Rajeet Guha

The Great Depression

There is a broad consensus among scholars that the cataclysmic event called the Great Depression occurred in 1929. It reared its ugly hood with the crashing of the New York Stock Exchange in Wall Street. It lasted well into the next decade, ravaging the lives of millions of people on its way. It was undoubtedly one of the worst economic downturns in the history of capitalism. The stubborn perseverance of the Great Depression wreaked havoc on large segments of society. The ranks of the unemployed began to soar in numbers. A large section of the middle class lost their savings and was reduced to a state of penury. At this time lots of businesses failed and stocks of companies became worthless scraps of paper. Many banks shut down their operations during this period. The plague soon spread to other parts of the Western capitalist world. The combination of disastrous policies, outmoded and harsh international agreements, creeping pessimism and mistrust, insufficient demand and a surfeit of overproduced goods created the Great Depression one of the longest and most severe recessions in the evolution of capitalism. It was ultimately the inevitability of World War 2 that proved to be the panacea for the vicious and unending cycle and misery of the Great Depression. In this paper I will analyze the nature and intensity of the Great Depression and the impact it had on people’s lives. I will also make an attempt to unravel the causes of the Great Depression by synthesizing the various arguments into a single coherent theory.
The Great Depression in the United States was largely the result of changes in economic institutions that lowered the normal or steady state market hours per person over 16. The difference in steady-state hours in 1929 and 1939 is over 20 %. The market hours did not return to their steady-state due to changes in labor market institutions and industrial policy actions. This is exemplified by steady-state market hours returning to normal in France but not in the U.S.
The stock market crash resulted in the devaluation of wealth and disruption of the banking system. This explains the intensity of the crisis. The stock market collapse created pessimism in the business and smothered investment. Financial markets collapsed because of the institutional distortions created by the treaty of Versailles.
Fisher and Robbins have argued that the depression was the inevitable result of the unstable credit structure of the twenties. There was a dangerous circle of obligations and risks epitomized by the loans that the U.S. had made to England, France during the war and for which they demanded back payment. But in order to pay back the loans the Allies depended on Germany’s war reparations but Germany was already in a mess.
Under the Dawes Plan of 1924 the U.S. loaned funds to GB, France and Germany but in 1929 they suddenly cut back on funds. The demise of the gold standard in international trade and demands that Germany make reparations payments in gold created a net gold flow into the United States that led to a veritable explosion of credit. Extremely unstable credit arrangements emerged in the twenties and once the crash came, the banking system quickly collapsed. Thus, excessive credit and speculation coupled with a weak banking network caused the Great Depression. The stock market crash resulted in a decrease in purchasing power and left the economy saddled with excess capacity and inadequate demand.
Some people say that market saturation had taken place in industry especially in residential construction. Some people say that there had been an increase in the tax rates and that is what caused aggregate demand to decrease. There was a decline in farm incomes during the twenties. Some people assert that the New Deal’s industrial codes raised labor costs and material input prices, thus negating, thus negating whatever monetary stimulus existed. The 1936-37 recession was dubbed the “Roosevelt recession”.
Some blamed that the private sector moved too quickly in the mid 1930s in raising prices. As a result by 1937 consumers increasingly resisted higher prices as they sought to liquidate the large debt incurred earlier in the decade and to maintain the savings in uncertain times. The average propensity to consume subsequently fell and a recession took hold. Some writers like Paul Sweezy have argued that during the 1920s the distribution of national income became increasingly skewed lowering the economy’s overall propensity to consume.
Others such as Kindleberger, Arthur Lewis have focused on the shift in the terms of trade between primary products and manufactured goods due to the uneven development of the agricultural and industrial nations. The change in the terms of trade created a credit crisis in world markets during the bad crop yields of 1929 and 1930. At the same time that agricultural economies were losing revenue because of poor harvests and declining world demand, the developed economies were contracting credit for the developing nations and imposing massive trade restrictions such as America’s Hawley-Smoot tariff of 1930. As the agricultural nations went into the slump the industrialized countries lost a major market for their output.
Price rigidity inhibited the recovery of both final product demand and investment demand. After the crash of 1929, prices became increasingly inflexible due to the concentrated structure of American industry and the impact of labor unions. These sticky prices further limited the already constrained power of consumers.
Secondly noncompetitive pricing predominated in the capital goods sector, meaning producers were less willing to buy new plants and equipments.
Schumpeter argued that the major cycles of economic activity had reached their nadir in the Great Depression. According to him in the United States and Europe development during the nineteenth century and early twentieth century took the form of a series of surges in output, capital and labor followed by periods of retarded growth. Each period of retardation in the rate of growth of output culminated in a protracted depression in which business cycle recoveries were disappointing and failing to lift the economy
Stagnation theorists agreed that stagnation involved a decrease of the rate of growth of heavy industries and of building activity and the slowing down of the rate of growth of the total quantity of production, employment and usually of population. Some people focused on the decline of new technologies while others focused on the shrinkage of investment outlets as the rate of population growth fell.
Steindl argued that long-run tendencies toward capital concentration, inherent in capitalistic development over time led to a lethargic attitude toward competition and investment. The emergence of concentrated markets prevented the utilization of excess capacity that is required for an economic revival. Price inflexibility in concentrated industries is intensified during depressions. Firms revenues tend to be jeopardized in a slump that price reduction seems unfeasible. There may even be incentives to raise prices in order to compensate for reduction in sales. In a sector where the squeezing out of competitors is relatively easy, large declines in demand will result in the reduction of profit margins for each firm as prices are cut.
