Friday, July 29, 2011

On Learning the Real Lessons of the 1930s Depression

Tom Clougherty (29 July) writes on the Adam Smith Institute Blog (HERE): a revealing and excellent account of the mythical explanations of what prolonged the Great Depression in the 1930s and what actually was its likely cause, contrary to Maynard Keynes’ widely accepted narrative in his 1936, General Theory, and in the post-war teachings of modern universities, up to the 1980s (which I, and members of the post-war university generation of economists took as gospel).

Follow the link and read Tom’s account. I have selected one paragraph from it for comment on the largely ignored side effect of the debate on Keynes’ narrative.

Debunking the Great Depression Myth

Indeed, Roosevelt was heavily influenced by his 'brains trust', which in turn was influenced by a variety of collectivist ideologies – progressivism, corporatism (of the European fascist variety), and socialism. The common theme was 'scientific' economic management by enlightened central planners, and a rejection of the free market. And, OK, perhaps that went beyond what Keynes himself would probably have advocated.”

Features of this debate are long forgotten but at the time it had some interesting side effects. People debating competing practical policies also rely on (and imply) competing theories. In the 1930s, the presence of Soviet Communism with the first of its 5-year plans’ counter-poised to capitalism, with its supposed ‘laissez-faire’ theories (though not so evident practices – tariffs, etc.,). This was the main political challenge in Europe (from the growth of communist and socialist labour parties) and in the USA (leftish Democrats v rightist Republicans), to which were added rapid military expansion into Western Europe by the Soviet Army and, in China, the seizure of power by Mao's Red Army.

Economists responded to the alleged virtues of state planning with claims for the benefits of markets and this was, perhaps, sourced from the distorting oral traditions in Cambridge, England, and Chicago, of claims for market-superiority based partly on (invented) attributions about Adam Smith’s supposed ‘invisible hand’. Oscar Lange, a Marxist economist (On the Economic Theory of Socialism, 1936 & 1938), asserted that socialist state-planning was a substitute for the market's invisible hand and claimed that socialism would do much better in directing the economy to its most productive uses than the unreliable and uncertain invisible hand:

The market has, therefore, been compared to that of an invisible hand which produces co-ordination out of the autonomous decisions of many separate units. Not all markets, however, are able to produce such coordination, nor is the coordination obtained always consistent with accepted social objectives. In such cases, planning is used to either reach the co-ordination, otherwise unobtainable or to correct the co-ordination produced by the invisible hand of the market” (Lange 1945, 26).

Paul Samuelson, while an undergraduate at Chicago, was taught that the invented ‘invisible hand’ theory belonged to Adam Smith, and in his famous and popular textbook (Economics: an introductory analysis, 1948, p 36) responded implicitly to the challenge of socialist planning by placing Smith’s alleged theory of the invisible hand as relevant only to a purely laissez-faire economy but not to a post-war mixed capitalist economy. This perpetuated a myth about Adam Smith (he never saw the metaphor of an invisible hand as connected to markets), but the belief that he did, became (and still is) ubiquitous.

It helped cement Keynes’ narrative of the Great `Depression’ – he referred to the alternatives of democratic governments’ demand management as an alternative to laissez-faire, classical 'do nothing' policies that allegedly were believed and advocated by ‘classical’ economics as best way to respond to crises. Keynes created a narrative of the causes of the 1930s depression that is now widely accepted along with its (not Smith’s) failures of ‘an invisible hand’, which is heard often in today’s debates on the current recession. Some politicians that it was the alleged absence of 'regulation' and state intervention –and a belief in 'laissez-faire' - that led to these crises in the first place and they advocate, instead, more regulations and more state stimulation by ‘quantative easing’, ‘subsidies’ and even ‘more borrowing’ (after the state’s credit cards are already ‘maxed out’!).

As the real lessons of the 1930s depression have not featured much in today's debate (and Tom Cougherty post is an excellent place to start) it might help clarify what is needed by paying close attention to it.

[Disclosure: I am a Fellow of the Adam Smith Institute.]

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Blogger Stephan said...

Aha … the right-wing propaganda about the Great Depression finally arrives at Adam Smith's Lost Legacy. The whole argument about unemployment seems to boil down to the ridiculous claim by Amity Shlaes: jobs provided and paid for by the government are not real jobs and thus these jobs shouldn't be part of the unemployment statistic.

>Disclosure: I am a Fellow of the Adam Smith Institute.

Nice. OK. That explains a lot. Good to know.

10:15 am  
Blogger Gavin Kennedy said...


Many thanks for your comments. They are always welcome.

However, on the substance of what you write I am perplexed. The whole point of my disclosure is to ensure that when I praise or criticize anything with which there is a personal or scholarly connection, that readers are aware of that connection. Lost Legacy does not purvey “right-wing” propaganda, or any political message, Left or Right. I do not comment on the politics of anywhere other than of the country in which I live and vote, i.e., Scotland – I am, as disclosed on Lost Legacy in May, a supporter of the Scottish National Party, which leaves the slur of “right-wing” or even “left wing”, propaganda with the laughable contempt it deserves.

I am uninformed as to who “Amity Shlaes” is or the relevance of your point. I would certainly not agree with his/her views expressed on my current evidence of them. Lost Legacy, presents Adam Smith’s actual views from his published writings and correspondence. It has no other ax to grind.

No doubt, Stephan, you are aware of Smith’s statements on ‘productive’ and ‘unproductive’ work, which has led to unnecessary confusion among some readers of Wealth Of Nations (WN II.iii.1-3: 330-32).

When the Government taxes or borrows to pay for products or buy them from the private sector the issue of whether they are “real jobs” is not so clear cut, as “Amity Shlaes” is reported by you to have asserted.

