Jeff Madrick: Was the New Deal a Bust?

Roundup: Talking About History

[Jeff Madrick is a contributor to the New York Review of Books and a former economics columnist for the New York Times. He is editor of Challenge magazine, visiting professor of humanities at Cooper Union, and senior fellow at the New School's Schwartz Center for Economic Policy Analysis. He is the author of Taking America, The End of Affluence (Random House) and The Case for Big Government.]

Nothing better illustrates the tenacity of the political right in America than the attention it has won for its claims that Franklin D. Roosevelt’s New Deal made the Great Depression of the 1930s worse. Despite heavy political losses, the right soldiers on, maintaining if not building support for bigger battles it expects to come.

The Wall Street Journal editorial page has provided the principal venue for the claims FDR’s programs failed. But today, the Council on Foreign Relations has put together an all-day conference in New York asking its audience to take a “second look” at the New Deal. It is another sign of the right’s influence that it is able to get the prestigious CFR to sponsor the occasion. I am participating and am very glad for the opportunity because claims that the New Deal failed are dead wrong.

What prompts the rightist outcry today of course is the government deficit spending proposed by President Obama. It is classic Keynesianism designed, along with the financial rescue and housing subsidies, to halt the current severe recession and ignite economic recovery. (The British economist John Maynard Keynes argued in his 1936 classic, The General Theory of Employment, Interest, and Money, that the government can stimulate the economy by spending more than it taxes, thus adding buying power and promoting business investment.)

The conservative critics of the New Deal today want nothing of Obama’s plan. Such Keynesian spending will do no good, make government still bigger, and encumber the U.S. with far more debt than it can manage for many years, they argue. But does a clear look at the 1930s Depression offer any serious evidence to support the contention that Keynesianism failed—and always will?

The claim is misleading from the very start. In fact, Keynesianism was not seriously applied in the 1930s. Economists and others in the 1930s supported government programs to increase consumption; an active right wing then opposed it. But no Keynesian or other serious economist for the last half-century has argued that the deficit spending applied by FDR had a chance to end the Depression. A paper by E. Cary Brown dismissed the notion as far back as 1955.
As Price Fishback, a centrist mainstream economic historian from the University of Arizona, points out, budget deficits never rose to the level of Keynesian prescriptions because they were far too small compared to the sharp drop in the nation’s income and industrial production on the order of 30 percent or more. The budget deficits came to roughly 5 percent at their height. While federal spending to pay for relief, work projects, public works, and other matters was increased to as much as 8 percent of a much-shrunken gross domestic product, taxes were also repeatedly raised. Keynesianism is not about public spending per se, but the degree to which outlays exceed tax revenue—the size of the deficit. Compared to the sharp drop in demand, the deficits were just too small.

But even those deficits, coupled with less-stringent monetary policy, had a substantial impact. From 1933, when Roosevelt took office, to the end of his first term in early 1937, the nation’s GDP rose by 9 percent a year. In fact, as Alex Field, an economist at Santa Clara University, points out, when properly calculated on a “chain-weighted” basis, GDP exceeded its 1929 high by the end of Roosevelt’s first term. So did capital investment, rising from some $11 billion in 1933 (in 2000 dollars) to $91 billion in 1937.

This doesn’t stop some economists from claiming investment was poor in these years, evidence to the contrary. They blame the purported weakness on uncertainty over Roosevelt programs and on unions, which, with newfound organizing power due to Roosevelt legislation, artificially pushed up wages and reduced profitability. If anything, it was persistent excess capacity, not somewhat higher wages, that deterred investment. Industrial production remained below 1929 levels until roughly 1937.

For four years, then, the economy was improving robustly. Moreover, the rate of unemployment fell rapidly from roughly 25 percent at its worst level in 1933 to 14.3 percent in 1937. Good progress, but still much too high. No doubt, unemployment would have fallen significantly more, however, except that, under pressure from the predecessors to today’s anti-New Dealers, FDR stepped on the brakes. Taxes were increased, government spending cut back (federal salaries were reduced, for example), and the Federal Reserve tightened monetary policy. The economy plunged into a new recession and the unemployment rate shot up four percentage points to about 19 percent. But the cause was not Keynesian stimulus, but its very opposite.

