Jason Taylor is a professor of economics at Central Michigan University and editor-in-chief of "Essays in Economic & Business History." Jason is also an expert in U.S. economic history, particularly during the Great Depression and World War II. He joins Macro Musings to discuss the causes of the Great Depression and the policy responses under Herbert Hoover and Franklin D. Roosevelt. David and Jason examine and discuss policies ranging from the international gold standard to the National Industrial Recovery Act. They also talk about the potential parallels between the Great Depression and the Great Recession.
Read the full episode transcript:
Note: While transcripts are lightly edited, they are not rigorously proofed for accuracy. If you notice an error, please reach out to [email protected].
David Beckworth: Jason, welcome to the show.
Jason Taylor: Thanks so much for having me, David.
Beckworth: I'm glad to have you on. I want to begin by asking, how did you get in to the economics, and specifically, economic history?
Taylor: I was actually a Journalism Major at Ohio University in my undergraduate years. I took some economics classes in my first year there. My first three quarters, I took economics and I just got hooked on it. I ended up majoring in journalism but I basically had a double major in economics as well.
Taylor: In terms of the economic history, I was really fortunate. I was able study with Richard Vedder. Richard Vedder, he had just published his book, "Out of Work ‑‑ Unemployment and Government in the Twentieth‑Century." with Lowell Gallaway. We use that book in his class and Vedder also hired me to work for him in summer of my junior year.
Taylor: What an experience to be able to really get my hands wet in terms of doing a hands‑on research [inaudible] process, works in action. I can still remember the day clearly when Vedder said, "Jason, you'd make a great professor one day." Basically from that moment on that's all I ever wanted to do.
Beckworth: That's crazy to hear, another inspiring a professor story. We've had several guests in the show who trace their interest in economics back to a pivotal teacher along their path. Interesting to hear that he was the one that did it for you. Let me ask about economic history as a field. My impressions used to be lot more people doing economic history and there seems to be it'll less? Is that a correct impression?
Taylor: I don't know if that's necessarily correct or not. We don't have a PhD program here at Central Michigan. We have a Masters program. I'm not able really see that firsthand in terms of graduate students. In terms of going to conferences and so on, the Economic History Association I go to, there are lots of graduates students that I see. I'm not sure whether that's correct or not.
Beckworth: There's still a lot of...
Taylor: It's not the right impression.
Beckworth: A lot of good graduate students still pursuing there. I was under the impression you don't see many places offering a field in economic history, but people are still doing it despite that. You in fact are on editor of the journal, so you'd probably see a lot of good papers coming through.
Taylor: Yeah and then lots have been from graduate students or are new...
Beckworth: That's good to know. Let's talk about your interest in it. How did you get into the area of the Great Depression, World War II? Obviously an interesting period but what opened your eyes to focus on that period?
Taylor: Again, a lot of it came from the way I started taking economic history with Richard Vedder and he had written his book, which basically focused on the Great Depression largely. It really fascinated me that the Depression is such an amazing time period.
Taylor: If we think about economic historians there's basically two different tracks. I think of economic historians and I see this as a editor of a journal. You have those that focus on economics and history for the sake of history. Then you have economists who look at history as a giant laboratory through which we can analyze and apply contemporary issues. I tend to fall more in that second camp.
Taylor: When you look at the Great Depression, it's a really interesting era, because there were so many policy experiments, many failures, some successes. Those events in the 1930s can really provide us with lots of valuable lessons in terms of today's economic theory and in terms of today's policies.
Beckworth: That what we're going to get in to today. Before we do that though let's talk about the Great Depression in general terms. So many of our listeners know but some may not. Walk us through what happened during the Great Depression? How pronounced was it? How was it compared to say the great recession of 2007, 2009?
An Overview of the Great Depression
Taylor: Sure. The episode, 1929 to 1941 is known as the Great Depression, both because of its depth, but also maybe more [inaudible]. You had particularly over a decade where unemployment rates were between 14 and 25 percent here in the United States. Within this 12‑year period there were many starts and stops.
Taylor: Many who don't study this period might not know this but it was really a big roller coaster of a decade. You start off with this from fall of 1929 to the spring of 1933 and that's a fairly continuous slide. Again, like roller coaster.
Taylor: If you've ever ridden a roller coaster you know that the first thing you do is you go slowly up, up, up, up and when you get to the peak and then you go down, and you go up and down, up and down. The Depression was the opposite. You had a three and half year pretty much continuous slide to the bottom. Then once we reached the bottom that's when the roller coaster really started, but getting to that bottom, though.
Taylor: Industrial production fell by more than half between 1929 and 1933. The stock market fell by 90 percent. Half of the nation's banks failed. The unemployment rate rose from 2.5 percent to 25 percent. The magnitude of this from '29 to '33 is just unprecedented. The downturn of 2007 or 2009, industrial production fell about 17 percent. Unemployment jumps from about four and half to about 10 percent. It doesn't compare all to the magnitude of the Great Depression.
Beckworth: Correct me if I am wrong. If you look at the nominal size of the economies, the nominal GDP or the dollar size of the economy, didn't it fall almost in half? Is it close to half? That was my impression.
