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We Need to Unlearn the Economic Lessons of the Great Depression

by William McGaughey


As the incoming administration faces what is considered the worst economic crisis since the Great Depression, it seems that tools that the Roosevelt administration used to deal with that earlier crisis are the mainstay of the current policy. But the lesson of history is that trends and developments seldom proceed in a straight line. The future is more likely to bring a reversal of past trends than their further continuance to the point of exaggeration and unbearable excess.

So it is with economic policy today. We are dealing with accumulated problems in an economy forged in the New Deal era. This is an economy in which the federal government plays an active role. Certain lessons learned from experiences in the Great Depression are fixed in public policy, supported by an economic priesthood in government and academia that did not exist seventy-five years ago.

What are some of these “lessons”?

(1) Jobs cannot be created by shortening work time. Where the free market does not provide sufficient consumer demand, it’s counterproductive to try to create new jobs by forcing some workers to share their work with others through reduced hours. That amounts to “sharing the misery”.

(2) Trade protectionism fails to preserve jobs in the domestic economy. The experience of the Hawley-Smoot Tariff Act of 1930 was that, when one nation tries to protect its jobs by imposing tariffs on imported goods, its trading partners retaliate by imposing tariffs of their own. The net result is a decline in both imports and exports. No jobs are gained.

(3) A good way to open up new jobs in the economy is to make it financially possible for older workers to retire. The Social Security system encouraged the growth of retirement as an alternative to shorter hours for active workers.

(4) During economic downturns, government needs to create an artificial demand for products through its own spending, even if it incurs a budget deficit. And if ordinary deficit spending will not work, a full-scale war may do the trick. Ultimately, it was World War II, not the other New Deal programs, that lifted our nation out of the Great Depression.

In the mid 1940s, we had an international conference at Bretton Woods that set policies for trade and development in the post-war years. Legislation enacted in 1946 set economic goals and created a Council of Economic Advisers to steer the right course. Keynesian economics plus judicious monetary regulation through the Federal Reserve Board became public policy. This has led us to the present state of affairs.

The problem is that years of “free trade” have decimated the nation’s manufacturing base and increasingly its white-collar occupations as well. Chronic budget deficits have created a huge national debt that the time that we need further deficits to keep unemployment from rising to intolerable levels. Instead of further “pump priming”, we need to have a continuing flow of water. We need jobs - good, productive jobs - but they have been lost in an economy given over to financial manipulation.

Herbert Hoover would have had a better sense of what needs to be done than economic policy makers today. In the late 1920s, U.S. capitalism had just experienced the most remarkable growth in its history, fueled by consumer spending. Henry Ford best explained the mechanism of that growth when he said: “The people who consume the bulk of goods are the (same) people who make them. That is a fact we must never forget - that is the secret of our prosperity. "

In plain academic English, this means that a healthy economy is defined by a reciprocal arrangement between capital and labor in which workers help to produce goods and receive a wage in return. Business supplies the goods in exchange for money that comes from workers’ wages. Not only do businesses need to earn a profit, but workers need to receive adequate wages to support consumer spending and leisure. They need adequate leisure both to support a lifestyle in which consumer products can be meaningfully used and to maintain employment as labor productivity steadily increases.

Instead, what we have had in recent decades is a continuing advance in labor productivity, a shift in employment from productive to nonproductive sectors of industry, stagnation and even reversal of previous reductions in work hours, and an economy that increasingly produces output that is not useful or needed in human terms but is instead a “necessary evil”. Our standard of living may improve in financial terms but not in reality.

The basic relationship between these various factors is described by the equation: Output equals labor productivity times employment times average hours of work. Productivity is a ratio between output and gross hours (employment times average hours per worker). Output is whatever product is furnished in a dollar-driven economy, whether useful or not. Employment and average work hours are elements that can be directly measured and compiled by government statisticians.

Let’s see how these various factors changed during the periods before and after the Great Depression keeping in mind that measurement of output (gross domestic product) and productivity dates back to the work done in the 1930s. However, the type of employment and numbers employed may indicate the nature of output in those earlier years.

With respect to average work hours, the U. S. Census Bureau does a monthly survey of hours worked by individuals, called the “household series”, which provides information for the period after World War II. For the earlier period, we have statistics developed by economist Paul Douglas (later U.S. Senator from Illinois), Ewan Clague, the National Bureau of Economic Research (NBER), and others. We will use the NBER numbers.

