Part 1

The New Deal Was a Bad Deal

Robert P. Murphy, Ph.D.

As the current recession deepens and the financial sector continues to sputter, commentators draw analogies to the Great Depression. In particular, former President George W. Bush is likened to the “do-nothing” Herbert Hoover, while the charismatic new President Barack Obama is the modern incarnation of FDR. The American public is told day after day that deregulated markets caused the stock market crash in 1929 and that deregulated markets also caused our current troubles with the housing bubble. Obama’s supporters claim that he will deliver us a “new New Deal” to once again rescue capitalism from its own excesses.

This typical view completely misreads the historical record. Yes, George W. Bush was like Herbert Hoover in that they both expanded the size of government, and they both responded to an economic crisis by crippling the free market. Their bungled responses actually made the situation worse, and yet, perversely, the “free market” got blamed.

Far from getting the U.S. out of Depression, FDR’s New Deal prolonged it. Most people agree that central planning doesn’t work and that it’s better to let private entrepreneurs steer the economy rather than a few “experts” in Washington. This wisdom is just as true during a severe economic slump. By any measure, the U.S. recovery from the Great Depression under Roosevelt’s leadership was the slowest and most agonizing in U.S. history. We can only hope that President Obama abandons his plans to give us a repeat performance.

Hoover Was No Liquidationist

In order to place the failure of the New Deal in its proper context, we first need to explode the myth that Herbert Hoover was a proponent of “hands off” when it came to the economy. On the contrary, Hoover did just what a modern progressive would have recommended. The fact that his policies led to disaster proves that government intervention to “fix the economy” is a foolish approach.

Immediately following the stock market crash in late 1929, Hoover began organizing meetings with the country’s major business leaders. He urged them to resist the natural inclination to look after their own bottom lines by laying off workers and slashing wages. Hoover subscribed to an “underconsumptionist” theory of economic depressions: Hoover thought that laying off workers was part of a vicious cycle, where each round of layoffs would destroy the purchasing power of consumers and thus cause businesses even more pain.

By all accounts, Hoover’s high-wage policy was “successful,” meaning that businesses really did behave different during the early 1930s from all previous downturns in American history. For example, on January 1, 1930, the American Federationist—a labor union publication—ran an editorial praising the President’s conference for giving “industrial leaders a new sense of their responsibilities. … Never before have they been called upon to act together.”

Hoover thought he was helping workers by insisting that employers maintain wage rates as the economy imploded. But in fact, this disastrous policy is what led to the horrific unemployment rates that kept rising as the years rolled by, reaching the incredible rate of more than 28 percent in March 1933.

Anyone who has taken Economics 101 can understand what happened in the early 1930s: When the market price of something—in this case, labor—is supposed to fall, and yet the government places an artificial floor under the price, the result is a surplus. With their sales collapsing and other prices falling, businesses needed to cut their costs. If the president of the United States told them they couldn’t reduce their wage payments, the only solution was to hire fewer workers. Consequently, there were more workers looking for jobs than there were employers looking for workers. If a business has unsold inventory piling up, the solution is to cut prices. By the same token, if the nation has more and more labor power piling up, unhired, the solution is to cut wage rates. But Hoover warned business leaders to avoid this obvious remedy.

Besides his intervention in the labor markets, Hoover also behaved as a textbook Keynesian and did what he could to prop up “aggregate demand.” In consultation with Treasury Secretary Andrew Mellon, Hoover pushed through a one-point reduction in income tax rates after the stock market crash. Further, he massively boosted government spending by 42 percent over his first two years. Hoover inherited a budget surplus from Calvin Coolidge, and yet the (fiscal year) 1933 federal deficit had risen to a peacetime record of 4.6 percent of the nation’s GDP.

Modern-day Keynesians argue that Hoover’s deficits weren’t big enough. That is a debatable proposition, but the important point is that by no means was Hoover a small-government man. It is true that he tried to close the budget deficit in 1932, but this was achieved through a small cut in spending and an enormous increase in tax rates. For example, from 1931 to 1932, the tax rate on the top income bracket jumped from 25 percent to 63 percent.

Contrary to most of the rhetoric we hear today, what the Hoover presidency really teaches us is that the federal government has no business trying to fight an economic downturn. Hoover did the same types of things that are being recommended today: He interfered with market prices, he massively increased the deficit, and he imposed enormous tax hikes on the highest income brackets. These policies gave us the worst economy in U.S. history, and they will be similarly disastrous in modern times.

FDR: A Continuation of Hoover

FDR’s New Deal only prolonged the crisis. Roosevelt was not the antithesis of Hoover; most of FDR’s programs were just extensions of initiatives that Hoover himself began.

According to the Bureau of Labor Statistics, the annual unemployment rate did not fall below double digits until 1941. Recall that FDR was first elected in November 1932, and his celebrated “hundred days” began in March 1933. Unemployment rates did begin falling almost immediately after his inauguration, but the fall was much slower than it had been in previous U.S. depressions. And then, after bottoming out at 14.3 percent in 1937, it jumped back up to 19 percent in 1938.