Taylor: That sound right, because real GDP fell about 20 percent and prices fell by around 30. I think that would add up to be about half.
Beckworth: If you do the math, to help put things in perspective ‑‑ I was thinking about this apparently for the show ‑‑ back in 2008 the US economy in dollar terms is roughly 14.8 trillion. If they'd had a similar decline as the Great Depression that would've fallen close to 7.5 trillion...
Taylor: In nominal terms.
Beckworth: In nominal terms. I can just imagine the carnage, the damage that would've done. We didn't fall about much smaller in nominal terms than that. It blows your mind. Imagine going from $14.8 trillion economy to seven and a half. That puts things in perspective about how severely the Great Depression was. Unemployment as you mentioned was really high. It's a pretty remarkable experience and you mentioned as roller coaster ride. There were several recessions and contractions within that period. What is the standard or consensus story for why it happened?
Taylor: How much time do we have here? To me it's amazing that, 85 years after the fact that scholars are still coming up with new insights into the causes of the Great Depression. Bernanke famously likened the economists search for the cause of the Great Depression to the search for the Holy Grail and were still looking for it. We still don't know exactly what the causes were. There are scholars working right now on this topic.
Taylor: In terms of consensus, most economists would agree that there is no one cause, that there are several important factors that worked together. I'm going to break this down to three. There are three important factors here. The first one is of course monetary factors. Money supply fell by around a third as you had four separate waves of bank failures that swept the nation between 1930 and 1933. Friedman and Schwartz of course famously pointed out the correlation between movements in GDP and the money supply in their book, "Monetary History of the United States.
Taylor: This view tends to say that if the federal reserve had just stepped in and stop the bleeding here, stopped the money from falling. Stop these banks from failing, the depression wouldn't have been nearly as severe as it was. It might have just been a garden‑variety recession. That's the first thing is, monetary factors definitely play a role.
Taylor: Secondly, we have the international gold standard. In the last three and half decades or so we've seen a lot of literature that's pointed to the gold standard, in terms of being a macro cause, but also the reason why it was such a global event. Barry Eichengreen calls the gold standard as the Golden Fetters that had us basically handcuff that placed constraints on governments and monetary authorities.
Taylor: Many papers have shown that basically it was a necessary condition for recovery was that you left the gold standard. Now countries that left the gold standard earlier, recovered earlier. If you didn't leave the gold standard you stayed in the Depression basically until you did. Then it's got some [inaudible] paradox, forces the importance of the gold oxen, gold hoarding in causing Depression. That's the second.
Taylor: Then the third one high wage policies particularly, Herbert Hoover. We think of Hoover as a do‑nothing guy, but he's actually an engineer. You know engineers. They think if you give them a policy letter big enough, they can move the world. For Hoover, it was really wage maintenance. Hoover, in November of '29, has a big meeting, calls the nation's business leaders together, meets with over 400 of them, and he get them to agree to maintain, or even raise nominal wage rates despite the fact that the economy is now sharply turning downward.
Taylor: Jonathan Rosner, in a recent paper, showed evidence that, in fact, those 400 plus CEOs that were at those meetings with Hoover were more likely to have maintained their wages through 1931, two years later, than the CEOs of companies that were not there. You've got the economy contracting, you've got prices falling, you've got the man falling, and wages going up, or which is being maintained. Of course, that's a recipe for unemployment, when wages rise and demand falls.
Taylor: Hoover believed in what was called the high wage doctrine, which basically said that wages in aggregate demand are tied together. If you raise worker's wages, it puts money in their pockets, they go out and they spend it, and this boosts the economy. That was Henry Ford, and many economists, Foster and Ketchings, on under‑consumption had held onto this view. Leo Hansen is probably the most recent paper from JET 2009, that really made this case, theoretically and empirically, that who or what caused the Great Depression, and his answer is basically Herbert Hoover, through his wage maintenance.
Taylor: This is the three consensus things. The monetary factors, the gold standard, and high wage policies. You can throw in there some things at the margin, like the Smoot‑Hawley Tariff, and the trade war, the stock market crash. Those things also contributed, at least to the margins. I would say it's fair to say the consensus is, there was this perfect storm of policy blunders and events that occurred, and they all came together, and no wonder the downturn was so bad because of all these things that happen simultaneously.
Beckworth: With that background, let's move on to some of the research you've done. You've done some really fascinating work in this area. I want to begin by looking at an article you have in the Journal of Explorations and Economic History. It looks at a recovery that occurred in 1933, and I think many observers aren't aware of this, but I would encourage my listeners, after this podcast, to go to FRED data and look at industrial production, which is available on a monthly basis all the way back to 1918, I think.
Beckworth: Just plot industrial production and growth rate terms, and you'll see this spike, this explosion that is unparalleled in this time series that occurs in that period. You talk about that in your paper. There's a really sharp recovery. You called it an unparalleled economic season. Then surprisingly, there's this really, really sharp fall. I believe you said the contraction was larger than what we had in 2007 to 2009. Tell us about this period, and what happened.