They show that the average workweek declined from 53.7 hours per week in 1890 to 41.2 hours per week in 1950. The period of most rapid decline was between 1920 (49.8 hours per week) and 1940 (43.9 hours per week), with two thirds of it occurring in the 1930s. Over the entire 60-year period, we have a decline of 2.08 hours per week per decade.

In contrast, the household series shows that average hours worked by all persons declined from 43.5 hours in 1947 (41.7 hours in 1950) declined to 39.1 hours in 1970 and to 38.5 hours in 1980 but subsequently rose to 39.2 hours in 2006. Over the 60-year period between 1947 and 2006, there was an average decline of 0.72 hours per week per decade, but more than 40 percent of it occurred in the first three years. The average workweek has actually increased in the period since 1980.

Clearly, the period after the Great Depression saw, at best, a leveling off of average work time per week in comparison with the earlier period in which work time steadily declined.
Now let’s look at employment, the other area in which we have hard information over a number of years. There was an increase in the number of persons employed in the U.S. nonfarm economy from 27, 340,000 in 1920 to 142,221,000 in 2006.

I wish to make a distinction between industries in which presumably useful goods are produced and industries that are services-oriented or are in government whose claim on usefulness is more tenuous. The Bureau of Labor Statistics distinguishes between “goods-producing” industries (mining, manufacturing, and construction) and “service-producing industries” (transportation and public utilities; wholesale and retail trade; finance, insurance, and real estate; “services”; and government).

Employment in the goods-producing industries rose from 12,828,000 workers in 1920 to 20,434,000 workers in 1960, and to 28,813,000 workers in 2006. In the service-producing industries, employment rose from 14,605,000 workers in 1920 to 33,756,000 workers in 1960, and to 113,408,000 workers in 2006. As a percentage of total nonagricultural employment, the goods-producing industries employed 46.9 percent of the total in 1920; 37.7 percent of the total in 1960; and 20.0 percent of the total in 2006.

As a school boy, I learned that “food, clothing, and shelter” described the basic material needs of people. Such products would be furnished by agriculture, manufacturing, and the construction industries respectively, if not acquired through international trade. In 1860, agriculture accounted for half of U.S. employment. In 1947, it was down to 13.8 percent. By 2006, only 1.5 percent of American workers were employed in agriculture and related industries.

That means that in 2006 only 21.5 percent of Americans were engaged in providing that “food, clothing, and shelter” that are at the core of human needs. What were the other 78.5 percent of the work force doing? Was the tremendous explosion of their product contributing much to people’s happiness and well being?

In this day and age, I would concede that entertainment-related products do contribute to happiness in our type of culture. Transportation is important to people who wish to travel or commute. Public utilities help keep our homes heated in the winter and supplied with electricity. At a certain level, health-care and educational services are justifiable; but not at the level to which they have lately become accustomed. Such services have become “necessary evils” more than they are sound economic products.

Let’s focus on several types of products:

(1) health care,
(2) military activities,
(3) crime, punishment, and incarceration,
(4) education,
(5) gambling, and
(6) consumer credit.

These are all growth areas in the U.S. economy. I would generally describe them as “necessary evils” - to wit,

We would not need health-care services if we did not get sick. Excessive services of this sort can actually make people sick or sicker. Therefore, increased expenditures for health-care services do not mean that we are becoming healthier. In 1950, health-related expenditures consumed 4.5 percent of GDP. This rose to 9.1 percent of GDP in 1980; and to 15.3 percent in 2004. We spend more on health care than other comparable nations. The United Kingdom, for instance, devotes 8.3 percent of its GDP to that purpose; France, 10.5 percent; Japan, 8.4 percent. If present trends continue, the Congressional Budget Office estimates that by 2082 half of the U.S. economy could be devoted to satisfying health-care needs.

We would not need military protection unless we felt threatened by a foreign power that might invade our country or otherwise use violence against us. However, excessive use of military force on our part, such as the Iraq war, could actually incite anti-American sentiment and make the possibility of future violence more real. In 2005, the United States devoted 4.1 percent of GDP to military activities, and had 109,306 persons under arms.

