WASHINGTON, Dec. 8 (UPI) -- Monday I looked at president Herbert Hoover's mistakes leading into the Great Depression, and asked whether they could be perpetrated again; today I look at the New Deal itself, and at which of its economic follies are liable to recur.
"FDR's folly" (Jim Powell, Crown Forum, $27.50) demonstrates, by use of economic rather than political analysis, that the majority of New Deal policies were counterproductive, and prolonged the Great Depression. One can differ with Powell in detail but the overall thrust of the book appears soundly based.
President Franklin Roosevelt continued Hoover's policy of increasing public spending, with federal spending, a remarkable 1.7 percent of gross domestic product in 1929 and 3.1 percent of GDP in 1932, increasing to 6.6 percent of GDP in 1936 and 6.4 percent of GDP in 1940, the last peacetime year. This produced short term stimulus to the economy, but over a decade, as Powell points out, was deflationary. However, the restraint in government spending from 1938 produced a considerable improvement in economic growth; as I set out in an article in August, Gross Private Product, the output of the private sector, increased by 8 percent in each of the three years 1939-1941.
Currently, public spending in the 2000-2003 downturn has risen much faster than GDP, from a much higher base than in the 1930s; it is likely to continue doing so whoever wins next November. The danger of a public-spending driven recession, with low-productivity government services eating up the growth produced by the private sector, must accordingly be even greater than in the 1930s. GPP, in particular, is very likely to grow very slowly or even decline, as it did in Japan in the 1990s, as government expands its take. As Powell documents in detail, the Public Works Administration expansion of infrastructure spending, and such uneconomic boondoggles as the Tennessee Valley Authority hydroelectric scheme, were about as successful in stimulating economic recovery in the 1930s as their Japanese equivalents were in the 1990s. Homeland Security "investment" may be their U.S. 2000s equivalent.
The other accusation Powell makes against New Deal federal spending is that it was channeled away from the poorest sectors of the United States, in particular the South and the African American community, whose votes Roosevelt didn't need (the south was locked up and African Americans mostly couldn't vote) and towards wealthier areas in the Western states which could provide Roosevelt with electoral votes and supportive Senators. If anyone thinks increased Federal spending in the 2000s wouldn't have similar political characteristics, I have a bridge to sell him!
The other half of Roosevelt's fiscal policy, continually raising taxes with an emphasis on the higher income earners, is more or less inevitable going forward. With the Federal deficit close to $500 billion, not only is there no room for further tax cuts, but any additional increase in Federal spending will need to be balanced by tax raises. Such raises are likely to be skewed to the upper income earners, by failing to implement (or allowing to expire) some of president George W. Bush's 2001 and 2003 tax cuts, by explicit tax increases, and by measures such as the increased taxation of stock options. This will be damaging to growth; the one saving grace is that it is very unlikely that the exorbitant 80-90 percent marginal tax rates, seen between Roosevelt and president John F. Kennedy, will return. That lesson, like the lesson from the failure of the 1930 Smoot-Hawley tariff, we may have truly learned.
The National Recovery Act, Roosevelt's attempt to legislate high prices, high wages and recovery, is pretty well unanimously admitted to have been a disaster. It increased unemployment, reduced living standards, and produced a huge and inept bureaucracy to tell business how to run itself. Only when it was declared unconstitutional by a unanimous decision of the Supreme Court, led by its gallant Four Horsemen (conservative judges Pierce Butler, George Sutherland, James McReynolds and Willis van Devanter) did the U.S. economy begin to recover, posting quite a nice 1935 and 1936. We are probably, thank goodness, safe from a revival of the NRA.
Then in 1937 the follies of the Second New Deal, the Supreme Court's abdication of responsibility after the court-packing scheme and a sharp rise in bank reserve requirements by the Fed produced a renewed and very sharp recession. Most notable of the Second New Deal activities was a sharp tilt in legislation and political support towards labor unions, primarily through the Wagner Act of 1935 and government support of the subsequent labor organizing campaigns. It is likely that this, too, will not be repeated this time
Agricultural subsidies were more or less invented by the New Deal, which pioneered the policy of paying farmers to destroy food to keep up prices. As president Bush showed in 2002, this policy has not gone away and indeed in a severe recession, when farmers were genuinely suffering hardship, it would probably be intensified.