The Rise and Fall of the 1933 Economic Period
Taylor: The predominant narrative of the time is that there's the strong recovery that takes place from 1933 to 1937. You just look at the annual data, the economy contracts to '33, then it recovers from '33 to '37, then there's another sharp drop from '37, '38, then the recovers again up to World War II. If you look at the actual data monthly, especially, you see that, as I said, it's a roller coaster. That time period from '33 to '41 is not some continuous rise from '33 to '37, then a drop. Not at all. It's a bunch of ups and downs. These ups and downs are, in my opinion, clearly correlated with policies that took place. Let me talk about this era that I call Recovery Spring, March to July of 1933. We're looking at a five month period, March to July of 1933.
Taylor: There's never been another five month period of growth like it in US history. It's not even close. That's where production rose 57 percent, manufacturing rose 78 percent. The Dow Jones Industrial average is up 71 percent in just these five months. This expansion towards the next closest five month expansion in history by almost a factor of three. There's no other time, it's unparalleled.
Beckworth: That's amazing.
Taylor: The current narrative of the cause of the recovery is money supply increases, the recovery from '33 to '37. Christina Romer and others say that money supply increases from '33 to '37, and that's what caused this recovery from '33 to '37. However, if you look at just this time period in 1933, the money supply doesn't do anything. The money supply is only up about one percent during this Recovery Spring period, so that's clearly not the cause. What caused, in my opinion, the huge boom starting in March of '33 is that Roosevelt did a lot of things right. He had a lot of good policies.
Taylor: One of the outstanding things he did, in my opinion, the day after he takes office, is he declares a bank holiday. He shuts down the banks for 10 days, has auditors go to every bank and basically determine which ones are healthy enough to reopen. Perhaps more importantly, he goes on the radio and gives the first of his famous fireside chats to the nation. He explains the problems of the banking system. He explains his proposed solutions, and it really calms everybody down.
Taylor: When the banks reopened on March 15th of 1933, after being closed for 10 days, what happens? You would think that after a 10 day bank closure, people would run to the banks, I get in line to try to withdraw money. That's not what happened. What happened is people actually ran to the bank to deposit money into the banking systems, because now suddenly they had confidence that the banking system was sound, and that they weren't going to lose their money if they put it in.
Taylor: That was, in my opinion, a necessary condition for getting this recovery going, was cleaning up the banking system. Roosevelt, I think he succeeded in doing that. The second policy that he did in late April, is he broke the nation's tie to the gold standard. He broke the tie to gold. It was $20.67 per ounce of gold, I believe is what the ratio was, and he began to devalue the dollar. Over that five month period, the dollar fell by about a third relative to the franc, and the reichsmark, and the pound, and other currencies.
Taylor: This devaluation is what many scholars, Peter Temin, Barrie Wigmore, Gauti Eggertsson, they claimed that what was behind this devaluation was really recovery, because in particular is signaled higher inflation expectations that we had been in four years, basically, of deflation crisis falling, and Roosevelt comes in with a policy regime change from the deflationary Hoover regime that focused on, "We're going to maintain the gold standard, we're going to balance the budget, to an inflationary Roosevelt regime that we're going to leave the gold standard. We're going to be willing to run deficits and so on." This boosted inflation expectations.
Taylor: The third thing that I think it's neglected sometimes is, just the confidence that Roosevelt brought back to the economy in terms of consumer confidence and business confidence. If you look at newspapers from that time period, "The New York Times," "Wall Street Journal," whoever. They don't tend to agree on a lot of stuff but they all were very effusive in their praise of Roosevelt, calling him a tower of hope that inspired the nation, brought it back from the brink.
Taylor: A lot of why people today still have so much loyalty and love for Roosevelt is because of those first four to five months of his Presidency. They saw that this guy comes in March of '33 and over the next five months he just turns things around dramatically. That bought a lot of loyalty for people for 80 years now.
Taylor: Had that recovery of March to July been allowed to continue with anything resembling that pace ‑‑ it didn't have to go at that exact pace but ‑‑ anything close to that, the Depression would have been over by the end of 1933. Unfortunately, though, beginning in August the economy takes a sharp downward trend. Between August and November of '33 manufacturing falls by about a third.
Taylor: This four months downturn, August to November was actually far more severe in terms of magnitude than that great recession of 2007 or 2009. This four month downturn is actually quite comparable to the second biggest contraction in our history, the 1920‑1921 Depression and yet it's not called that. It's not called the recession‑depression because it only lasted for four months. A recession...
Beckworth: That's amazing.
Taylor: Officially is we call it two quarters, but it wasn't. It was only four months. You're not going to see any recession of '33. Officially it wasn't a recession but if you look at those four months it was one of the worst downturns in our nation's history.
Beckworth: That's amazing. They packed in those few months what we've experienced over two to three years more recently. Let's just talk about that period, because you've also looked at that question? What explains that sharp decline?
Taylor: In my opinion it's the National Industrial Recovery Act. The NIRA is something I've been working on for a long time or I wrote my dissertation on it. The NIRA had two major parts to it. Perhaps most famous aspect of the NIRA is that it required firms to join cartels, get together and collude. The second part of the act is that it mandated higher hourly wage rates and shorter work weeks, as well. Dougherty Albertson contends that the NIRA couldn't have hurt the economy because both higher wage rates and cartels would have further boosted inflationary expectations. He argues that anything that boost inflationary expectations during these emergency economic conditions of 1933 would have been expansionary.