We would not need government bureaucracies to deal with crime if people did not commit criminal acts. A certain amount of crime will occur. However, it’s possible to boost activity in this area by passing laws that criminalize previously permitted acts, or by making crime-related procedures more rigorous, or, of course, by denying persons at risk opportunities for employment as an alternative to a life of crime. In 1950, there were 166,123 inmates in federal and state prisons. This number jumped to 315,974 persons in 1980; to 773,919 persons in 1990; and to 1,525,924 persons in 2005. In fact, in 2005, more than 7 million Americans were either in jail or in prison, on probation, or on parole.

In addition to allowing some serious-minded individuals to pursue truth, education has become a gate-keeper to employment whose function can be increased by increasing the competition for jobs and imposing ever higher academic requirements for those who seek to enter a profession. Most professionals favor this as a means of limiting access to their profession and keeping fees or salaries high. The number of Americans obtaining bachelors degrees increased by 55 percent between 1980 and 2005; masters degrees, by 93 percent; and PhD’s, by 61 percent.

Gambling can be a harmless diversion for some, but for many Americans it has become an addiction leading to economic ruin. It’s disheartening to see government sponsor lotteries as a revenue-raising scheme. In 2004, the social cost of gambling in the United States was estimated to be $54 billion.

The interest that one pays on credit cards, mortgages, and other forms of debt do not make a person happy but are a necessary consequence to borrowing money out of careless pleasure or satisfying real needs. While earned income remained flat, credit-card debt rose by 31 percent between 2000 and 2005. The housing bubble provided alternative funding to meet current expenses. Americans took out $2 trillion in home-equity loans and mortgage refinancings between 2002 and 2005. A bombardment of ads, combined with easier standards for credit, persuaded Americans to enjoy a more abundant lifestyle without increased income.

These categories hardly exhaust the list of questionable economic activities. Does it contribute to human happiness or well being when a telemarketer hooks a person on a purchase that must be made immediately to lock in the best deal? Or, how about an expensive gift to a loved one at Christmas? Is the gift made in a spirit of joy or love; or is it done out of fear that omission of such a gift will raise suspicions of being mindlessly selfish or weakening in affection? Our high-pressure economy pushes products on consumers in so many ways. And the government welcomes this activity as a source of its own revenues, whether or not the products bring a real benefit to people.

Regardless of GDP calculations, this is not true national wealth. In Wealth of Nations, Adam Smith observed: “Whatever be the actual state of the skill, dexterity, and judgment with which labor is applied in any nation, the abundance or scantiness of its annual supply must depend ... upon the proportion between the number of those who are annually employed in useful labor, and of those who are not so employed ... The labor of some of the most respectable orders in the society is, like that of menial servants, unproductive of any value .. Both productive and unproductive laborers, and those who do not labor at all, are all equally maintained by the annual produce of the land ... This produce, how great soever ... must have certain limits. Accordingly, therefore, as a smaller or greater proportion of it is in any one year employed in maintaining unproductive hands, the more in the one case and the less in the other will remain for the productive, and the next year’s produce will be greater or smaller accordingly.”

Benjamin Franklin made the same point even more succinctly. Writing to an American friend from France, he asked: “What occasions then so much want and misery? It is the employment of men and women in works that produce neither the necessaries nor conveniences of life, who, with those who do nothing, consume the necessaries raised by the laborious ... Look around the world and see the millions employed in doing nothing or something that amounts to nothing ... Could not these people, now employed in raising, making, or carrying superfluities, be subsisted in raising necessaries? I think they might ... It has been computed by some political arithmetician that if every man and woman would work for four hours each day on something useful, that labor would secure all the necessaries and comforts of life, want and misery would be banished out of the world, and the rest of the 24 hours might be leisure and pleasure.”

That is the question, more pertinent today after decades of progress in “labor-saving” technology than in Smith’s and Franklin’s time. Why put ourselves through this rat race of needless production and the intensifying competition for jobs when all we need to do is cut work time, lure workers back into useful production, and enjoy the undiminished produce in leisure time? Are we against this because such a solution seems too “French”; and the French, of course, are wimps when it comes to waging wars or competing in global economies? But what kind of fools are we? Did they or we let the banks collapse under the weight of unrestrained gambling debts or fall for multi-billion-dollar Ponzi schemes? Our national comeuppance is surely at hand.

