Anti-Depression Economics

A distinguished economist argues that the basic cause of the recession haunting our economy today is the same as one of the chief causes of the Great Depression—the luck of an agent of “transformational growth.”Whereas the automobile served that function in the 1920s, there is today no technologically equivalent breakthrough for new private investment. Therefore, he argues, government investment must catalyze growth


ALL THROUGH MY BOYHOOD DAYS, IN NEW YORK City, I was aware of a presence called the Depression. I remember an enormous headline in late October of 1929 in the evening newspaper The Sun, but at age ten I had no idea what the word “crash” meant. I found out in school, where the joke went around that hotel clerks were supposed to ask “For sleeping or jumping?” when someone inquired about rooms. That winter two fathers of school friends jumped.

Within a few months men were selling small pyramids of apples on upended crates on the avenue where we lived. A year later there were shantytowns in the city’s parks. Not long after, in the District of Columbia, a tent city built by the Bonus Expeditionary Force—veterans hoping to get help from Congress—was set upon by the Army with fixed bayonets, tanks, and tear gas. That raid was led by General Douglas MacArthur, who said afterward that “beyond a shadow of a doubt” its inhabitants were about to seize the government.

These are snapshots of the way the 1930s appeared to people in families like my own—the lucky half to two thirds of the nation which did not lose its jobs, its apartments or homesteads, its life savings. For us, the Depression was a series of frightening realities glimpsed in the newsreels or read about in the papers, behind which loomed something vast, oppressive, and incomprehensible. When I went to Harvard, in 1936, I took economics because I thought it would help me understand the nature of that mysterious presence.

I soon discovered, however, that the Depression was as great a mystery to my professors as it was to us students. I recently took down from my shelf the textbook we used, Principles of Economics, by Frederick Garver and Alvin Hansen. On page 16 it reads, “The total money income of the people of the United States was about $80,000,000,000 in 1929. Owing to the fall in prices, output, wages and employment, it fell to about $40,000,000,000 in 1932.”

That catastrophic event is not mentioned again in the remaining 600-odd pages of the text, which explain how firms supposedly operate under conditions of competition and monopoly, how income is distributed in a market system, and other such matters. The book’s highlight was a chapter on business cycles, but it taught little more than that what goes up must come down, and that there are a number of ways of explaining why things go up. There was certainly no notion that what went down might stay down—that a business slump could go on more or less indefinitely, as the Great Depression did.

It was not only in academic circles that the Depression was an incomprehensible presence. The Senate Banking Committee had begun holding hearings in 1932 to probe the causes of a disaster that was threatening the political as well as the economic stability of the nation. A parade of eminent businessmen confessed that they had no explanation for the Depression. It was equally clear that the nation’s bankers had no inkling of what the trouble might be. At the Senate hearings the famous financier and presidential adviser Bernard Baruch spoke for many when he said, “Balance budgets, stop spending money we haven’t got. Sacrifice for frugality and revenue. Cut government spending—cut it as rations are cut in a siege. Tax—tax everybody for everything.”

Keynes Brings Clarity

WHAT WAS NEEDED, WE CAN SEE, IN RETROspcct, was some new way of conceptualizing the workings of the system. The new conception arrived on campus in late 1936, and immediately set the economics department on its ear—it was John Maynard Keynes’s General Theory of Employment, Interest, and Money. I recall a debate organized by the economics faculty in which voices shook and faces became empurpled over Keynes’s ideas about government spending—which according to some represented longawaited salvation and according to others the final nail in the coffin. Oddly enough, Keynes’s most persuasive proponent was none other than Alvin Hansen, who had by that time become his ardent disciple.

For all the furor about spending, what was ultimately new about the Keynes-Hansen view was not so much its policy proposals as the diagnosis that preceded them. The argument that galvanized the economics world was that unemployment might not be just a temporary condition from which the system would naturally recover, as markets naturally recovered from unsustainably high or low prices. Keynes showed that unemployment could easily reflect a condition of “equilibrium”—a state of affairs that would continue indefinitely, unless something changed in the prevailing situation. Later Hansen argued convincingly that the prevailing situation would not change, because capitalism was entering a period of stagnation in which its propulsive momentum would be undermined by slower population growth and a lack of new investment frontiers.

