While some observers liken America's current economic condition to the Great Depression, others say the correlation is unjustified. For instance, in the 1930s, unemployment reached as high as 25% and the GDP dropped 25%. Current unemployment is around 10%, and real GDP actually increased 5.7% in the fourth quarter of 2009, according to the latest statistics from the U.S. Bureau of Economic Analysis. Close to 50% of banks failed between January 1930 and March 1933, while less than 3% failed between December 2007 and January 2010. Some scholars, however, find aspects of the current situation even more troubling than those during the Great Depression, because the U.S. has become a debtor nation and many households today carry much greater debt than those of the 1930s.
In this Q&A with Knowledge@ Emory, Leonard Carlson, associate professor of economics at Emory University and an expert in the economic history of the U.S., compares and contrasts the two periods and discusses the creative destruction that may follow the Great Recession.
Knowledge@Emory:How did circumstances in the Great Depression differ from what is happening now?
Carlson: During the Great Depression, there was no clear ideology on the part of the Democratic Party about what to do in the crisis. They borrowed ideas from reforms proposed in the 1920s or earlier. One idea was to treat the depression in the same way that the federal government had responded to World War I, which was to centralize the economy. In order to ramp up for war, the federal government took control of the railroads, established price controls, and directly managed a lot of the economy. This became the model for programs like the 1935 Works Progress Administration [which employed millions in public works projects] and the 1933 National Industrial Recovery Act [which allowed the president to regulate industry to stimulate recovery].
There were also proposals in the 1920s to raise agricultural prices, protect labor unions, deal with perceived excesses on Wall Street, and provide electricity to rural areas. These led to the creation of the 1933 and 1938 Agricultural Adjustment Acts, which raised prices for farmers by reducing production; the 1934 National Labor Relations Board [a government agency charged with protecting the rights of workers to bargain collectively]; the Tennessee Valley Authority, which developed flood control and electrification; a minimum wage; banking reform . . . in other words, a whole range of programs to see what would work here and fix this thing. Some of these programs were counterproductive in terms of creating employment and spurring recovery (such as cartelizing industrial prices and cutting agricultural production), while others worked well (some of the public works projects and creating deposit insurance to prevent bank runs). Success was mixed, but what remained was a legacy of government intervention in the economy.
Knowledge@Emory:What about the current recession?
Carlson: I think there is more resistance to change by government policy. When people talk about health care reform, for instance, well established interest groups oppose certain aspects of the reform. It's the same thing with the financial market. So compared to the 1930s, I don't expect to see as big a set of institutional changes. The 2008-09 crisis threatened the financial system and the whole economy. But now that the worst is past, it will be harder to advance proposals for preventing a second round of problems, because vested interests do not want change.
As for what to do now about the recession, the choices are limited. Since the recovery has begun, there is not the same sense of panic. Due to concerns about the deficit, there is relatively little room for more federal spending. Most monetary economists, I think, support a steady balancing of the goals of encouraging growth while not pushing so hard as to restart inflation.
Knowledge@Emory: Running a deficit is not unusual in a recessionary time. Why do you think there is such an uproar now over the deficit?
Carlson: We really need to think about the deficit in two parts. One is the short-run deficit due to the decline in output and employment that reduces tax revenues and leads to expenditures like unemployment insurance payments. This is part of what are called automatic stabilizers and are useful in a recession to help counter the business cycle.
The second is due to long-run trends in government spending and tax revenues. This is sometimes called the full-employment deficit. In the long run, we are headed to bigger and bigger deficits, and this is a serious problem. To correct this, Congress will need to address politically difficult issues, such as raising taxes or cutting Social Security and Medicare spending.
In the long run, deficit is a real problem (and not just for the United States), but some of the current concern about the deficit reflects opposition to specific proposals before Congress. Pointing to the deficit adds one more reason to oppose a measure.