Back in the days of Herbert Hoover, our nation’s political and business leaders had a better grasp of reality. When the Great Depression hit, President Hoover publicly urged that workers’ hours be cut in preference to layoffs. At his urging, the president of Standard Oil of New Jersey (now Exxon Mobil) toured the country recommending shorter work hours (with reduced pay). Organized labor was divided. Some union leaders were opposed to the idea of cutting hours and pay. However, the American Federation of Labor made its own proposal of a five-day week with no cut in pay. Late in 1932, Senator Hugo Black of Alabama introduced a bill in Congress calling for a 5-day, 30-hour workweek. This bill easily passed the U.S. Senate but then ran into unexpected opposition from the incoming Roosevelt administration. It was buried in the House Rules Committee.

In hindsight, one sees that shorter work hours may not have been the right remedy for an economic crisis caused by a collapse of public confidence. Maybe bank holidays, deposit insurance, fire-side talks, and government spending addressed that problem more directly. The shorter-workweek proposal is better suited to deal with the long-term adjustment of employment to continual year-to-year improvements in labor productivity.

It was not that President Roosevelt was opposed to the idea of cutting hours; he wanted to include this proposal in a broader package of economic reforms. The National Industrial Recovery Act of 1933 (NIRA) regulated wages and hours through industrial codes. In May, 1935, the U. S. Supreme Court declared it unconstitutional because of a questionable link to interstate commerce. After President Roosevelt unsuccessfully attempted to pack the court, his administration enacted two other pieces of legislation to regulate hours: the Walsh-Healy Public Contracts Act of 1936 and the Fair Labor Standards Act of 1938.

The second law has become the cornerstone of federal work-hours regulation. Essentially, it set a 40-hour standard workweek and required employers to pay an overtime penalty of half-time extra pay for hours worked beyond the standard. There was both firmness and flexibility in this law. Unfortunately, however, it had a fatal flaw. The time-and-a-half wages that the Fair Labor Standards Act required became an incentive for employees to work longer hours as much as it was a disincentive for employers to schedule such work. The labor movement was diverted from its original purpose of reducing work time. Instead, union members wanted the extra money they could earn in overtime.

In the 1950s and 1960s, when federal policy makers worried about the effect of automation on employment, some proposed that further cuts in hours be made. The Senate Special Committee on Unemployment, chaired by Eugene McCarthy of Minnesota, made certain recommendations. Much to Senator McCarthy’s later regret, its package of recommendations did not include reduced work hours. Why not?

In the late 1950s, the shorter-workweek question was seen to be in the hands of three interest groups: organized labor, which supported shorter hours; the business community, opposed to this idea; and government, a neutral party, In reality, labor was far from being a strong supporter of the shorter-workweek proposal, and government was far from being a neutral party. In reality, government leaders wanted to keep America’s workers working long hours in order to provide financial support for their various projects.

The Secretary of Labor in the Kennedy administration, Arthur Goldberg, said: “It is my considered view that the effect of a general reduction in the workweek at the present time would be to impair adversely our present stable price structure by adding increased costs that industry as a whole cannot bear.” While a U.S. Senator, Lyndon Johnson had said: “Candor and rankness compel me to tell you that, in my opinion, the 40 hour week will not produce missiles.” It was missiles to fight communism rather than leisure for America’s workers that won the argument at that time.

One other voice in the argument should be mentioned: that of academics. Paul Samuelson, an MIT economics professor and Nobel prizewinner, wrote in his best-selling economics textbook that the shorter-workweek proposal was based on a “fallacy” which he called the “lump-of-labor fallacy”: “The lump-of-labor argument implies that there is only so much useful remunerative work to be done in any economic system, and that is indeed a fallacy ... There is no doubt that drastic shortening of hours would imply lower real earnings than a full-employment economy is capable of providing at a longer workweek.”

