Ideology and economic policy

Charles Calomiris writes a really insightful review of a new book that I will be sure to check out, when I get a chance, he Forgotten Man: A New History of the Great Depression by Amity Shlaes.

Calomiris' review highlights the dangers of political tinkering with economic issues that is the temptation of both parties, but particularly Democrats, today, and which were likely largely responsible for the length and severity of the very period where they won so much support: The Great Depression

From that review:

"A DEPRESSING RECOVERY

Some readers -- those whose prior knowledge of the economic history of the Depression comes from high school or college textbooks -- may find the basic facts about the economy and economic policy reviewed by Shlaes a bit surprising. Most basic treatments of the Depression and the New Deal are written by social and political historians with limited knowledge of economics. They tend to view the Depression as an inevitable consequence of alleged market excesses of the 1920s and see the New Deal as having substantially aided economic recovery. (A notable exception to this rule is the recent best-selling textbook A Patriot's History of the United States, by Larry Schweikart and Michael Allen, which offers a detailed review of the deficiencies of other textbook treatments of the Depression and the New Deal.) However, the research of economists and economic historians tells a very different story, one consistent with Shlaes' account. The Depression resulted primarily from poor monetary policy by central banks, including the Federal Reserve, and was perpetuated by a combination of disastrous fixed-exchange-rate policies (which transmitted deflation around the world), protectionism, and the severe problems with the balance sheets of banks and firms. In the United States, added damage was done by the wrong-headed policy responses of the Hoover and Roosevelt administrations, including New Deal policies that raised prices and wages (phase 1 of the New Deal, before 1936) and those that raised taxes and increased the costs of hiring laborers (phase 2, after 1936). Whatever the desirability of the New Deal policies from other perspectives, they did not provide an effective boost to the economy.

Shlaes' criticisms of these policies will be familiar to economists and economic historians who have studied the Depression. (For a recent overview of the academic literature, see Randall Parker's The Economics of the Great Depression and Michael Bordo, Claudia Goldin, and Eugene White's The Defining Moment.) It is well known among scholars of the Depression that there was no consistent theme or philosophy underlying New Deal policies but rather that Roosevelt and his changing team of experts innovated in ways that were hard to predict and impossible to explain from the perspective of any coherent macroeconomic theory. Even economists at the time, including Irving Fisher and Keynes, recognized this.

Economists and economic historians today, echoing Fisher and Keynes in the 1930s, generally see the abandonment of the gold standard in 1933, which allowed the money supply and the economy to begin to grow, as Roosevelt's major contribution to economic recovery. Other New Deal policies are generally understood to have set back the recovery of production, employment, and asset prices, as Shlaes argues. The National Recovery Administration's price and wage hikes have long been seen as mistakes (and a continuation of Hoover's bad policies) that contributed to unemployment and the slow recovery of production from 1933 to 1935. The tax hikes and labor legislation of 1935-37 have been widely considered by scholars as having prolonged the economy's slow recovery and meager job growth during those years and as having helped caused the relapse into recession in 1937. Shlaes' contention that policy errors -- and, more important, the unpredictability of policy -- fed economic uncertainty and discouraged businesses and consumers from investing and consuming is not a new view of the New Deal.

A few scholars may quibble with some of Shlaes' claims. She argues that Roosevelt's ad hoc management of the dollar's value after March 1933 and his decision to abandon multilateral efforts to reestablish the international gold standard created unnecessary price-level uncertainty. This may be true, but the point seems a bit overemphasized in light of the positive effects of abandoning gold parity -- namely, the growth that came from decoupling monetary policy from worldwide deflation. Similarly, Shlaes' mainly tangential discussion of banking crises in the early 1930s exaggerates the impact of depositor panic, underestimates the difficulty of solving the problems that were then gripping banks, and overstates the ability the Federal Reserve had to prevent financial distress by pumping more liquidity into the system. The abolition of gold clauses in bonds in 1933 (which allowed creditors to repay their debts in depreciated paper dollars rather than in a fixed quantity of gold) was not, as Shlaes argues, merely a redistribution of wealth from creditors to debtors; as the economist and current Federal Reserve governor, Randall Kroszner, has shown, the measure benefited creditors -- and the whole economy -- by increasing the likelihood that depreciated debt would be repaid.

