studies of the great depression have attempted to discover why it had been deeper and more prolonged than anything that happened before or since, and although some uncertaities have been reduced, a definitive answer to that question has yet to be established.

(For the international effects of the great depression see the Addendum subpage, for the sequence of main events, see the Timelines subpage and for a discussion of economic theories concerning causes and remedies, see the Tutorials subpage.)

The crisis in summary

The Great Depression started in the United States in 1929, reached its zenith in 1932 and lasted there until 1939. It spread to most industrialised countries, in most of which it was less severe and of shorter duration. In the United States it was accompanied for part of that period by the stock exchange crash of 1929 and the banking crisis of 1931 and a severe deflation; and resulted in a massive loss of output, with a 47 per cent fall in industrial production and a 30 per cent reduction in GDP, and persistently high unemployment, that peaked in 1933 at 25 per cent of the working population and was still about 15 per cent in 1939.

The development of the depression

According to John Maynard Keynes "...the world was enormously enriched by the constructions of the quinquennium from 1925 to 1929; its wealth increased in these five years by as much as in any other ten or twenty years of its history" .

Series of tax reductions from 1920 to 1931

Between 1929 and 1933, 10,763 of the 24,970 commercial banks in the United States failed. As the public increasingly held more currency and fewer deposits, and as banks built up their excess reserves, the money supply fell 30.9 percent from its 1929 level. Though the Federal Reserve System did increase bank reserves, the increases were far too small to stop the fall in the money supply. As businesses saw their lines of credit and money reserves fall with bank closings, and consumers saw their bank deposit wealth tied up in drawn-out bankruptcy proceedings, spending fell, worsening the collapse in the Great Depression.

tax increase 1932

Explanations: the question of causation

There have been a great number of attempts to establish the cause of what has come to be seen as an unprecedented self-inflicted injury, and a great deal of disagreement. However, the unprecedented feature of the great depression was not its initiation (there had been a succession of recessions in the United States throughout the previous eighty years , and it was no worse in its early months than the preceding recession of 1921 ) - but, rather, its unprecedented severity and persistent depth. That consideration and others suggest that any search for a single cause is likely to be confusing and inconclusive. For example, although the popular view that it was initiated by the stock market crash can be shown to be mistaken , it must be presumed to have contributed to its subsequent severity. Similarly, it can reasonably be presumed that although the 1931 banking panic could not have started the great depression, it intensified its subsequent severity.

Contributory factors

(the discussion in the following paragraphs is based upon material that is set out in more detail on the tutorials subpage)

Trade protection

U.S. imports from Europe declined from a 1929 high of $1,334 million to just $390 million in 1932, while U.S. exports to Europe fell from $2,341 million in 1929 to $784 million in 1932. Overall, world trade declined by some 66% between 1929 and 1934.

The New Deal in the United States

Roosevelt attacked the depression problem on two levels: First, emergency measures, such as social relief programs and make-work programs of all kinds, urgently needed to prevent millions of Americans from literally starving, and give them work—any work. Secondly, on a strategic level, were those measures to reconstruct and develop the country’s totally ruined infrastructure. Dozens of alphabet agencies (AAA, CCC, CWA, FHA , FDIC, NRA, NRLA, PWA, TVA , SEC, SSA , WPA, etc.) were created as a result of the New Deal. F.D.R. reduced unemployment by over 5 million in his first term—and reconstruct the country by physically changing its economy.

From 1932 onward Roosevelt argued that a restructuring of the economy—a "reform" would be needed to prevent another depression. New Deal programs sought to stimulate demand and provide work and relief for the impoverished through increased government spending, by:

• reforming the financial system, especially the banks and Wall Street. The Securities Act of 1933 comprehensively regulated the securities industry. This was followed by the Securities Exchange Act of 1934 which created the Securities and Exchange Commission. (Though amended, the key provisions of both Acts are still in force as of 2006). Federal insurance of bank deposits was provided by the FDIC (still operating as of 2006), and the Glass-Steagal Act (which remained in effect for 50 years).
• instituting regulations which ended what was called "cut-throat competition" which kept forcing down prices and profits for everyone. (The NRA—which ended in 1935).
• setting minimum prices and wages and competitive conditions in all industries (NRA)
• encouraging unions that would raise wages, to increase the purchasing power of the working class (NRA)
• cutting farm production so as to raise prices and make it possible to earn a living in farming (done by the AAA and successor farm programs)

The most controversial of the New Deal agencies was the National Recovery Administration (NRA) which ordered:

• businesses to work with government to set price codes;
• the NRA board to set labor codes and standards.

