Sunday, January 4, 2009
How the US Escaped the Great Depression
Ben sent me a link to an NPR debate between two economists, an Austrian and a Keynesian, on getting out of the present financial crisis. Thanks Ben! The interview/debate was insanely short and superficial to cover such an important and complex topic, and I would imagine that the average listener walked away with the impression that economists don't know what the heck is going on and can't agree on anything. Which is fairly accurate of the economics community as a whole, and is at least a heck of a lot better than what I would have expected from such an interview: that Austrian/free marketeers are barbarian, inhuman, bloodthirsty capitalists who don't care if the whole world goes to pot and all the poor starve to death so long as they wind up with all the money. However, the whole idea of complete disagreement and confusion over crises like the Great Depression is not entirely accurate. At least within the Austrian community, there is pretty fair agreement about how the Depression got started, why it lasted so long, and how the US got out. The other schools also have their own theories; it is only between schools that there is disagreement. But you wouldn't know it from the interview. The "Austrian" comments boiled down to "its not fair for the government to decide how the money gets spent. That should be left to the consumer." This is a strange argument to put up that, although true, is really a diversion from the larger point that a) spending or a lack of it is not the problem, and b) government spending is not the solution and wouldn't work anyway. But I kinda doubt the guy was actually an Austrian. Austrians do not "hyphenate" themselves or affiliate with the Chicago school, which they consider to be barely separable from Keynesians. Either that, or his arguments got ripped apart in the editing, and this was the only thing he said that the program producers thought the audience would latch onto. Neither would surprise me. Just for the record, I'll do my best to lay out at least my understanding of the Austrian perspective on the Great Depression. Once again, be mindful that I am only an amateur at this, and probably won't get it all right, but I think I can at least do better than this dreadful interview. First, we got into it pretty much the way I've already explained things: excessive inflation in the 1920's, stabilization of the money supply in 1929. Unsustainable malinvestments revealed, etc. etc. Second, we got mired down in it for so long because of heavy government intervention. But specifically, some interventions were far more deleterious than others. Inflation is always bad, but I do not think that inflation of the time hurt nearly so much as government fixing of price structures. That was really the killer. Inflation erodes savings and therefore capital formation and the ability to make the investments required to restore rising productivity. Without inflation, the changes will occur quickly. With inflation, they will take a little longer, but they will still happen. But when wages get locked in at artificially high rates, and prices are held at levels that simply cannot produce a profit, changes do not occur at all. Unemployment of capital and labor increases to ghastly levels, and the entire system goes into lockup. The big question: how did we get out? From the previous assertion, it appears that we must have somehow "unlocked" the price fixing. Indeed, that is just what happened, at least according to the brief explanations I have encountered thus far. WWII led to a massive overhaul of the entire economy as wartime production ramped up, basically, through government diktat. No, this is not what "fixed" things. What "fixed" things was that the government stopped fiddling with wage and price fixing as it had larger issues to deal with. It also rationed private consumption and inflated like crazy through the whole ordeal. Once the other side of the war had been reached, wages had not been tampered with, at least in nominal terms, but thanks to inflation, prices had been allowed to adjust. The inflation and the war had been the enforcer of the wage cuts and consumption adjustments necessary to achieve sustainability. It therefore became profitable once again to run a business. Basically, the war provided a politically acceptable rationale for doing what needed to be done from the beginning: allow wages and prices to adjust to sustainable levels. Enduring "wage cuts" and a "reduction in the standard of living" in the name of profits would have appeared intolerable. But not to do so in the name of "freedom" and slaughtering Japs and Nazis would have just been un-American. So WWII "tricked" the country into doing what it should have done from the beginning: suck it up and accept painful short-term adjustments, shake the silly notions and dreams of the 20's from our minds, and then get on with our lives. At least, that is my understanding of it. Let's hope history won't repeat itself in this case.