Taylor: I appreciate his point but I think that by August of '33 the economic emergency conditions were pretty much abated and that the economy was on a self‑sustaining path to recovery. Despite that event it may have boosted inflationary expectations, the NIRA had a very negative impact. My evidence for that is on August 1, 1933, which is the very date that the turnaround of economy peaks and then goes back into the tank.
Taylor: That's the date that the President's reemployment agreement takes place. What this was, was Roosevelt had asked firms to individually sign on to an agreement with the President basically, that said they would pay a minimum wage of at least $040 an hour and that they would raise wages across the board, but especially have this minimum‑wage of $040 an hour.
Taylor: As a result of this President's reemployment agreement, which takes place in August 1st, the average hourly earnings in manufacturing rose 20 percent from around $045 an hour to $054 an hour in just two months. You get a 20 percent exogenous wage shock in just two months, which corresponds to the exact time of the downturn.
Taylor: My research with Todd Neuman ‑‑ this paper that you mentioned in Explorations in Economic History ‑‑ we find that if you look at high‑wage industries like automobile manufacturing, machine tool manufacturing, they saw a very little drop in employment during this sharp downturn because in their cases they are already paying wages that are $055, $060 an hour and they're really not impacted by this higher minimum wage.
Taylor: But if you look at the industries that pay low wages like say clothing production, shoe production, they're paying $025, $030 an hour and now they have to raise their minimum wages to $040. Those are the industries that see the biggest decline during this downturn. It's not really a macro economic downturn, it's a downturn that hits different industries differently because this minimum‑wage hits different industries differently. That's the way that we support this idea that I really think that the wage shock that occurs in August and September of 1933 is a big part of this downturn.
Taylor: Cartelization also contributes to it. I've shown in many of my other papers that under the NIRA, cartels that output fell that just as economic theory would suggest, cartels reduce output. This one two punch of higher wages and cartelization together derailed this very promising recovery of 1933. As I said, I think that had that recovery been allowed to continue, the Depression would've been over by the end of '33, early '34. Instead, we basically had to wait until World War II for the Depression to end. In that sense the NIRA is what really made the Depression great, made it the Great Depression, that 12‑year period.
Beckworth: It prolonged it. Scott Sumner tells a very similar story. He summarizes it this way. He says look, the first part of the great recession, a great contraction was a demand shock, the money story, the international gold standard story, but then he effectively had big supply shock from this, what you just said this, exogenous wage increase. Legislation that hit the supply side of the economy pretty hard and made this recession protracted.
Beckworth: Then we have this other this other recession '37, '38 another tinkering of policy, but the point you make and I think Scott has too is, this is an underappreciated development. That's my impression and correct me if I'm wrong but a lot of observers simply aren't aware of this period or take it for granted. Is that right?
Taylor: They're unaware of the fact that you had...if you just look at the annual data of '33, it does imply OK, output's up a little bit. You have to look at the monthly data and the industrial production data and the manufacturing data because the NIRA really affected the manufacturing sector the most. It didn't affect the agriculture and so on. If you look at that data then you can really see if there's something very amazing that happened and then something very bad that happened.
Beckworth: You have the know the counterfactual to know to really appreciate this in one sense, but you can get at that counterfactual by looking what did happen up until July, if you extrapolate. In your paper you do. You extrapolate and show how rapid the recovery would've been.
Taylor: No, what we suggest is it's not exactly counterfactual because who knows what would have happened, but had the recovery continued at the same pace that it continued ‑‑ if it'd gone on March to July ‑‑ had it gone just three more months at that same pace and I acknowledge that as has to get closer to go full employment, you are likely to grow slower. Hadn't it continued we would've been back to the 1929 level of industrial production, and manufacturing. If it had continued for four months, for one additional month, we would've been back to where we would've been even with a three percent growth trend in place.
Taylor: We would've been back to ‑‑ if the economy had continued at that pace from March to July through November, we would have been all the way back to the level of industrial production that we would've been had the Depression never have happened and had we continued on a three percent growth trend throughout '29 to '33. Again, I'm not saying that would've happened, but just to show you how impressive that recovery was.
Beckworth: Right. It could have happened. It's very interesting and it speaks to what you mentioned earlier this idea of the high wage shock and the importance that it played in prolonging the crisis. It sounds like Roosevelt agreed with Hoover in terms of its merit. Can you speak a little bit more about this high wage shock and what's the fallacy in it that caused this problem?
The High Wage Shock and Its Implications
Taylor: Definitely. Roosevelt and his advisors, his brains trust, they also believed in this same thing. Even Hover believed in the same thing that many economist and many businessmen like Henry Ford and others were saying that, you pay higher wages [inaudible] and they were basically mistaking symptoms for causes. If you look wages and the economy and they're procyclical.