These reforms (together with relief and recover measures) are called by historians the First New Deal. It was centered around the use of an alphabet soup of agencies set up in 1933 and 1934, along with the use of previous agencies such as the Reconstruction Finance Corporation, to regulate and stimulate the economy. By 1935, the "Second New Deal" added Social Security, a national relief agency the Works Progress Administration (WPA), and, through the National Labor Relations Board a strong stimulus to the growth of labor unions. Unemployment fell by two-thirds in Roosevelt's first term (from 25% to 9%), but then remained stubbornly high until 1942.

In 1929, federal expenditures constituted only 3% of the GDP. Between 1933 and 1939, federal expenditure tripled, funded primarily by a growth in the national debt. The debt as proportion of GNP rose under Hoover from 20% to 40%. FDR kept it at 40% until the war began, when it soared to 128%. After the Recession of 1937, conservatives were able to form a bipartisan Conservative coalition that stopped further expansion of the New Deal, and, by 1943, had abolished all of the relief programs.

Great Infrastructure Projects

The best of big "hard" infrastructure projects being carried out under the New Deal examples are the results of the Public Works Administration (PWA) , a former U.S. government agency established by Congress as the Federal Administration of Public Works, pursuant to the National Industrial Recovery Act, and the almost legendary Tennessee Valley Authority (TVA) , both of which, President Roosevelt ran, more or less directly. The PWA became, with its "multiplier-effect" and first two-year budget of $3.3 billion (then an enormous sum), the driving force of America’s biggest construction effort up to that date. By June 1934 the agency had distributed its entire fund to 13,266 federal projects and 2,407 non-federal projects. For every worker on a PWA project, almost two additional workers were employed indirectly. The PWA accomplished the electrification of rural America, the building of canals, tunnels, bridges, highways, streets, sewage systems, and housing areas, as well as hospitals, schools, and universities; every year it used up roughly half of the concrete and one-third of the steel of the entire nation. The development of the huge Tennessee River basin in the South by the TVA was a model for what a modern nation could accomplish. By stopping the yearly floods of the Tennessee River and making it navigable, an entire area of almost the size of England could be opened up for development. Franklin Delano Roosevelt was the first President who attacked this problem from a higher level.

The projects to develop the "hard" infrastructure of the country were flanked by measures to improve its "soft" counterpart: important social measures, which for the first time in U.S. history, established the concept of a minimum wage, created insurance for the unemployed, sick and old, established decent health care, and abolished child labor. The Works Progress Administration (later Work Projects Administration, abbreviated WPA), was created on May 6, 1935 by Presidential order (Congress funded it annually but did not set it up). It was the largest and most comprehensive New Deal agency, employing millions of people and affecting every locality. The crowning achievement of these measures was the Social Security Act of 1935. This law was overturned by the Supreme Court, so that Roosevelt had to pass it in another form the Wagner Act of 1935, the "Bill of Rights" of American labor. Many of the New Deal regulations were abolished or scaled back in 1975-1985 in a bipartisan neoliberal wave of deregulation. However various of them, such as the Federal Housing Administration (FHA) , the Social Security Administration (SSA) , the Tennessee Valley Authority (TVA) , the Federal Deposit Insurance Corporation (FDIC) , the Securities and Exchange Commission (SEC) and the so called Glass-Steagall Act sections of the original Banking Act of June 1933, (sections 16, 20, 21 and 32), which regulates Wall Street, won widespread support and continue to this day.

Keynesian models

In the early 1930s, before John Maynard Keynes wrote The General Theory, he was advocating public works programs and deficits as a way to get the British economy out of the Depression. Although Keynes never mentions fiscal policy in The General Theory, and instead advocates the need to socialise investments, Keynes ushered in more of a theoretical revolution than a policy one. Keynes's basic idea was simple: in order to keep people fully employed, governments have to run deficits when the economy is slowing because, under unemployment, the private sector won't invest to increase production and reverse the recession.

As the Depression wore on, Franklin D. Roosevelt tried public works, farm subsidies and other devices to restart the economy, but he never completely gave up trying to balance the budget. According to the Keynesians he had to spend much more money; they were unable to say how much more. With fiscal policy, however, government could provide the needed Keynesian spending by decreasing taxes, increasing government spending, increasing individuals' incomes. As incomes increased, they would spend more. As they spent more, the multiplier effect would take over and expand the effect on the initial spending. The Keynesians did not estimate what the size of the multiplier was. Keynesian economists assumed that poor people would spend new incomes; in reality they saved much of the new money, that is they paid back debts owed to landlords, grocers and family. Keynesian initial ideas of the consumption function were harshly questioned in the 1950s by the monetarist Milton Friedman and have since been considerably refined by Franco Modigliani who, with help from the Hicks-Hansen IS-LM model, created the nucleus of the Neoclassical Synthesis of Keynesianism which was embraced and further developed by Paul Samuelson, James Tobin, Wassily Leontief an his pupil Robert Solow to became the mainstream economic thought until the early seventies.