In spite of these few shortcomings, however, Shlaes' overall analysis of the economic history of the Depression is remarkably well informed and balanced. Her emphasis on the disastrous effects of higher taxation of corporate profits and retained earnings in the mid-1930s is especially incisive. In the areas where the analysis is a bit weak (especially pertaining to financial-sector issues), the controversies surrounding those matters are largely beside the point of the book.

Shlaes' main contribution is not the novelty of any one of her views about economic policy but rather her ability to synthesize the story of policy failure with a cultural and ideological history. In doing so, she tells the tale of the Depression in a way that allows readers to understand how leaders as intelligent as Hoover and Roosevelt could have failed to get the economy back on track for so long. Inconsistencies in economic policy over time reflected political leaders' basic lack of understanding of economics, upheaval in the composition of President Roosevelt's pool of most influential advisers, and the schizophrenic nature of those advisers' political and economic ideologies (alternating as they did between budget balancing and aggressive spending, between attacking big business and supporting corporate consolidation). Moreover, Supreme Court rulings that rejected the constitutionality of many actions from the first wave of the New Deal and, later, partisan strategies designed to favor particular groups that Roosevelt believed would deliver his reelection further hampered meaningful reform and economic recovery.

Shlaes properly attributes the persistence of the Depression in part to a new ideological orientation toward government intervention that gained credence in the 1930s: the idea that there is great potential gain and little harm in ad hoc policy experiments designed to plan and shape the economy. Shlaes believes that this ideology reflected a lack of understanding of the damage that state intervention can wreak on the economy -- especially when applied in an incoherent and unpredictable way -- and a failure to appreciate the ability of the market to successfully respond to economic challenges on its own when it is permitted to do so. Ill-advised government plans during the Depression were often destructive to recovery and damaged private-sector initiative either willfully or unwittingly by imposing high taxes and creating an environment of high political and regulatory risk.

GONE BUT NOT FORGOTTEN

As the 2008 presidential election nears, Shlaes' book will make good bedtime reading. During the campaign, the candidates will offer hundreds of new policy ideas for ways to make the economy perform better and to help the new generation of "forgotten" men and women. The Forgotten Man offers the useful reminder that seemingly bright new government initiatives can cause harm as well as good. It especially highlights the unintended risks of class warfare in the formulation of public policy. Policies that cater to disadvantaged constituencies, perhaps, as in 1936, as part of a political strategy for electoral victory, can sour the economy and end up harming those whom they were intended to help. A protectionist backlash against China, for example, could result in a major global growth slowdown and the destruction of millions of U.S. jobs.

The Forgotten Man is history with a point of view -- a moral history in the best sense of the term. For economists and economic historians, the book offers a synthetic view that places the myriad policy errors of the 1930s within a coherent narrative about the evolution of U.S. culture and ideology and that is full of insightful commentary about the main players in this drama. For nonspecialists, many of whom may be suffering from fundamental misconceptions about the New Deal, the book will be an eye opener."

It is the field of economics, as much as the field of psychology that is the discipline that my work in special education most draws upon, that should caution our romanticism of power, force, and state intervention, right now.

Ironically, we have spent the entire 20th century slowly learning that lesson only to take several steps back at the turn of the 21st century. I can only hope that this is the last gasp of such regressive foolishness that is perpetually refuted by empirical analysis of its effectiveness, nevertheless its relationship to the principles of self-governance and self-determination of independent citizens that the title of this book, The Forgotten Man, alludes to.

Power, I am learning, if far too often the refuge of self-centered and cowardly interests conspiring against the merits of most matters in the world best decided and shaped by independent consciences rather than group imposition.

And this period better than any other I have encountered in this world, reflects this most serious shortcoming of those engaged in the field that I care so much about.