A further clarification of Keynes’s theory emerged some dozen years later in an enormously influential textbook written by Paul Samuelson, a brilliant young professor at the Massachusetts Institute of Technology who had been a protégé of Hansen’s. Samuelson’s text presented the economy not just as the unified market system that was the organizing concept in the Garver and Hansen text but as two quite distinct systems at work within a single territory. The first of the two—the microeconomy—consisted of the mosaic of markets in which supply and demand established the prices that guided the activities of sellers and buyers. The second—the macroeconomy—comprised the flows of investment, spending, and saving which determined the level of overall employment and output.

This division made it possible for the first time to study “macroeconomics” independent of “microeconomics.” For all the difficulties to which this bifocalism led, it gave to the understanding of depression a hitherto missing clarity. A depression was now seen as a condition of large and persisting unemployment brought about by a large and persisting insufficiency of spending. The remedy was therefore to increase spending, especially for investment purposes. In turn, the way to increase spending was to lower interest rates, making it easier for business to borrow and invest; or, if need be, to supplement private investment with public spending. In a typical sally, which brought delight to his friends and set the teeth of his enemies on edge, Keynes wrote,

If the Treasury were to fill old bottles with banknotes, bury them at suitable depths in disused coalmines which are then filled up to the surface with town rubbish, and leave it to private enterprise on well-tried principles of laissez-faire to dig the notes up again (the right to do so being obtained, of course, by tendering for leases of the note-bearing territory), there need be no more unemployment. . . . It would, indeed, be more sensible to build houses and the like; but if there are political and practical difficulties in the way of this, the above would be better than nothing.

By the time I left Harvard, in 1940, the Depression no longer seemed an incomprehensible presence. The continuing high level of unemployment only reflected the problems of applying Keynesian remedies on an adequate scale in a country that still regarded Bernard Baruch as the embodiment of political and economic wisdom. Proof of this heretical idea was shortly thereafter provided by America’s entrance into the war. Prior to 1938, despite New Deal programs, total spending for public works did not equal pre-crash levels. Once war was declared, all considerations of prudence were set aside. Federal expenditures rose from $16.9 billion in 1941 to $51.9 billion a year later, and then to $81.1 billion over the next year. Unemployment was cut in half the first year and in half again the year following. Gross national product, which had not yet quite regained 1929 levels in 1940, climbed 25 percent in 1941 and kept climbing, to almost double 1929 levels in 1943. Thus, whatever else it was, the war was an extraordinary vindication of Keynesian economics. The Depression had been banished not only in theory but in fact.

Our Recessionary Economy

AT FIRST GLANCE THE PROLONGED AND PAINFUL recession that is officially behind us—although one would not know it reading the grim announcements of mass layoffs—seems utterly different from the Great Depression. To begin with, it started not with a crash but with a stock-market boom that has gone on more or less steadily since 1983, despite one precipitous drop—from which it quickly recovered. For another difference, unemployment actually declined from 1982 until 1989, and although joblessness has grown by almost 50 percent in the early nineties, this must be compared with an 800 percent increase from 1929 to 1932. Not least, output did not fall sickeningly, as it did during the thirties, but rose more than 25 percent from 1982 to 1992, after allowance for inflation. In fact, over these years real output shrank in only one year, 1991, and the fall wars barely more than one percent.

Yet despite all these differences, I think we have been going through a depression much like that of the 1930s— with one very important difference. It is that the economy in the thirties entered into a kind of free fall, whereas during more recent times its contractive momentum has been held in check. The crucial element in warding off another collapse has been the rise of government spending, led by Social Security, Medicare, and welfare programs generally. Even as late as 1941 federal, state, and local expenditures for such programs came to only eight percent of GNP; they had been half that in 1929. By the 1970s social spending as a percent of GNP had almost doubled from its 1941 level, and if we add in government spending for all other purposes, such as the military, the total contribution of public expenditure to GNP rises to about 35 percent. This is a good deal less than in Germany or the Netherlands or England, but it is enough to provide a floor under economic activity about four times as large as that in the Great Depression days.