This “lump-of-labor fallacy” was first enunciated in 1892 by a certain D.F. Schloss who was discussing workers’ attitudes toward piece work. In the first decades of the 20th Century, the National Association of Manufacturers in a pamphlet adapted the concept to its fight against the eight-hour day. In reality, it was a straw-man argument, something advanced by critics of shorter hours rather than by its proponents. An abler and better-informed economist than Samuelson, Paul H. Douglas at the University of Chicago, wrote a book, “The Problem of Unemployment”, in which he furnished evidence of a positive correlation between shorter work hours and higher hourly pay - quite the opposite of Samuelson’s assertion.

Today, one seldom hears of proposal for a shorter workweek except from political leftists whose small vote-getting performance tends to discredit their ideas. Instead, the action has shifted abroad - first to western Europe where weekly schedules of hours have dropped to below 40 and where annual vacations of five and six weeks are not uncommon; then to Japan, determined to reduce its workers’ extreme hours to a level at or below that of other First World nations; and finally to China whose People’s Congress enacted a 5-day, 40-hour week in 1995, ushering in a period of unprecedented leisure and wealth for the Chinese people.

In the meanwhile, U.S. “realists” managed to stifle all progress. The trade-union movement had run out of steam. Business, under the thumb of Wall Street money managers, was focused on improved quarterly earnings and pumped-up CEO pay. Government, fiscally irresponsible, never seriously considered any measure that would threaten its taxpayer-supported revenue stream. The last serious attempt to enact shorter-workweek legislation in the United States was Rep. John Conyers’ bill introduced in April 1985.

Now we come to the present economic collapse and the dawn of a new presidential administration. In some respects, Barack Obama’s prospects resemble those of Franklin D. Roosevelt when he first became president, except that the labor movement is weaker and appeals for shorter work hours are seldom heard. Yet, the fundamental challenge of this administration is jobs - how to restore productive, high-paying jobs.

The challenge has become more difficult because the U.S. economy is embedded in a global economy, more difficult for a national government to control. Due to outsourcing of production, industries which once flourished in the United States no longer exist in this country; those jobs have disappeared. The incoming president, who once organized communities on the south side of Chicago in the wake of steel mill closings, is certainly aware of the problem though he has surrounded himself with economic advisers steeped in the old traditions.

I think the shorter-workweek proposal still has a place in our nation’s economic policy. For better or for worse, however, such a proposal must be advanced in the context of a global economy. If we keep an open mind on the subject, we will find that foreign governments and economic leaders may also be receptive to the idea of shorter hours. It is they, after all, who have had more recent experience with this type of change than we. In all nations, both developed and undeveloped, there is a problem of potential or real unemployment. Industrial technology lets more output be produced with fewer workers. A comparable adjustment needs to be made in hours.

While businesses may profit from this labor-saving technology, ultimately they need consumers with sufficient purchasing power to buy their products. The outsourcing model in which workers live in one country and consumers live in another cannot be sustained indefinitely. We need to find new ways to have “the people who consume the bulk of goods,” be, in Henry Ford’s words, “the (same) people who make them.” Only through a balanced ecological relationship between production and consumption can the free market continue to flourish. That is our long-term challenge, not to be confused with short-term fixes of the credit market.

This leads us to the second “lesson” allegedly learned during the Great Depression: that a national government cannot impose tariffs on products imported from other countries lest this move spark a self-defeating “trade war”. Yes, the Hawley-Smoot Tariff Act of 1930 did provoke retaliatory moves. However, the situation today is different than it was in the 1930s.

Today, we do not have businesses tied to particular nation states that compete with businesses tied to other nation states. We do not have, for instance, General Motors’ Chevrolet competing for customers against the Volkswagen of Germany, the Fiat of Italy, Renault of France, or Toyota of Japan, where any move by the U.S. Government to protect Chevrolet by erecting tariffs would provoke retaliation by the German, Italian, French, or Japanese governments. No, General Motors is a multinational corporation with subsidiaries in many foreign countries. Toyota is a corporation which produces cars in the United States as well as in Japan.

The reason free trade must be rejected is because it hasn’t worked. Any healthy trading system must feature reasonably balanced trade, not an exchange of goods for debt or for the productive assets of another country. The United States has shown itself to be incapable of maintaining balanced trade relations with other countries. In 1960 and in 1970, we had a small surplus in our trading accounts. The balance shifted toward a deficit in 1980 although it was small. In real 2000 dollars, the trade deficit climbed from $78 billion in 1990 to $92 billion in 1995, to $380 billion in 2000, and to $763 billion in 2006. In actual dollars, the trade deficit has been increasing by $80 billion to $100 billion each year in the 21st century.