Taylor: When the economy grows, wages grow and when economy falls, wages fall. That's a symptom. The wages are rising because the economy is booming. They mistook those symptoms for causes. They thought, "Well, OK. If the correlation is there then let's raise wages and that'll boost the economy. If we cut wages. Oh, that's bad. Cutting wages is terrible." That's what Hoover told at those meetings, that's where Hoover basically said it. "You cut wages in light of the stock market crash you're going to make things worse, not better. Look, when wages fall the economy does poorly and when wages rise the economy does well."
Taylor: But he had the causality wrong. Yeah, when the economy booms, wages endogenously rise but an exogenous increase in wages is not a good thing especially in a time period when you have the economy contracting as it was then. I can just finished the story on the NIRA, along the same lines. If the NIRA is ruled unconstitutional in May of 1935 and at that point all of these wage agreements, the minimum wages, the cartels they all go away, and the economy actually booms for the next two years from June of '35 till the spring of '37, the economy goes on very swift and fairly continuous recovery.
Taylor: Then what happens in '37 is, you get another wage shock and I know Scott Sumner ‑‑ I've again read this book and I know, yes ‑‑ he makes the same point that in '37 the Supreme Court rules the National Labor Relations Act constitutional, which was a surprise that, that happened in April of '37 and as a result this made the right to collective bargaining, they cemented that right to collective bargaining.
Taylor: You see another wage spike, real wages rise, I think it's around 10 or 12 percent, just in a couple of months, and just shortly after that by the summer of '37 then the economy goes back into a very deep contraction. These supply shocks definitely play a major role in this roller coaster of '33 to '37.
Beckworth: Can you talk more in general terms about the New Deal. You have written about three Rs of the New Deal. In general what did the New Deal do to the US economy?
The Economic Impact of the New Deal
Taylor: It really transformed the role of the federal government in the American economy. If you look prior to the Great Depression of the 1920s. In the 1920s the local government's share of total government spending was about 60 percent, about $006 of every dollar of ‑‑ $060 of every dollar of government spending was at the local level. Federal spending share was only about 25 percent. Now if you go a decade later, go to the end of the 1930s after the New Deal gets put in place, those numbers basically reverse. Federal spending now is about 60 cents on the dollar, and local spending is only about 25 cents on the dollar, with state being fairly constant, about 15 or 20 cents of its share.
Taylor: One of the major things that happens with the New Deal then is you get this transformation from government being primarily local spending to being primarily federal. In terms of the three R's Roosevelt talked about not reading, writing, and arithmetic, but Relief, Recovery, and Reform. These were really short run, medium run, long run goals, so relief being short run, reform being long run. Roosevelt had programs like the Works Progress Administration, the WPA, the Civilian Conservation Corp, the CCC.
Taylor: These were primarily relief organizations to get people who were out of work, get them back on their feet, get them working, give them paychecks, short‑term kind of goals, but then you had another aspect of the New Deal that was focused on long run reform. You had the creation of the Security and Exchange Commission, Social Security Administration, the FDIC. These are programs that are, of course, still in place today, and that were basically rewriting the whole rules of the economy. Roosevelt had some programs to provide short‑term relief. He tried to promote recovery in a moderate term sense like the National Industrial Recovery Act. It didn't work. Then reform for the long term.
Beckworth: Now when you have a big transformation like this and a lot of increased government spending in the economy, one thing that's likely to happen is it's not always going to be the most efficient use of funds. There's a literature that speaks to this. There's a "Public Choice" literature on the New Deal spending. You have a paper with Fred Bateman on at least the World War II aspect of this. Could you tell us about what does Public Choice literature say about government spending incentives for government employees and public servants? What does it find for the 1930s? Then tie that into your own research for World War II.
Public Choice and Government Spending
Taylor: Sure. I was really fascinated by the literature suggesting that New Deal spending was driven by politics rather than these three R's, Relief, Recovery, and Reform. This literature goes back to the 1970s, and when I first read it I thought this is really interesting because it basically suggests that there's a fourth R driving spending and that's, of course, Reelection. Gary Anderson and Robert Tollison in a 1991 paper they said that the New Deal is not government's Garden of Eden, but rather the more familiar stomping ground of homo economicus. I love that quote.
Taylor: What they showed was that New Deal spending went disproportionately to states whose congress people were in Congress longer, had longer tenure so they had a little more power. They went disproportionately to states that had congressmen that were on key committees like the Appropriation committees or that had leadership positions, like if you were the Speaker of the House or president pro term. That was interesting, and that was following up on some literature that Gavin Wright had written back in the 1970s two decades earlier that suggested there were electoral politics at the presidential level being played.
Taylor: Gavin Wright suggested that states that were what we call today swing states ‑‑ like today we would think Pennsylvania, Ohio, Florida ‑‑ that those states got dis‑proportionally more New Deal funding per capita than states that were solidly either solidly Democrat or solidity Republican. That suggests that Roosevelt was playing electoral politics. He was funneling money to try to promote his chances of reelection. Of course, he gets reelected three times. In the last couple decades John Wallace and Rob Fleck and others have found some weaknesses with those early studies, but the overall conclusion still remains in place that the New Deal and politics went hand in hand.