There are other important differences between then and now. Public regulation of key sectors has prevented a repetition of the worst disasters of the 1930s. The stock market collapsed on October 19, 1987, falling more sharply and deeply than in 1929, but there was no wholesale slaughter of brokerage firms or their customers, because the margin accounts and easygoing brokerage practices of that earlier day had been outlawed. Similarly, the savings-and-loan debacle was potentially as grave as the bank failures of the early 1930s, but whereas in the Great Depression nine million savings accounts were wiped out, in the 1980s scarcely a cent was lost, because the federal government insured all S&L accounts up to $100,000. Incidentally, that government obligation is responsible tor most of the current $350 billion-odd bulge in the deficit—something to be borne in mind by those who see all deficits as pure profligacy.

Hence, in overall terms the performance of the economy since 1980 is to that of the Depression years as a tremor is to a quake. To be sure, statistics of overall performance can be deceiving. The slow rise in “average" incomes during the past dozen years is a statistical artifact that reflects unprecedented gains for families in the topmost bracket, with incomes over $600,000 a year, and actual losses in income for the two thirds of all families with incomes under about $45,000. If there are no visions of revolutionary takeover, such as General MacArthur had, there are many fears of social breakdown, epitomized by widespread homelessness, crime, and drug addiction. And notwithstanding the comparatively lower increases in unemployment, joblessness has hit very hard. The past decade has been one of shrinking employment for the middle class as well as for the unskilled worker, and the past two “recovery” years have seen tremendous cutbacks at IBM, at Sears, and in the aircraft industry generally. Unemployment today is higher, not lower, than it was in 1991, when the “all clear" bell was rung. To deepen the gloom, the decade ahead holds prospects of a further migration of jobs overseas.

For all these reasons the recession has felt like a depression, even if not one of earthshaking proportions. Nonetheless, these disturbing realities are not the basic reason that I see our present experience as a reflection of the past. That reason can be best understood if we turn once again to our understanding of what depressions are.

Transformational Growth

WHEN I WAS STUDYING ECONOMICS IN COLLEGE, depressions were seen as the “troughs” of business cycles, which implied that they would naturally be followed, sooner or later, by periods of revival and boom. Nowadays depressions are generally regarded instead as periods of slower-than-average growth. I remember Alvin Hansen tracing the upward-sloping wavy outline of a series of business cycles on the blackboard and remarking in a bemused way that the trough of the last cycle was often higher than the peak of a cycle two or three waves back. Hansen was stumbling on the idea of changes in the rate of growth—not the self-correcting mechanisms of credit squeezes and inventors pile-ups, or the pendulum swings of optimism and pessimism—as the basic force behind prosperity and depression.

Such changes in the rate of growth have long been a fact of economic life. Capitalism is by its very nature always in a condition of potential growth, as business seeks to expand its output or to create new kinds of goods and services, but potential growth is by no means always realized. Sometimes the decisive element is the social structure surrounding investment, such as the relative strength of labor unions, the web of government regulations, the climate of opinion. More striking is the appearance of what the economist Edward Nell has called periods of transformational growth. In such periods new technologies literally reshape the economic landscape, opening whole new territories to business investment: the Industrial Revolution and the age of railroad building are cases in point.