Recession of 1937 in the United States

In 1937, the American economy took an unexpected nosedive that continued through most of 1938. Production declined sharply, as did profits and employment. Unemployment jumped from 14.3% in 1937 to 19.0% in 1938. The administration reacted by launching a rhetorical campaign against monopoly power, which was cast as the cause of the new dip. The president appointed an aggressive new direction of the antitrust division of the Justice Department, but this effort lost its effectiveness once World War II, a far more pressing concern, began.

But the administration's other response to the 1937 deepening of the Great Depression had more tangible results. Ignoring the pleas of the Treasury Department, Roosevelt embarked on an antidote to the depression, reluctantly abandoning his efforts to balance the budget and launching a $5 billion spending program in the spring of 1938, an effort to increase mass purchasing power. Business-oriented observers explained the recession and recovery in very different terms from the Keynesians. They argued that the New Deal had been very hostile to business expansion in 1935-37, had encouraged massive strikes which had a negative impact on major industries such as automobiles, and had threatened massive anti-trust legal attacks on big corporations. All those threats diminished sharply after 1938. For example, the antitrust efforts fizzled out without major cases. The CIO and AFL unions started battling each other more than corporations, and tax policy became more favorable to long-term growth.

On the other hand, according to economist Robert Higgs, when looking only at the supply of consumer goods, significant GDP growth only resumed in 1946 (Higgs does not estimate the value to consumers of collective goods like victory in war) (Higgs 1992). To Keynesians, the war economy showed just how large the fiscal stimulus required to end the downturn of the Depression was, and it led, at the time, to fears that as soon as America demobilized, it would return to Depression conditions and industrial output would fall to its pre-war levels. That is, Keynesians predicted that a new depression would start after the war, unless some government measures were enacted to prevent it, such as the Marshall Plan in destroyed Europe.

Gold Standard

Britain departed from the gold standard in September 1931, allowing the pound sterling to float. As a result, the value of the pound dropped significantly and British exports became cheaper. In 1933, the United States followed suit and dropped the gold standard.

Madsen (2004) provides an econometric analysis from an international perspective on the consequences of inflexible wages and prices on the length and depth of the Great Depression beginning in 1929. In order to analyze the sources and consequences of the supply-side failure during the Great Depression, it is necessary to create a supply model consisting of price and wage settings in which, in addition to using instruments and alternative estimators, the sensitivity of the estimation results to different data sources, data coverage, instrument set, and restrictions imposed on the estimates are examined. The analysis indicates that inflexibility of prices in the manufacturing sector of the industrialized and semi-industrialized countries in the data set was the primary factor for the extent of the Great Depression.

Aldcroft (2004) notes the 1930s are often seen as a time of almost continuous currency disorder around the world, particularly between 1931 and 1933, when many countries went off the gold standard and allowed their currencies to float free. However, the wild fluctuations of the early years in the decade began to subside, and stability returned to the currency market due, in part, to the emergence of the sterling bloc; the name given to a group of countries that pegged their currencies to the value of the British pound. The arrangement worked well, in spite of there being no constitution or administrative regulations governing the operation of the system. The creation of the sterling bloc helped Britain to regain its position in international finance, accelerated its recovery from the Depression, and helped to stabilize international trade generally.

Rearmament and recovery

The massive rearmament policies to counter the threat from Nazi Germany helped stimulate the economies of many countries around the world. By 1937 unemployment in Britain had fallen to 1.5 million. The mobilization of manpower following the outbreak of war in 1939 finally ended unemployment.

In the United States, the massive war spending doubled the GNP, helping end the depression. Businessmen ignored the mounting national debt and heavy new taxes, redoubling their efforts for greater output as an expression of patriotism. Patriotism drove most people to voluntarily work overtime and give up leisure activities to make money after so many hard years. People accepted rationing and price controls for the first time as a way of expressing their support for the war effort. Cost-plus pricing in munitions contracts guaranteed that businesses would make a profit no matter how many mediocre workers they employed, no matter how inefficient the techniques they used. The demand was for a vast quantity of war supplies as soon as possible, regardless of cost. Businesses hired every person in sight, even driving sound trucks up and down city streets begging people to apply for jobs. New workers were needed to replace the 12 million working-age men serving in the military. These events magnified the role of the federal government in the national economy. In 1929, federal expenditures accounted for only 3% of GNP. Between 1933 and 1939, federal expenditure tripled, and Roosevelt's critics charged that he was turning America into a socialist state. However, spending on the New Deal was far smaller than on the war effort.