Taylor: In fact a recent paper by John Wallace, Price Fishback and Shawn Kantor, which very interesting from 2013 also in "Explorations in Economic History," shows that New Deal spending brought about a major political realignment in favor of the Democratic Party. Basically what they show is that voters in 1936 and 1940 rewarded more spending during the previous four years, so more New Deal spending.
Taylor: If you get an increase in public works spending from zero, which basically where it was in 1932 before the new Deal up to the sample mean of $145 per capita in 1936 what that meant was by increasing that $145 that increased the vote share for Roosevelt by 5.4 percent relative to what he got in 1932. If there's a $300 of spending in that state Roosevelt's vote share goes up by over 10 percent. If there's $100 of spending in that state Roosevelt's vote share goes up by only about three percent.
Taylor: They show this strong correlation between New Deal spending and loyalty. He's buying votes in a sense. I'm not sure whether he's trying to buy the votes, but the data show that in fact that voters rewarded Roosevelt with votes, but what's most interesting, though, about this study is they show that there's a persistent long run effect that...and it goes back to my story about the loyalty that Roosevelt garnered from this turnaround in early '33. What they show is that states that go more New Deal spending...it's actually counties. It's actually county‑level data. I should say counties. Counties that received more New Deal spending in the 1930s actually voted more for Roosevelt all the way through the 1960s, that there was a persistent effect.
Taylor: It really brought about a major political realignment that led to the Democrats controlling the House of Representatives for decades between the 1950s and the 1990s that this New Deal spending, again, goes hand in hand with politics. In terms of what I had done with Fred Bateman we were interested in this literature. We felt that they had been doing a good job on the Depression era, but let's see what happened in World War II. Let's expand this to 1939 to 1945. That's basically what we did. We asked effectively whether the wartime symbol V stood for Victory or whether it stood for Votes.
Taylor: We thought if it stood for victory then you'd see more spending going to states that were more strategically‑oriented like coastal states that had shipbuilding, that had more military bases, that had more horsepower capacity of power. It would make more sense to spend funding for the work in those states than it would in some landlocked low power state in the middle of nowhere. We ran regressions just like duplicating what they did in the 1930s. We had political variables, and we had our strategic variables. What we found in this case was the political variables were not significant, that the strategic variables were.
Taylor: We did not find that politics was really being played during the World War II era to the extent that it was in 1933. That might make sense, that in a sense the politicians may have thought, "Look, if I'm going to be reelected we got to win this war." That was our finding that if the V did stand for Votes it was only through the idea that we got to get Victory first. If we want to get reelected we've got to win the war.
Beckworth: That's very interesting. Going back to your point about politicians, civil servants, technocrats, they, too, respond to incentives. They, too, are homo economicus. There's a recent article by Andrew Young and Russ Sobel in Public Choice," 2013 that looked at President Obama's fiscal stimulus bill, and it also found similar results in terms of how the dollars were allocated per state was tied to some extent to Congressional power, to the dominance, how important presidential election swing states were.
Beckworth: They didn't find as much importance on indicators like unemployment rate, per capita income, those type of issues. It's an important literature, and it's very interesting to see it applied to the Great Depression period. Now with that said, there are some interesting developments, some positive developments, that also come out of the New Deal spending and that you've looked at, and that relates to the US South. Tell us about the southern US economy. My understanding is between the end of the Civil War and really World War II period it was a backwards economy. It was isolated. Labor markets were almost separate from the US, but World War II and maybe the New Deal to some extent, changed that. Can you tell us about that?
The New Deal’s Impact on the Southern Economy
Taylor: If you look at the American South, as you said prior to World War II, the South had an underdeveloped infrastructure, transportation, because it was poor, but it was poor in part because it had a bad system of transportation. The South had bad schools because it was poor, but it was poor because it had bad schools.
Taylor: Firms had very little incentive to locate in the South even though labor costs were much lower in the South than they were in the North basically because the South had very bad public capital, had very bad infrastructure, limited power capacity, poor roads, poor communications. The South couldn't afford to upgrade those things because they didn't have the tax dollars because the firms weren't there. In a sense it's a classic poverty trap. The South is poor because it's backward, but it's backward because it's poor.
Taylor: It's in this Nash equilibrium of non‑industrialization. There's a theory in development economics called the big push theory, and the big push theory suggests that government investment in public capital can push an economy from the sub‑optimal poverty trap Nash equilibrium to the other Nash equilibrium where firms do industrialize, which of course, is much better. You break out of the poverty trap. The theory says then government invests in better roads, cheaper power, better communication systems, better schools.
Taylor: You get a higher rate of return to manufacturing and then manufacturing firms will locate in that area. That'll encourage a positive feedback loop that will lead to better outcomes in terms of infrastructure, better outcomes in terms of manufacturing. This is what Fred Bateman and Jaime Ros and I we had a paper, I think it was in 2008, I believe, that basically made this case for the South, this big push case, that the government's investments in public capital during the New Deal and World War II had a tremendous positive long run impact on the American South.