From this perspective, the uncontained depression of the thirties and the much milder one of our own times have an important aspect in common. Both followed in the wake of periods of large transformational changes. The twenties saw the gradual exhaustion of the extraordinary economic stimulus of the automobile. America literally rode to its prosperity during the long boom following the First World War—a boom that made the automobile industry the largest in the United States by 1923, that made it possible for tens of thousands of communities to prosper without rail or water connections, that spawned the ubiquitous garage and gas station, and that gave an immense boost to the oil industry. By 1927 the boom in new car sales was over, and three quarters of auto sales were replacements. New investment possibilities arose in the 1930s—frozen foods were coming in, the electric light bulb was an exciting new product—but they were not enough to establish the basis for a transformational boom. Had the credit system not been so rickety, the mistrust between business and government so deep, the subservience to the gold standard so slavish, a quicker and stronger recovery could perhaps have been mounted. But a technological impetus comparable to that of past booms seems to have been lacking. It was not provided until the Second World War itself opened a huge new investment terrain and the much-needed spending to finance it.

The contained depression of the 1980s followed the great transformative period of the 1950s and 1960s, when the jet plane, the computer, and the final emplacement of the welfare state brought about deep and pervasive change. Tourism, with its air traffic, car rentals, hotels, restaurants, and just plain shopping, became the largest single industry in the world; the computer affected the productivity and organization of businesses ranging from the neighborhood cleaner to the multinational corporation; the growth of government spending provided an unprecedented basis for long-term investment planning. Yet here, too, by the 1970s there were signs of an impending end to the transformative impetus. Tourism was by then a vast industry, but it was no longer a growing one. The computer was a staple, not a novelty, and improving its speed did not have the same galvanizing effect as introducing it in the first place. Not least, the welfare state had settled down to a stable flow within the gross national product: from 1975 to 1980 government spending as a percent of GNP actually decreased in Australia, Canada, Germany, the United Kingdom, and the United States.

Once again, the underlying problem was the failure of another transformational boom to take the place of the fading one. As in the earlier period, the great boom of the postwar world came to an end when its investment terrain was finally settled; and once that happened, no equally transformative successor took its place. Marvelous breakthroughs in technology occurred during the 1980s, and no doubt others will occur during the 1990s, but as yet none has opened an investment Klondike. The consequence has been a long period of insufficient growth that is very different from its near-mythic predecessor in surface details but much like it in its causal basis.

The Catalyst of Public Investment

THE QUESTION IS, WHAT NEXT? I DO NOT MEAN What will the new Administration do?—I will come to that in a moment—but What will the economy do? What can we expect from the raw forces of the market, the energies of capitalism, the existing and prospective state of technology?

The only answer on which we can depend is that the economy will continue to do what it has been doing, helped along somewhat by an apparent recovery from the recession, and no doubt buoyed by expectations of growth which, however vague, will lift the spirits of the business community. An end to the recession is like a boat rocking back to a level position; brightened hopes are not a substitute for new economic territory to conquer. The underlying reality is that we move into the future as we have moved in the past—borne along in a system driven by a need for expansion, always on the alert for promising avenues for investment but never able to foresee whether or not their technological impact will generate strong growth. We do not know whether genetic engineering, ceramics, space technology, atomic physics, cellular telephones, or whatever comes next will open the gates to another great boom. Neither do we know whether the increasingly unified global patterns of production will spur growth or deter it, or whether increasingly automated production systems will open up new job horizons or simply condemn more working people to unemployment.

There is, however, a new possibility on the horizon—a possibility full of uncertainties but with the potential to serve as a transformational impetus. It is that the government itself can set in motion a bold and far-reaching improvement in our national public capital. This was, in fact, an important means by which the United States achieved its original takeoff into growth in the early nineteenth century, as the thriving business of barge transportation found its economic leverage vastly multiplied by the gradual emergence of a network of public improvements, capped by the opening, in 1825, of the audacious Erie Canal. That model of a boom led by public investment is what the Clinton campaign, in cautious language, was proposing; and hemmed about by a thousand difficulties, it is still what the Clinton Administration is hoping to achieve. Its purpose would be to set the stage for an invigoration of private enterprise by providing a public underpinning, like the canal boom, without which the boom could not get going in the first place.

