26 September 2011

Didn't the War end the Great Depression?

The last time the world was suffering from this kind of economic malaise my father was just a boy, so it's not surprising no one really remembers it. Still - although it's hard to imagine! - there was in fact scholarship and research before the internet, and for those who care to have actual evidence there is plenty available.
Of course 2008 is not 1929, but it is the only historical analogue so there's a lot to learn. Sensible questions to ask would be "What helped us recover last time? What hurt or slowed that recovery?"
It is beyond doubt that stimulus spending aided the recovery, and austerity set back the recovery
This graph (courtesy Wikipedia) shows the dramatic crash of 1929, with the downward trend in GDP finally rebounding in 1934. The correlation could hardly be more clear: laissez-faire economics and extreme wealth disparities enabled the crash; the austerity measures in the 2 years following the crash either did nothing to help or made it worse; and the depression ended with GDP and employment growing almost immediately following the adoption of the New Deal (1933-1936). 

Now, that is only one data series, but it is a very powerful one and while it does not prove that spending works and austerity fails, those who cheer for austerity have a lot of explaining to do (in particular, why they recommend a policy that has never been successful in ending a depression). 
The 1937 Double-Dip
Fortunately there is another data series hidden within. Going into his re-election campaign, FDR was under attack from exactly the same kind of economic conservatives that are on the austerity warpath today (mostly simplistic Tea Party types but also including genuine conservatives like David Cameron and genuine Libertarians like Ron Paul).
In 1937, following the end of the New Deal II stimulus and under pressure from Republicans who had surged to big gains in mid-terms on cries to reduce the debt (sound familiar?) the US entered a "double dip". While conservatives blame the New Deal, the fact remains that prior to the New Deal the economy was in free fall; during the New Deal and New Deal II programs the economy and jobs rebounded to a higher point than the pre-depression peak; following the end of those programs and a return to austerity politics the economy went into free fall again. 
This no longer looks like a single persuasive series of data. Rather, it looks like a full blown experiment that shows the effectiveness of stimulus and the damage of austerity. The government was able to turn the taps on and off and see dramatic economic results - results that could be misconstrued only by the most intentionally obtuse and faith based economic conservatives.
But didn't World War Two end the Depression?
No. This is a facile response made by economic conservatives for a reason: Since we only suffered one massive global depression before, and since it was manifestly resolved by Keynesian stimulus spending, the entire episode has to be struck from the record lest the conservative emperor be revealed to have no clothes.
The argument is a false dichotomy, since of course there were and are multiple influences at work, not simply a binary choice of the Federal government to spend or a binary circumstance of war/peace. Of course the impending war (all data precede direct US involvement) had some effect, and government programs had some effect. The "War hypothesis" posits that WW2 was the single overwhelming cause of the recovery, such that we can reject any other cause no matter how well supported by the data. This monocausal explanation provides a simple answer to those without much knowledge of history or economics, but is clearly incorrect:
  • If it was WW2, why did the recovery begin 6 years before the war started?
  • If it was WW2, why doesn't economic growth steadily increase with war spending in 1937-1938?
  • If it was WW2, why did New Deal policies and agencies (and a 90% marginal tax rate for the richest) continue to correlate with US economic growth for another 20 years? 
  • What is a war effort anyway if not a crisis-inspired stimulus package?
The "War Hypothesis" is facile: of course the thirties were different from today, but that does not mean we have nothing to learn from our history. On the contrary, we recorded and learned from that history specifically so that we would not face calls from the ignorant or self-serving to repeat the mistakes of their economic and spiritual forbears. 
The only conclusion that is justified by the evidence is the conclusion that wise Keynsian investments are absolutely necessary, and that austerity is not bitter medicine but poison that will damage the economy. Any other prescription is made on pure faith in the face of clear, contradictory evidence and therefore must be rejected by sensible and rational people.

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