How New Deal Policies Prolonged the Depression

There's an interesting, albeit typical, meme this weekend across the leftosphere suggesting that the easing of Democratic public works spending in the late-1930s was the main causal factor precipitating the "Roosevelt Recession" of 1937-38.

Responding to Senator Mitch McConnell's remarks this week that "big spending programs of the New Deal did not work," Glenn Thrush wrote yesterday:

Lots of historians, economists and bloggers disagree of course, saying that the Depression was, in fact, eased by FDR's programs - and the "Roosevelt Recession" of the late 30s was the result of his scaling back on public works too quickly.

Thrush's post set off a round of rebuttals to Senator McConnell's thesis.

Steve Benen parrots Thrush:

It's especially interesting to hear McConnell say WWII improved the economy. How, exactly, does McConnell reconcile this? FDR's government spending didn't help the economy, but FDR's government spending for a world war did help the economy? As Krugman recently explained, World War II was an "enormous public works project ... which finally provided a fiscal stimulus adequate to the economy's needs."

But check out Matthew Yglesias:

To be precise, the historical record shows that throughout FDR’s first term, the country was on a path to recovery—albeit from a very low point. Then there was a recession-within-a-depression associated with efforts to return to McConnell-style policies of fiscal restraint. By 1940, things were much better than they had been in 1932. But still, as he says, not very good. Thus far we don’t have a very solid case against stimulus spending. And now things get worse. The conclusion McConnell wants is that “big spending programs” couldn’t help fight the Depression. But World War II was, among other things, a huge spending program.

I just love how Democrats love wartime spending when it works to make the case for big government. Amazingly, all those attacks on out of control deficit spending disappear upon change of party control in Washington. Even Yglesias himself included a $1.2 trillion projected budget defict for 2009 as part of the "wreckage" of the Bush administration!

As for public works spending and the 1937 recession, let's check in with economists Harold Cole and Lee Ohanian, and their essay, "How Government Prolonged the Depression":

Some New Deal policies certainly benefited the economy by establishing a basic social safety net through Social Security and unemployment benefits, and by stabilizing the financial system through deposit insurance and the Securities Exchange Commission. But others violated the most basic economic principles by suppressing competition, and setting prices and wages in many sectors well above their normal levels. All told, these antimarket policies choked off powerful recovery forces that would have plausibly returned the economy back to trend by the mid-1930s.

The most damaging policies were those at the heart of the recovery plan, including The National Industrial Recovery Act (NIRA), which tossed aside the nation's antitrust acts and permitted industries to collusively raise prices provided that they shared their newfound monopoly rents with workers by substantially raising wages well above underlying productivity growth. The NIRA covered over 500 industries, ranging from autos and steel, to ladies hosiery and poultry production. Each industry created a code of "fair competition" which spelled out what producers could and could not do, and which were designed to eliminate "excessive competition" that FDR believed to be the source of the Depression.

These codes distorted the economy by artificially raising wages and prices, restricting output, and reducing productive capacity by placing quotas on industry investment in new plants and equipment. Following government approval of each industry code, industry prices and wages increased substantially, while prices and wages in sectors that weren't covered by the NIRA, such as agriculture, did not. We have calculated that manufacturing wages were as much as 25% above the level that would have prevailed without the New Deal. And while the artificially high wages created by the NIRA benefited the few that were fortunate to have a job in those industries, they significantly depressed production and employment, as the growth in wage costs far exceeded productivity growth.

These policies continued even after the NIRA was declared unconstitutional in 1935. There was no antitrust activity after the NIRA, despite overwhelming FTC evidence of price-fixing and production limits in many industries, and the National Labor Relations Act of 1935 gave unions substantial collective-bargaining power. While not permitted under federal law, the sit-down strike, in which workers were occupied factories and shut down production, was tolerated by governors in a number of states and was used with great success against major employers, including General Motors in 1937.

The downturn of 1937-38 was preceded by large wage hikes that pushed wages well above their NIRA levels, following the Supreme Court's 1937 decision that upheld the constitutionality of the National Labor Relations Act. These wage hikes led to further job loss, particularly in manufacturing. The "recession in a depression" thus was not the result of a reversal of New Deal policies, as argued by some, but rather a deepening of New Deal polices that raised wages even further above their competitive levels, and which further prevented the normal forces of supply and demand from restoring full employment. Our research indicates that New Deal labor and industrial policies prolonged the Depression by seven years.

Today's leftists seem to be overlooking arguments like this (although they can't pass up the chance to trash McConnell). What's interesting is how these folks almost universally cite Paul Krugman (and just Paul Kruman) as their source of authority, as did Josh Marshall as well, a few days back, in an attempt to smear Republicans as obstructionist.

But what do you know?

Via Memeorandum, here comes Krugman now with a just-in-time take down of the "centrists" in the Senate who have cut some pork out of the Democratic stimulus package, which was apparently, "already too small." On top of that, Firedoglake's got a follow-up smear against this "gang-of-four," Senators Collins, Specter, Lieberman, and Nelson, who have used their "power to deny Americans between three-quarters and one and a quarter million jobs."

Smells like more calls for "Stimulus Socialism" to me?

As always, I'll have more later ...