The word for such a boom these days is “infrastructure.”In its narrowest meaning “infrastructure” refers to great physical works such as canals, roads, roadbeds, dams, sewer systems, and the like. But as the word is bandied about in Washington today, it refers to public reinforcement of our human as well as our physical capital. Education plays a central role, insofar as productive efficiency cannot be expected to flourish so long as the United States finishes last, or near last, in comparisons of its students’ test scores with those of its European or Japanese competitors. Research and development is another new salient for infrastructure, in such areas as more-gasoline-efficient engines, effective use of solar power, electric automobiles, advanced air-traffic control systems, and the much talked about but still nonexistent bullet or maglev trains needed to bind together urban centers. Not least is the immense challenge of reclaiming the economic vitality of the tenth of our population that today rots away in the urban slums we euphemistically call our inner cities.

The Stumbling Block of the Deficit

IS IT POLITICALLY IMAGINABLE THAT WE CAN LIFT ourselves by our bootstraps in such a fashion? Two great obstacles stand in the way. The first is the deficit. It is evident that a public-investment boom would cost—should cost—a great deal of money. The financier Felix Rohaytn has suggested that it would cost $100 billion a year for ten years. The Nobel Prize-winning economist James Tobin has proposed $60 billion a year, and during the campaign Bill Clinton spoke of a stimulus in the range of $30—$50 billion. After the election the Administration floated figures of $15 billion to $30 billion. These steadily diminishing numbers imply a jump-start rather than a full-scale boom in public investment, but the jump-start may make us think about using the government as a means of revitalizing the economy, not merely keeping it going.

That more ambitious aim will certainly not become part of the active public agenda until we have dealt with the deficit, a presence that hangs over the economy today much as the Depression did in the 1930s. What the deficit means, of course, is borrowing, and even the most modest infrastructure program will require something like $150 billion of borrowing over the ten-year span that is normally projected for capital improvements. Yet I do not think that the obstacle is as formidable as it appears. The reason is that borrowing can be good as well as bad. Public borrowing to pay interest on the national debt or to meet the payroll of the armed forces would be an obvious waste of the public’s savings and an abuse of the borrowing function, exactly as if a corporation borrowed to pay interest on its debt or the salaries of its employees. But public borrowing to build a new road system or to finance a major research-and-development program can be justified on precisely the same grounds as business borrowing to build a new plant. In both cases borrowing is expected to pay for itself over the long run—in the case of business, with revenues generated by the new plant; in the case of government, with revenues that will result, without any increase in tax rates, from the growth in GNP generated by the new infrastructure.

Why is this basic similarity not widely recognized? The most important reason is that government does not keep its books the way business does. All corporations separate their capital borrowing and spending from their current revenues and costs. Only government—or, to be more precise, only the government of the United States— charges its borrowing against its regular income. The result is that Americans have no way of telling whether their government is borrowing for good purposes or bad. Suppose, for example, that we adopted Rohatyn’s plan. Because we do not distinguish capital expenditures from ordinary ones, this added spending would be set against our tax revenues, with the result that the $100 billion borrowing would show up as an addition to our annual “deficit.” If we had a “capital budget,”the borrowing would be shown on a separate schedule that put only borrowing, not tax revenues, on one side, and only capital spending, not ordinary expenditures, on the other. We would then know that that much of our borrowing was being put to good use, and we could concentrate on bringing down the borrowing that was not.

Deficits might still be needed for a variety of peacetime purposes—to give a quick boost to general purchasing power if the economy should hit an air pocket, or to prevent catastrophes, such as allowing S&Ls to fail without honoring the insurance on their deposits. But a capital budget would be a first essential step to removing the incomprehension that today imperils even the most conservative and constructive use of the government’s transformational economic powers. In addition, to touch on a point of some political importance, a capital budget is likely to win the support of the business community. As I have said, every corporation, and every industrial nation except our own, separates its running expenses from its capital expenditures. Thus the Clinton Administration might well seek to defang the deficit by convening an unimpeachable committee of business executives to endorse an accounting system that would enable us to see whether we were squandering our national wealth by borrowing to pay for the ordinary expenses of government or enhancing it by borrowing to lay the basis for what we hope will become a transformational boom.