Taylor: For example, miles of surfaced roads doubled from 222,000 miles to 444,000 miles between 1930 and 1945. If you look at power production it increased by a factor of four over the same time period in the South. In the rest of the nation those were increasing as well, but it was disproportionately increasing in the South. We have some evidence. In fact there was a survey done in 1949, a survey the government did of firms that had moved in the South in the last couple years, and they asked them, "Why did you move south?" because firms weren't moving there before. They surveyed 88 firms, and many of these firms they pointed specifically to public capital, infrastructure, power, and things like that that were not there prior to the previous decade, but now were there.
Taylor: They moved there because of cheap power because of the TVA. They moved there because of a better road system that they move their products. They could now hire the lower cost labor, produce the products in the South and then transport it to the northern markets because you have four‑lane highways now that are paved. This leads to a larger point that from a Keynesian demand side perspective the New Deal is viewed as having only moderate success or perhaps even being a failure, but if you look at a supply side long run perspective I think that the infrastructure investments in roads, and schools, and communications, and power, and airports, and so on, that these actually did have a positive impact on the long run economy and particularly in the American South.
Beckworth: Could you also argue World War III also provided another kind of shock to the South? You're talking about an exogenous capital shock to the South so capital stocks rapidly growing. I think of the World War II experience that was also a culture shock to the South, human capital formation shock to the South, in the sense that people in the South as you mentioned they were kind of closed off. The labor market was almost separate from the rest of the country.
Beckworth: Many of them got drafted. They got moved outside of the South. Many of them maybe went up north, saw how life was different. Many northerners came south to military bases, and they were shocked to see what it was like down here. Kind of an awakening that put in motion things down the road like Civil Rights Movement, more emphasis on higher education, that may not have happened had there had been no World War II. Is that a reasonable argument?
Taylor: It's a reasonable argument, definitely. Part of that time period people in the South stayed in the South, and after World War II there was a lot more mobility. People were leaving the South and going up North for the higher wages where...and vice versa as you said, and as I said a minute ago. You had firms now moving to the South.
Taylor: The South went from being in a very isolated place where people did not move, firms did not move ‑‑ it was just its own little country almost down there ‑‑ to being integrated with the rest of the United States, and it was a time where you saw factors of production labor, capital, firms, moving back and forth across this Mason‑Dixon Line that hadn't happened before.
Beckworth: The “Big Push” as a theoretical idea is very controversial in development economics, but this seems to be one case at least where it fits the data, it fits the story really well. I'm wondering, have you had any feedback from any kind of development economists or anyone else about your paper?
Taylor: Not really, unfortunately. I thought it was a really interesting paper, and I thought it was somewhat unique because there really is not much imperial evidence of an actual big push taking place. When we wrote the paper, Fred and I and Jaime, we thought, "Oh, this could be a really important contribution." But no I really haven't, unfortunately, had much feedback in terms of whether people agreed or disagreed with it.
Beckworth: Maybe this podcast will change that.
Taylor: I hope so.
Beckworth: Any of you listeners out there looking for a good data point on the “Big Push” you now know it.
Taylor: That was in the Journal of Institutional and Theoretical Economics. It was 2008.
Beckworth: Very interesting study. Let's move to the recovery from the Great Depression. What is the standard story and then what is the critique of the standard story?
Economic Recovery Following the Great Depression
Taylor: The standard story of World War II spending ended the Great Depression. We're all familiar with this massive deficits, massive government employment, central planning, unemployment falls to basically below two percent. More recently though we've seen critiques of this. Robert Higgs perhaps most famously has questioned this wartime prosperity story noting that just because employment's low and GDP is high doesn't mean we have economic prosperity.
Taylor: Of course if you draft 18 percent of the workforce and put them in the military and have over half the workforce employed in the war effort you're going to have what looks like a healthy labor market, but if we look at utility and consumption it wasn't a prosperous time. Goods were being rationed. You couldn't go out and buy whatever you wanted. It was a time of shortages and rationing, and the work that people were doing was often very dangerous on the frontlines in battle, very grueling conditions for relatively low pay for the soldiers, anyway. It really was not a prosperous time of World War II.
Taylor: To me what's really interesting is the story of the postwar transition. What Higgs argues is that the economy actually recovers in 1945 and 1946. That's when the Depression really ends, that the wartime is still a depressed time if you look at things like, again, utility and consumption. The postwar transition really fascinating time period because as the war is winding down, it's clear we're going to win the war in '45, and then, of course, we do win it in August of '45, the Keynesian economists and politicians are all up in arms saying that, "Look, we can't just disband the military.
Taylor: We can't just stop producing stuff. We have to keep producing, whether it's military stuff or whether it's civilian. The government has to continue to play a major role in the economy," because in their view what needed the Depression was World War II. "When World War II ends we're going to go right back into the Depression economic conditions." The National Resource Planning Board predicted in August of '45 after the Japanese surrender that unemployment would rise to between 12 and 14 percent over the next year. That was the official government prediction.
Taylor: This was optimistic compared to other projections. Some economics had used Keynesian models, and they suggested that if the government spending fell to...if we just cut back all the military spending that unemployment would be as high as 25 to 35 percent. This is what people were saying in 1945. Despite these dire warnings the government basically just did what the Keynesians told them not to do. They did just discharge just 10 million men and women from American military service. They went from running a deficit that was about 20 percent of GDP in 1945 to actually running a surplus by 1947, a huge fiscal turnaround.
