Free Market To The Rescue
Free Market To The Rescue
Economic anxiety haunts the land. And understandably so. Since hitting its all-time high last October, the Dow has shed nearly a quarter of its value. Fannie Mae, Freddie Mac and AIG have been nationalized in emergency moves (by a Republican administration, no less). Lehman Brothers is history, housing prices are falling, unemployment and inflation are rising and only the ghost of Alexander Hamilton knows what additional horrors await us.
Not surprisingly, many pundits and politicians are comparing today's economy to that of the Great Depression. There are a few similarities. But--so far, at least--the differences outnumber the similarities.
The most obvious and important difference is in the labor market. While today's unemployment rate of 6.1% isn't sterling, it is magnitudes lower than the double-digit rates (as high as 25%, in 1933) of the Depression. Unless and until this rate reaches, say, 15% or higher, comparing today's economy to that of the 1930s is a hysterical exaggeration.
Another difference is trade policy. Compared to the Great Depression, America today is far more integrated into the global economy. Consequently, our economic eggs--our customers, suppliers and investments--are in a greater number of baskets. We're not as dependent now as we were 75 years ago on a recovery starting in America.
And despite the heated protectionist rhetoric of late by some prominent politicians, the post-World War II trend of increasing free trade is unlikely to be reversed. This fact is vital. One of Uncle Sam's first moves following the market crash of 1929 was to enact the Smoot-Hawley tariff. This unprecedented hike in tariff rates told the world "America is closed for business!" Less able to sell products to Americans, foreigners earned fewer dollars with which to buy products from Americans.
The resulting contraction of cross-border trade, combined with the waste of keeping inefficient domestic producers in business, only deepened and prolonged the Depression.
Perhaps the greatest difference between now and then, though, is something simultaneously nebulous and quite real: the prevailing ideology. From the late 19th century until the 1970s, a dangerous idea took hold of the minds of intellectuals and opinion-makers throughout the world: socialism. And the grip of this disastrous, economic-growth-killing idea was strongest during the 1930s.
It's easy to blame the Depression for fueling socialist sympathies. But in his important book Depression, War and Cold War, economic historian Robert Higgs argues that socialist sympathies were responsible for the depth and length of the Depression. Higgs' case is persuasive.
People will not invest if the prospect of their investments being nationalized--that is, taken from them by government--is real. Nor are people eager to invest when the public-policy regime is very vague. Significant uncertainty about tax rates and regulations cause investors to cool their heels.
Such a prospect of nationalization, along with regulatory uncertainty, was real throughout the 1930s. Although we know now that America never moved as far toward socialism as did Europe, Higgs points out that it was quite reasonable during that decade for investors to worry that widespread nationalization and tight government control of economic activity were in the cards. It's not only that large numbers of intellectuals were confidently predicting that socialism was inevitable; more practically, the cascade of centralizing policies that was the New Deal signaled that Uncle Sam was indeed ready to transform the U.S. from a market-based economy into a socialist one.
Potential investors in the 1930s witnessing the creation, for the first time in American history, of large government bureaucracies--whose powers and reaches were still unknown--understandably stuffed their money into their mattresses rather than invest it in such an environment.
This regime uncertainty diminished at the end of World War II. First, Uncle Sam led efforts to expand global trade. Even more importantly, skepticism of central planning grew. This skepticism was signaled in part by the Republican takeover of both houses of Congress in the 1946 election, and strengthened by Harry Truman's ascendancy to the presidency. Truman was regarded to be much less committed than FDR to a radical restructuring of the economy. Investors came back in droves, sparking one of the greatest economic booms in history.
Although market ideas are today taking something of a beating, nothing like the 1930s fervor for central planning is in the air. For this reason alone, I am optimistic that we are not on the verge of a second Great Depression.
But in this optimistic account there's a warning. If our confidence in free markets does come to be overwhelmed by a renewed, if utterly baseless, confidence in the central direction of the economy, then our economic prospects will once again truly be in a great depression.
Donald J. Boudreaux is chairman of the department of economics
at George Mason University.