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Busting Depression myths

| Tuesday, Dec. 10, 2013, 9:00 p.m.

There are no greater obstacles to the formation of sound public policies than mistaken understandings of history. Unfortunately, popular culture overflows with historical ignorance about the economy. Perhaps the most destructive historical myth in America involves the Great Depression.

That economic calamity was not caused by laissez-faire capitalism. Instead — as argued by the late Nobel laureate economist Milton Friedman and his co-author Anna Schwartz — the Depression was caused by the failure of the Federal Reserve to maintain adequate liquidity in the banking system. From August 1929 through March 1933, the Fed allowed the supply of dollars to shrink by more than a third. This was an inexcusable deflationary monetary move that turned what would have been a mild and short-lived downturn into the Great Depression.

Making matters worse were the unprecedented interventionist policies of Presidents Herbert Hoover and Franklin Roosevelt. FDR's New Deal interventions and his increasingly anti-capitalist rhetoric were especially harmful. These interventions and the anti-market climate of FDR's Washington generated what economic historian Robert Higgs calls “regime uncertainty.” Investors were scared of what government might do to their property: tax it excessively, regulate it until most of the value was squeezed from it, or even confiscate it.

In such an economic climate, investment dries up — and, along with it, the creation of jobs. Thus, the Depression wasn't prolonged because of a lack of spending. Rather, the lack of spending was a result of government policies hostile to business and entrepreneurial activities.

Contrary to myth, New Deal policies prolonged and deepened the Great Depression. They didn't end it.

A related myth is that the Depression was finally cured by America's involvement in World War II. While unemployment shot way down and industrial output shot way up during WW II, neither of these occurrences can be read as a sign of economic recovery. That massive military mobilization forced millions of young men into the armed services and employed millions of other people in factories ordered to make munitions and military supplies.

Not only was the U.S., for much of the 1940s, a command economy, it was an economy in which people, despite being employed, were able to consume relatively little. America's involvement in WW II cannot be said to have brought about the kind of recovery people have in mind when they think of a market economy recovering its ability to create widespread prosperity and economic opportunity.

Compelling evidence marshaled by Higgs shows that genuine economic recovery occurred in the U.S. only after FDR was succeeded in the White House by the less ideological Harry Truman and the more market-friendly Republicans won control of both houses of Congress in 1946.

Higgs' account of regime uncertainty and the timing of America's recovery from the Great Depression makes sense. If wartime spending were sufficient to cure a depression, war zones all over the world today would be among the most economically vibrant places on Earth. Egypt and Syria would each be on the verge of stupendous economic booms. Of course, the people of these countries are quite poor and seem destined to remain poor for the foreseeable future. The reason is that economic prosperity grows not from mere spending but, instead, from secure property rights and entrepreneurial creativity.

Donald J. Boudreaux is a professor of economics and Getchell Chair at George Mason University in Fairfax, Va. His column appears twice monthly.

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