Taylor: You remember that fiscal cliff back in 2013, January 2013. This is a fiscal chasm basically. Yet despite this huge fiscal turnaround, the unemployment rate in 1946, 1947 was 3.9 percent. This is a remarkable story that totally defies Keynesian logic 100 percent. You get this major contraction of government alongside a fully employed economy, and the data show that as government contracted the private sector grew. You had higher investment, higher exports, higher consumption that helped offset that decline in government spending.
Taylor: In a recent paper in the Cato Journal, Ron Klingler, a student of mine, and I have a piece that we look at the parallels between the sequester of 2013 and the post‑war transition of 1946. It was very similar. In 2012, you have President Obama warning that the sequester's going to cost us 750,000 jobs and shave GDP by a half percentage point or more. You had economists like Paul Krugman predicting doom and gloom if we don't avoid the sequester. It was very similar. The magnitude might not have been quite as bad as what they were saying back in 1945. Despite those dire warnings, of course, the sequester went into effect and the economy didn't miss a beat, just like the economy didn't miss a beat in 1946. In fact, after the sequester went into effect, the unemployment rate fell a little bit faster than the 18 months before it went into effect.
Taylor: GDP and industrial production actually grew a little bit faster in the 18 months after the sequester, than they did in the 18 months prior. The sequester appears to not have done us any harm from the perspective of the macro economy. It did us tremendous good, though, if you look at the perspective of our national depth and our long‑term budgetary outlook. Federal spending fell in 2012 and 2013. First time that you had two consecutive years of federal spending falling since the Korean War. Today the deficit is back under three percent of GDP. I don't think that would have happened had we not have had the sequester in place to make that happen.
Beckworth: What do you think caused the recovery to continue after World War II? I ask that because prior to World War II, the private sector was struggling. What do you think changed, prior to World War II and then after World War II, that allowed this private sector expansion to take hold?
Taylor: There are a couple things. One factor is labor markets were allowed to adjust. As I've told you over the course of our discussion, during the 1930s you had President Hoover, then President Roosevelt, constantly trying to raise wage rates and getting in the way of allowing labor markets to clear. During the war you have massive inflation and wages don't keep up with inflation so real wages then come back down to a more normal level. They were artificially inflated in the '30s and I believe that's part of why we had persistent unemployment in the 1930s. During the war, then, we still did have the Fair Labor Standards Act. The minimum wage gets passed in '38, but the 40 cent per hour minimum wage by 1946 isn't quite as much as it was in 1941 because of the wartime inflation.
Taylor: Part of that is that labor markets were for the first time in 15 years not being tinkered with by presidential leadership. I do also think there's more to the story than just that, though. The US had a lot of winds at our back. Europe had been devastated by the war, obviously. We were the last big industrial power that was really unscathed for the most part. That definitely helped us in terms of exports. We exported a lot of products to war‑torn Europe. This certainly contributed to our postwar boom. The Marshall Plan was part of that, but even apart from the Marshall Plan, our exports rose in '46, '47, and throughout that time period. That also contributed to the postwar being a relatively prosperous time period, avoiding going back into the Depression.
Beckworth: I know this is not what maybe you're intending, but if I could paraphrase, my own sense of this is, World War II, maybe the direct Keynesian story never occurred ‑‑ the end of World War II, but kind of an indirect effect of World War II. You mentioned inflation helped make the minimum wage not binding.
Taylor: Less binding. Yeah.
Beckworth: Right, less binding. The inflation out of World War II was a necessary piece of that story to take hold. Also something else that strikes me, and I've read Robert Higgs' story and it makes a lot of sense. The big difference between peacetime consumption and wartime consumption. You've got rationing and all these other constraints on your behavior, but there is something to having a job, right? To having meaning in life.
Beckworth: I'm not meaning to advocate war as a solution to a depression by any means, but I do think one of the indirect effects of war ‑‑ in this case World War II ‑‑ it did provide some kind of meaning. If you've been unemployed, a decade of unemployment, labor's not been fully utilized, to suddenly have a purpose, even if it's not an ideal job, I wonder to what extent that may have changed people's outlook in life, gave them some kind of purpose as opposed to maybe being a wanderer, being unemployed.
Beckworth: Then you mentioned Europe, the recovery in Europe. Again, all this is a consequence of World War II. It paints a picture that World War II maybe indirectly helped the recovery, if not the traditional Keynesian story.
Taylor: Yeah, David, I would agree with that. I believe that psychology plays a major role, and confidence maybe is a better word that economists use, plays a major role. I totally agree with you that I think that the war, winning the war, and having a purpose certainly provided a boost to our morale, and by boosting our morale that certainly had some positive effects on the American worker, on the American business. I'll agree that that had some contributing effect.
Beckworth: Clearly we hope for a better alternative than war but that's the way it unfolded. Our guest today has been Jason Taylor. Jason, thank you so much for being on the show.
Taylor: I really appreciate the time, David, to be on the show. Thanks so much.