The Liability to Inflation

THAT LEAVES THE SECOND, AND MUCH MORE OBdurate, problem of inflation. The Keynesian enthusiasm of the 1930s for public spending has dimmed before the awkward fact that capitalism today is a great deal more inflation-prone than it was in the 1930s. Since the Second World War every capitalist nation has been coping with pressures that did not exist when Alvin Hansen explained to congressional audiences, as rapt as those at Harvard, how public spending could work its anti-depression magic. From 1935, when prices finally stopped falling, until 1940, consumer prices rose by only about two percent. Inflation was a word that frightened bankers but had no meaning for ordinary citizens until we got into the war in earnest, and quickly put on price controls. Once the war was over, price controls came off, but the cost of living did not soar; from 1947 through 1967 the average yearly rise in consumer prices was around two percent.

The lurking inflationary menace with which we are familiar did not arrive until the late 1960s, when the cost of living began to rise steadily each year, the percentage increase passing the double-digit mark in 1974. That alarming breakthrough was an immediate consequence of the doubling of petroleum prices at the hands of the newly formed OPEC cartel, but “oil shock” was by no means the only reason for the advent of double-digit inflation throughout the Western world by the late 1970s. The culprit was more likely the strengthened position of labor in the welfare state, and insofar as the welfare state itself was built on Keynesian foundations, it is probably correct to call the inflationary propensity of modern capitalism an unwanted and unforeseen outcome of Keynesian economics.

This introduces an obstacle to starting up an infrastructure boom which is of much greater substance than the deficit. Until the pressure for wage hikes can be prevented from pushing up production costs, the likelihood is that at the first sign of the inflationary tendencies that would likely emerge from a public-investment boom, the Federal Reserve would raise interest rates to “cool down” the boom—which is to say, stop it in its tracks. The pressures generated by such a boom are not likely to be great if the scale of spending is as small as the numbers now being put forward by the Administration’s spokesmen. But if, or when, a public boom of transformational potential were to be launched, the pressures would very possibly mount to levels that threatened economic, or even political, stability.

To those who see dire portents in the deliberate use of government as a transformational force in its own right, this would probably be regarded as a kind of divine retribution for having succumbed to the Keynesian enticement in the first place. But there is a more sobering side to the matter. It is that any major private boom would be cursed in the same way. The dollars that push prices up exert the same pressure whether they come from Federal Reserve accounts or from corporate ones. Inflation will accompany a business-led boom exactly as it would a publicly led one. Indeed, to the extent that public capital is today more productive than private, because it is in shorter supply, a public boom should be less inflationary than a private boom.

For that reason, a much talked about means of taming inflation is some kind of concordat among labor, management, and government, perhaps along the lines being tried out in Germany. It would work this way: labor agrees to hold the line on wages in exchange for some union voice in labor-related corporate policy and a strong program of unemployment insurance and job retraining; management is given the right to deploy labor efficiently, in exchange for full union recognition; and government becomes the coordinator of the economy but not its boss.

Some kind of “social contract” along these lines is now emerging in many parts of the industrial world, but there is no sign of one here, and there are deep-rooted forces in our political culture that militate strongly against its emergence. Some years ago the political scientist Seymour Martin Lipset compared the national ethos of two nations of strikingly similar historical backgrounds—the United States and Canada. Both countries in their early years went through the character-shaping experience of conquering and settling a vast wilderness to the west. From this experience, however, emerged two very different national heroes: for the Canadians it was the scarletjacketed North West Mounted Policeman, bringing law and order to the new territories; for the United States it was the cowboy. There is still a certain cowboy outlook deep in the American mentality which does not bode well for the creation of the kind of social contract that may be necessary if we are to find an effective anti-depression policy. I suspect that this is the single most difficult, protracted, and important economic challenge that President Clinton will have to face.