A particular feature of the New Deal that had not previously been present in American business was the uncertainty it brought to contracts. Notoriously, Roosevelt invalidated all past gold clauses, by which the value of bonds had been linked to the value of a specific amount of gold -- post facto expropriation at its worst. He also through antitrust actions attacked business (for example oil companies, in the Socony-Vacuum case) for pursuing the very policies, of cartelizing and maintaining stable prices, that he had enjoined on them through the NRA. This, as much as any other policy, tended to depress the "animal spirits," in John Maynard Keynes' phrase, of American businesses and restrict them from expansion.
This tendency has not gone away, although in Republican and moderate Democrat administrations (such as that of Bill Clinton) it lies dormant. However, governments now through the Environmental Protection Agency, the Occupational Safety and Health Administration, and modern anti-discrimination legislation have far more tools to harass business than in the 1930s. More important, the rise of the tort bar has introduced a new and troubling element of uncertainty into business decisions; asbestos companies have been driven into bankruptcy, tobacco companies into funding an enormous settlement, and food companies are now under attack.
This is the one area where the November 2004 election makes a difference. If Bush wins, the powers of government to harass business will remain dormant. If a committedly liberal Democrat wins, and if the Democrats also recapture control of Congress, then both government and the trial bar may declare open season on business, particularly if the country is once again in recession. At that point property rights will be largely moot until the storm passes, and business activity will be commensurately depressed.
The final significant area where the New Deal messed up the U.S. economy was that of securities regulation. The disclosure regulations in the Securities Act of 1933 put only a moderate chill on the markets, but the aggressive attitude of the new Securities and Exchange Commission made the legal risks to underwriters appear severe. Even more important, the split between commercial and investment banking decapitalised the major underwriters in the bond and stock primary markets, making them extremely hesitant to assume any kind of risk, and woefully understaffed to handle any upturn in issue volume. The total volume of stock issues in 1933-1941, except for a brief and modest upward blip in 1937, averaged little more than $100 million per annum, around a quarter of the average volume in the trough of the 1921-23 recession, and less than a twentieth of the volume in 1927-29. The inability of business to get new financing was a severe constraint on expansion, let alone entrepreneurship; this alone was responsible for much of the economic lassitude of the era.
Thankfully, this is also a problem that appears unlikely to face us. The Sarbanes-Oxley Act of 2002, passed after very considerable provocation from Enron and WorldCom, was at worst a harmless piece of legislation, adding some bureaucracy but having little effect on the willingness of business to expand. The one danger is the mutual fund scandal; were it to expand and deepen to the extent that the major "no-load" funds such as Vanguard, T. Rowe Price and Fidelity were seen by the investing public as tainted, then retail investor money might move out of equities altogether -- causing the same problem at the investor end of the capital markets that New Deal meddling caused at the underwriter end, with the same chilling result. Fortunately, that is unlikely.
Adding it all up, you have three counterproductive Hoover/New Deal polices that appear likely to be repeated (increased taxes, higher public spending and agriculture subsidies) four that don't (Smoot-Hawley, the NRA, the Wagner Act and market-killing securities regulation) one (excessively tight Fed monetary policy) where we may run into trouble in the opposite direction and one (increased insecurity of property) that may depend on the result of the November 2004 election.
On balance, we are unlikely to suffer a repeat of the 1930s. If the multiple imbalances currently visible in the U.S. economy result in a substantial downturn, then an inflationary repeat of the 1970s, albeit with somewhat worse growth performance, appears the most likely scenario.
(The Bear's Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that, in the long '90s boom, the proportion of "sell" recommendations put out by Wall Street houses declined from 9 percent of all research reports to 1 percent and has only modestly rebounded since. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)