Of course, FDR hagiographers respond that things would have been even worse were it not for the New Deal. For example, William Leuchtenburg writes, “The havoc that had been done before Roosevelt took office was so great that even the unprecedented measures of the New Deal did not suffice to repair the damage.”

To test this theory, we can compare U.S. and Canadian unemployment rates. Although Canada did not suffer to the same degree as its neighbor, even so things got pretty ugly, with Canadian unemployment hitting 19.3 percent in 1933. But Canada recovered from its slump much more quickly than the U.S. did (under Roosevelt’s leadership). During the Hoover years (1929–1933), American unemployment on average was 3.9 points higher than Canadian unemployment. Yet during the peacetime heyday of the New Deal (1934–1941), American unemployment was 5.9 points higher than Canadian unemployment.

Under the New Deal, the U.S. economy suffered the most lingering and agonizing recovery in its history. What’s more, the U.S. economy recovered more slowly than other economies during the 1930s. Modern historians and economists can argue about the various causes for this poor performance, but in no way can they continue to credit FDR and the New Deal for “getting us out of the Depression.”

Why Was the New Deal So Disastrous?

As a whole, the New Deal was a giant cartelization scheme. It allowed big businesses to work in combination with big labor unions and draw up standard “codes” governing most industries. This crippled innovation, reduced output, and made goods more expensive. Many are familiar with John Steinbeck’s famous passage in The Grapes of Wrath where the impoverished protagonists watch with helplessness and growing rage as perfectly good food is purposely destroyed in order to raise prices. But they may be shocked to discover that it was not market forces but government orders that led to this result. For example, the Agriculture Department paid $100 million to cotton farmers to plow under 10 million acres of farmland, and the government also paid farmers to slaughter 6 million baby pigs.

Modern Americans also fail to appreciate the force needed to implement Roosevelt’s “compassionate” programs. After all, FDR wasn’t making suggestions to businessmen; his programs (such as the National Recovery Administration, or NRA) laid out new rules from Washington, and any malcontents had to be knocked into line. John T. Flynn lived through the period and was a caustic critic:

The NRA was discovering it could not enforce its rules. … Only the most violent police methods could procure enforcement. … [Enforcement police] roamed through the garment district like storm troopers. They could enter a man’s factory, send him out, line up his employees, subject them to minute interrogation, take over his books on the instant. Night work was forbidden. Flying squadrons of these private coat-and-suit police went through the district at night, battering down doors with axes looking for men who were committing the crime of sewing together a pair of pants at night.

More generally, FDR and his New Dealers created what economic historian Bob Higgs calls “regime uncertainty.” Nobody knew what the rules would be one month down the road—just as investors today have no idea what Treasury Secretary Tim Geithner or Fed Chair Ben Bernanke will announce about the financial sector or mortgage-backed securities.

The huge tax increases and government cartelization—not to mention the ever-shifting rules—caused investors to walk away from the U.S. economy during the 1930s. For example, in 1938 net investment was negative $800 million. This means that businesses didn’t even invest enough back in their operations to even replace the machinery and goods-in-process that were worn out during the year. With such lackluster investment, it is no surprise that the nation’s hordes of unemployed could not be integrated back into productive niches in the economy.

The Myth of War Prosperity

Those who preach the virtues of massive government “stimulus” spending point to the apparent ability of World War II to “pull us out of the Depression.” In this typical view, Roosevelt was on the right track during the 1930s with his big government programs, but he just didn’t have the courage (or the political support) to do it right. We are told that only the threat of Nazi Germany and imperial Japan gave the U.S. government the excuse to spend enough money to restore full employment.

This common explanation is also dead wrong. For one thing, it is no virtue to “cure unemployment” by shipping millions of able-bodied men overseas to fight and die. As Higgs points out:

Between 1940 and 1944, unemployment fell by … 7.45 million … while the armed forces increased by 10.87 million. Even if one views eliminating civilian unemployment as tantamount to producing prosperity, one must recognize that placing … 146 persons … in the armed forces to gain a reduction of 100 persons in civilian unemployment was a grotesque way to achieve prosperity, even if a job were a job.

Higgs goes on to demonstrate that the rapid rise in “inflation-adjusted GDP” during the war years is a statistical illusion. The private component of the nation’s economic output fell sharply during World War II. The huge GDP numbers were thus driven by the government’s military purchases. But $1 billion spent by the military is not measuring true economic output in the same way as $1 billion spent by consumers in the private sector. Military procurement officers are notoriously careless with money, because they face much different incentives from executives running a private corporation.

No Coincidence

In truth, the American economy did not truly recover from the ravages of the Great Depression until the year 1946, when the federal government drastically cut its spending and relaxed its onerous controls on the private sector. Inasmuch as Roosevelt was dead at that point, we can safely put to rest the claim that “FDR got us out of the Depression.”

The New Deal/World War II episode was a horrible period in which the federal government came the closest to outright central planning that the U.S. has ever experienced. It is no coincidence that this period also displayed the worst economic performance in U.S. history. What Hoover and FDR teach us is that the federal government only makes things much worse when it tries to “fix” the market economy during a severe downturn.

NEXT: Jeff Madrick responds to Robert Murphy.