Equally revealing, in my view, is the composition of trade. In 2006, 46.8 percent of the $1.845 trillion of imported products for consumption in the United States came from “related parties” which means trade between U.S. companies and their foreign subsidiaries or between foreign companies and their U.S. subsidiaries. (Apparently, this total does not count trade between U.S. companies and unowned but closely affiliated contracting firms or suppliers abroad.) On the other hand, only 27.0 percent of U.S. exports represented trade between related parties.

In other words, nearly half of all U.S. imports in 2006 represented the intracorporate trade of multinational businesses. Business, I suspect, was purchasing products from itself in cheap-labor areas and selling to the high-priced consumer market in the United States. The predominance of intracompany trade tends to invalidate the theory of comparative advantage that is at the core of free-trade arguments.

What do we do about this situation? If international trade is cost-driven, then the United States needs to impose tariffs on low-priced goods produced in low-wage factories abroad in order to equalize costs or at least make American consumers pay for part of the lost production in the United States. I think that tariffs need to be directed at the individual company, or even the factory, which is exporting the goods. It would be a system of “employer-specific tariffs”, driven by information gathered and verified by auditing of foreign facilities and calculated by a computer.

I also think that such a system could be implemented with the consent of the international community including both national governments involved in the trade. After all, while chronic trade surpluses such as those enjoyed by China, Germany, and Japan may seem difficult to renounce, the end result of chronically unbalanced trade would be to hold a reserve of increasingly worthless dollars. The economic piper will be paid in the end.

Reform of international trade needs to be combined with a worldwide move toward shorter work time in a single development package accepted by all governments in the world. As part of this package there would be a restructuring of economic activity to meet new environmental challenges - Global Warming, depletion of oil and water reserves, disposal of waste materials, etc. Governments nationally and internationally need to build financial incentives into the required new ways of doing business so that future generations will find suitable material conditions in which to maintain human civilization.

Here again the lesson learned in the Great Depression through the experience of the Hawley-Smoot Tariff Act should not be set in stone. Economic conditions change. The question is whether economists’ minds will change.

I will touch briefly on the other two “lessons” or legacies bequeathed to us from policy makers during the Great Depression. First, there is the Social Security program as a mechanism for allowing older workers to retire so younger people can take their place. Second, there is World War II as an example of effective economic stimulus.

The Social System has had the greatest lasting impact upon our economy. Certainly its impact was positive for the many older Americans able to retire in comfort. The impact has been negative, however, upon the budget of the United States. Billed as an insurance program, it has not been properly funded. Social Security’s huge pot of money has been an irresistible lure for politicians eager to spend without taxation. The resulting underfunding of the program is, in effect, a tax on future generations of workers who will pay more into the program than the benefits that they will receive upon retirement. Furthermore, the Social Security Disability program has become a welfare substitute for too many people, fostering the idea that the federal government will take care of people if they manage to “medicalize” their situation.

World War II is fondly remembered as a triumph of national purpose. Our “greatest generation” participated in that difficult event. Few would claim that President Roosevelt got this nation into war in order to end the Great Depression; defeating Hitler, Mussolini, and Tojo must be given at least equal billing. On the other hand, this great war may have set a precedent for other wars to come. It left in its wake the “military-industrial complex” of which President Eisenhower warned. Perhaps, it has created interest groups in favor of wars: defense contractors, certain veterans organizations, flag-waving politicians, etc. Our lesson must be that, while wars may sometimes be necessary for real national defense, they should never be used as a jobs program. There are better ways to provide economic stimulus.

In summary, it would be a mistake for the incoming Obama administration, members of Congress, and others to accept uncritically the conventional wisdom inherited from the Great Depression. Lessons too well learned should often be reexamined. While some parallels exist between events in those times and in our own, the world is changed in so many ways. We are truly living in a global economy and society.

Economic growth is pushing against the limits of finite natural resources. Thanks to George W. Bush and others, the United States is on shaky grounds as an economic and political superpower. We will need, instead, to be creative much like those who weathered the earlier crisis. Maybe, even, the approach taken by President Hoover will be given a second look.

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