Knowledge@Emory: From history, are there other ways the president could stimulate the economy without increasing America's debt?
Carlson: At this point in the recovery, the federal government needs to do what it can to make the economy work better. That could involve infrastructure investment or better educational policies. But entrenched interests opposed to change exist in both parties.
The most important thing for both the president and the Congress is to take seriously the fundamental principle of the Hippocratic Oath: First, do no harm. This seems obvious, but history offers a cautionary tale. Christina Romer, the current chair of the Council of Economic Advisors, has pointed out the country's steady economic improvement between 1934 and 1937 due to an expansionary monetary policy (fiscal policy in the 1930s was really rather small). Then in 1937, the federal government did some very unwise things. In order to balance the budget, Congress raised taxes while unemployment was still well over 10%. The Federal Reserve severely restricted the growth of the money supply by raising the reserve requirement for banks (three times) to stop a potential inflation that had not happened. The result was a spike in unemployment back to 16.9% (counting emergency workers as unemployed). This was the granddaddy of all double-dip recessions.
Knowledge@Emory: You mentioned earlier that in the current recession, Americans are not likely to see much change by government policy. What should they expect?
Carlson: I think there may be more change in the labor market than in government regulation, but that is harder to speculate on. But if the '30s is any indication, I expect there will be some surprising innovations coming out of this period.
Knowledge@Emory:The Great Depression was a period of innovation?
Carlson: Yes. When you think of the '30s, you tend to think of high unemployment and low capacity. But it was also a period of creative destruction. We got synthetic fabrics like rayon and nylon, plastics, aluminum. Automobile transmissions and motors improved, as did the aircraft industry.
Knowledge@Emory:What was the reason for this innovation?
Carlson: Because so many old businesses were in trouble, opportunities arose for new technologies and new firms that wanted to do things to try to survive in this difficult time.
Knowledge@Emory: Can you name a few of the new companies that were created during this time?
Carlson: The 1930's saw the consolidation of the automobile industry into the big three, and the rise of aircraft manufacturing companies like Boeing, Lockheed and Douglas. Cross-country truck companies became important rivals to the railroad. Modern airline companies also came into being. A number of big companies became active in private research and development, including RCA, AT&T, IBM, DuPont, Alcoa, GM, Kodak, and General Electric. These companies became leaders of US industry after World War II.
Knowledge@Emory:How do you think the workplace will change in the future?
Carlson: One aspect, which we are already seeing, is that we are living longer. When the stock market was riding high, people thought they'd retire early and live off their stock market earnings. Now that wealth has declined, everyone is saying, I can't retire now, and so the idea of retiring in your 60s is getting harder and harder. You're going to see more and more older people in the market. This will help GDP growth and reduce some of the pressure on the Social Security system and Medicare.
Knowledge@Emory:And maybe retraining for another job?
Carlson: Yes, you have to be ready for that or for taking another job at a lower income. The idea of progressively getting higher and higher salaries as you get older, well, if you're retraining, you won't have that higher salary. People will have to cut back their expectations. Hopefully it will lead to a higher savings rate. It was the incredibly low rate that indirectly led to the huge trade deficit and the sale of so many bonds to China. It would be desirable for us to ratchet up our savings rate to where it was 20 years ago. Living off the wealth of our stock market accounts and spending every dollar that comes through the door is not good.
Knowledge@Emory:So you see some positive consequences of the recession?
Carlson: Yes, it goes along with that idea of creative destruction. It's a pretty high price to pay, but maybe we can get rid of some bad habits.
Knowledge@Emory: People continue to speculate about when the recession will end. What's your thought on this? Is there any historic benchmark for comparison?
Carlson: Looking back at the fact that it took World War II to end the Depression suggests that it will take years, not months, for us to recover. One key element is not to do foolish things out of frustration. The relatively close vote on Ben Bernanke's conformation for a second term (which most economists supported) shows that mistakes are possible, just like those made in 1936-37.