By contrast, in a concentrated market, profit margins will tend to be inelastic in the face of lowered demand, as prices remain the same. In such circumstances where price reductions do not compensate for declines in the rate of growth and thus companies tend to reduce their rate of capacity utilization. Reductions in capacity utilization imply not only decreases in national income but also increase in unemployment. In the presence of underutilized capacity, firms will be increasingly disinclined to undertake any net investment. A cumulative process is thereby established wherein a decline in the rate of growth, by generating reductions in the rate of capacity utilization will lead to a further decline in the rate of expansion as net investment is reduced.
Individual firms by believing that decreases in their own investment will alleviate their own burden of excess capacity, merely intensify the problem economy-wide. The higher profit margins secured by large firms indicate an increasingly skewed distribution of output that when combined with the reluctance of firms to invest generates a rising aggregate marginal propensity to save. The potential for recovery is thus barred.
According to Marxists crises are possible and inevitable due to the unplanned nature of the capitalist system. According to them forces that delay a crisis only tend to intensify it. Capitalism leads to uneven development of the economy and in order to adjust to get back into sync there is forcible adjustment, which is the economic crisis itself. The initial maladjustment is reflected in changes in the profit rate. The form of these changes can vary depending on the objective encountered.
Capitalist competition is aggressive, resulting in invasion of old markets, creating new ones, introducing new technologies and management strategies. This results in capitalist accumulation. Competition even exists among banks in supplying credit. This leads to aggregate over-investment and over accumulation. In this process individual capitalists push down wages in order to cut costs and compete in the market thereby causing underconsumption causing a depression in the profit rate and lowering capacity utilization. Combined with excessive debt and capacity utilization this will create a depression. According to Kindleberger and other Keynesians, the U.S. failed to fulfill the role of a hegemonic power. This created instability.
The U.S. Federal Reserve’s attempts in 1928 and 1929 to raise interest rates to discourage the speculative demand for company stocks as a rise in interest reduces the speculative demand for money as people tend to buy bonds rather than sell them. The increase in interest rate decreased the investment demand for producer goods leading to a drop in production of producer goods. There was therefore retrenchment and the fear of being thrown out in these industries decreased the demand for consumer goods as well. The increase in interest rates also reduced consumption as people tended to save more. The decrease in the price level or deflation reduced aggregate supply and contracted production in the short-run but aggregate demand decreased faster because of a decrease in consumption and investment. The decrease in aggregate demand resulted in a further fall in price. With deflation setting in and prices falling rapidly, investors decided that they would delay investment as in a deflation, money tomorrow is worth more than money today resulting in more profits in the future investment than current investment. The failure of businesses resulted in their inability to pay back the loans leading to bank closures and the wiping out of people’s life savings. This cast doubt on the credit system and therefore there was a lack of funds for investment.
Milton Friedman and Anna Schwartz believed that the Depression due to blunders in monetary policy. A range of evidence points that at the market peak forty percent stock market values were pure air. Prices were above stock market for unrealistic optimism. Federal Reserve initially raised interest rates by making borrowing money for stock speculation difficult and costly. However, in 1927 Federal Reserve lowered the interest rates and created easy-money policies and expanded the boom for two more years. The Federal Reserve contracted the money supply continually thereby pushing up interest rates continually. At that time interest rates were hiked up to discourage gold outflows from U.S. to other countries as every country was then on the gold standard.
The major economists of the day like Schumpeter, Hayek and Robbins believed that liquidation of the economy would be the panacea for the depression. They believed that propping up aggregate demand through govt. spending (printing money) would lead to inflation. Fiscal Orthodoxy and balanced budgets led to a reduction in aggregate demand thereby leading to a reduction in wages and prices. This led to further deflation. In a deflation the collateral value goes down and therefore banks stop giving credit. Countries without massive gold reserves could not even lower interest rates as this would lead to massive gold outflow and domestic investors would invest abroad. Additional credit could not be injected as this would lead to higher imports and balance of payments deficit. The countries that abandoned the gold standard recovered faster.
The Keynesian explanation of the Great Depression can be found in the decrease of aggregate demand. The boom in the automobile and radio industries and residential construction propelled growth in the 1920s according to this view. The drying up of investment opportunities created a downward shift in aggregate demand. Bad fiscal policy has been attributed the blame for the Great Depression. The increase in taxes and a lackadaisical attitude shown by the govt. towards spending created and lengthened the Depression.
In a nutshell it can be said that the Great Depression resulted from the lowering of working hours, loss of income due to the stock market crash, clinging onto the gold standard, the harsh reparations of the treaty of Versailles, hiking up of interest rates, skewed income distribution, overproduction, tariff barriers, increase in taxes, saturation in residential construction, New Deal’s industrial codes, adverse shift in the terms of trade, lack of an international financial institution, weak banking network, Federal Reserve’s refusal to increase the money supply, sticky prices, noncompetitive pricing, stagnation and tendency towards the concentration of capital in few hands, weak banking system and the quenching up of international credit. The juxtaposition of these factors created a recipe for disaster. The disaster manifested itself in the Great Depression. It was ultimately World War 2, which unfettered the Western capitalist world from the clutches of the Depression.
















Reference:
1) Great Depression and American capitalism – Robert Himmelberg
2) Great Depression and World War 2 – Thomas Cochran
3) The Great Depression – John A. Garraty
4) The World Economy, Money and the Great Depression – Gottfried Haberler
5) World in Depression 1929-39 – Charles Kindleberger
6) A Monetary history of the United States – Milton Friedman & Anna Schwartz


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