The anti-New Dealers apparently love to tell us that Keynesianism did not end the Great Depression, the war did. Exactly. Huge amounts of military spending provide the example that solidifies the Keynesian claim. Military spending is also government spending.
Christina Romer, the current head of Obama’s Council of Economic Advisers, has done academic research suggesting looser monetary policy in the late 1930s resulted in more rapid gains in the economy in 1938 and 1939. This is hardly inconsistent with Keynesianism. But it was the rapid rise in government spending in 1941, leaping from roughly $200 billion to $355 billion, that makes the Keynesian case. The economy took off at this point, and unemployment (before large-scale military conscription) fell by four percentage points. It is more than a little interesting that Romer also now supports deficit spending as a stimulus to the economy. So does Ben Bernanke, long a subscriber to the monetarist explanation of the Great Depression until his own place in history has been put on the line as Federal Reserve chairman.

If the New Deal was not about Keynesianism, then what good did it do? A great deal, and that’s understating it. It provided regulation for a modern financial economy, establishing the Securities and Exchange Commission, passing the Glass-Steagall restrictions on banks, and creating deposit insurance. It established federal unemployment insurance, a minimum wage, and of course Social Security. It enabled unions to organize. And I leave much out on the regulatory front. Eventually, it created the Bretton Woods framework for international trade and investment.

The New Deal also aggressively built the nation’s roads and bridges, again a fact often neglected. In the 1920s, the nation’s surface infrastructure did not keep up with the increase in auto ownership. But the capital stock of the nation’s roads, bridges, and new highways rose by a remarkable 70 percent between 1929 and 1941. The development of sewers and water systems was almost as robust. This enormous investment laid the groundwork for the suburban development and growing commercial economy after World War II.

The current right wing complains about all of these government programs, not least Social Security. They were supposedly dangerous interventions that reduced economic efficiency. Yet in the post-World War II era, the economy grew with remarkable speed despite its relative maturity after having become the world’s largest by the late 1800s, and wages doubled for all income groups. All the while, Social Security reduced elderly poverty rates from more than 30 percent to less than 10 percent. Those who complain about unions and their undermining of investment have a hard time explaining the economy’s success in the 1950s and 1960s, a time in which union power was at its height and capital investment was nevertheless robust. By contrast, after Ronald Reagan helped lead to declining unionization, capital investment was disappointing in the 1980s. In the 2000s, when unions seem almost nonexistent, median wages have fallen, and capital investment has been persistently weak.
Some on the right even deny the value of the new transportation infrastructure of the 1930s, claiming that public works spending did not produce an economic miracle. Of course it did not. It was never enough spending in the short run. Its benefits were longer term and critical to future prosperity, as public infrastructure has been since the beginning of the Republic.

One other neglected but remarkable fact should be mentioned, emphasized in particular in fine work by the economist Alex Field. Productivity rose rapidly in the 1930s. I don’t mean simple labor productivity—the output per hour of work. But total factor productivity, or TFP, rose at rates that exceeded growth in most other decades, including the 1920s. TFP is the true source of economic growth. It is, to simplify, the sum of new technologies, managerial innovations, learning on the job, scale economies due to growing demand, and other factors that cannot be attributed merely to increases in labor supply or capital investment. One reason, as Field persuasively computes, was the growth of surface transportation built by the government that made the productivity of private industry greater.
The New Deal, of course, was a hodgepodge of programs and as such, some of them failed and were damaging to the economy. Even Keynes decried provisions in the FDR’s National Industrial Recovery Act of 1933 that resulted in allowing businesses to raise prices. No doubt, some public works programs were more worthwhile than others. But on balance, the New Deal left a stunning legacy that changed America incomparably for the better, made the growth of a true middle class possible, and reaffirmed faith in American democracy when it was perhaps most challenged under the dark cloud of the Depression. This is what many of us long believed, and despite efforts to revise this history, we still should.

The failure to adopt a powerful Keynesian stimulus delayed recovery far longer than necessary. The key lesson of the 1930s is that we cannot afford timidity.
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