For example, if a private contractor builds a bridge paid for from public finds it produces ‘value’ for the contractor (costs plus a profit; where the latter is re-investible in the ‘Great Wheel of circulation”), as it does if the contractor sells the bridge to the government or within the private sector for a re-investible profit.

Similarly, if your buy a bottle of wine, re-investible value is created in the purchase, as it is with paying an impresario to hear an opera or concert company perform, or to hear the declamations of an theatre player. If such activities make a profit, re-investible value is created. The labour employed is productive on Smith’s definition; but if the government merely transfers money from its sources to individuals who are and remain unemployed, they are properly counted as unemployed.

If government-paid employees provide services that facilitate the economy (they are unproductive in not producing a re-investible “value”) they are still employed. If no work is involved in the transaction, they are not employed. (Smith, of course, wrote long before unemployment pay, though unproductive prodigals took ‘retainers’ from the sovereign, associated with ‘maintaining his dignity’, and his soldiers “lounging about the palace” were unproductive).

A valid debate about the 1930s should not be dismissed as “propaganda”. Study the evidence and assess the credibility of the conclusion. If unemployment as defined – no work was involved – did not decline over the 1930s as we were taught in the 1960s, but did decline from 1945 onwards when “pent up” demand became realisable in purchasable products, then that is a different story to what was purveyed in the Keynesian orthodoxy.

I was there, Stephan, and as rationing ended (Oh! The joy of my first “Five Boys” Chocolate bar and eating my first banana – I’ll never forget those moments) and saw my working-class family adults getting and changing jobs – when most predicted post-war unemployment after demobilisation – it was my early introduction to economics. I am not convinced you can borrow your way out of recession. If you build a surplus in the boom years, you can ameliorate the effects of a recession and overcome unemployment.

Governments (Left and Right), alas, do not follow prudent policies.

3:38 pm  
Blogger Don said...

Gavin, I must say that I'm surprised by this post. What was passed & implemented in the 33 & 35 Banking Acts was a watered down version of The Chicago Plan of 1933. Among its sponsors were Frank Knight, Jacob Viner, Aaron Director, Irving Fisher, & Henry Simons. I know some libertarians consider these men Collectivists, but I didn't think you'd be one of them. This is well documented in Ronnie J. Phillips The Chicago Plan & New Deal Banking Reform. BTW, FDR opposed Deposit Insurance because he believed it created Moral Hazard. It was passed without his help by the Congress. I think this plan worked, and, in doing so, I'm following Milton Friedman.

Hoover did agree to increase the size of Govt, although some of the increased spending was passed over his objection. Where he went terribly wrong was in believing that a Balanced Budget was necessary in order to get out the mess. Hence, he raised taxes in 32! The Chicago Plan, on the other hand, recommended Monetary Reflation plus a Reinforcing Stimulus being Govt Borrowing to help people in need. That was a much better plan. BTW, Hayek himself later recanted his ideas about letting Deflation take its course.

I think I've mentioned Frank Knight's great book On the History & Method of Economics. Necessary reading I'd imagine. Here's a quote from page 9:

Despite some sweeping phrases which invite another interpretation, Smith was no doctrinaire advocate of a hands-off policy by government in respect of economic matters.

And you yourself have approvingly quoted his Chicago colleague Jacob Viner. So, what's up?

I hope you're well,

Donald Pretari the lib Dem

5:10 pm  
Blogger Gavin Kennedy said...


Nothings ‘up’ Don. I have long insisted to economists must submit to the facts. If an argument is questioned by empirical evidence, we must treat it seriously before continuing to insist that our argument has validity.

Allowing for the nature of the US political system – the balances among the Congress (Senate and House of Representatives), the President, and the context of US Constitutional Law, and the Laws as they stand, and the politics of re-election of the personnel, the evolution of current crisis is not clear-cut. I do not know enough about US political history to make judgements about 1930s politics, or even today, plus my self-denying ordinance not to comment on the politics of other countries.

I do know that what I was taught as an undergraduate (and graduate) economist in the 1960s, when the certainties of Keynesian demand management were under stress from the Monetarists, are at least questionable. My comments in my post were about empirical facts (The New Deal did/did not reduce unemployment) brought to my attention by Tom Clougherty, which require either challenge or confirmation.

Stephan claims I have revealed myself to be a purveyor of “right-wing propaganda”; and you think that I may be a (Leftist) “Collectivist”. I am neither. Nor am I disputing that there is a positive role for government in the economic cycle; the debate is about what they might do. It might be simplistic: but in heavy debt – stop increasing borrowing, even cut it; and in rampant inflation – stop increasing spending, even reduce it. There is a valid argument about the details and the priorities (shift taxation from the poor to the rich; stop adding worthy spending [contra-Brown] funded by borrowing; reduce imperial defence postures not in line with our real “mediocrity” of means [Adam Smith]; reduce tax burdens on business and consumption, etc.,). Alongside these sorts of possibilities, don’t continue fantasies of a so-called ‘invisible hand’ of markets, a wholly invented ideology from the Cold War years and nothing to do with Adam Smith.

Why this makes me ‘a right-wing propagandist’ or ‘leftist”, I do not know. Anyway, thanks for your comments.


2:18 pm  
Blogger hettygreen said...

Interesting read in the context of all the current economic angst and hand wringing (faux or otherwise) in Washington these days. Suggest an edit is in order though. Also, something you might care to read/comment on over at Washington's Blog:

3:11 pm  
Blogger Don said...

Gavin, Here's a chart from the BLS:

Does it look to you like there was no reduction in unemployment after FDR was elected?

Secondly, many of the people who influenced FDR's Banking Policies & Economic Policies were not collectivists of any sort.

Thirdly, neither Frank Knight or Jacob Viner, who were both at Chicago in the 1930s, disagree with you about Smith and the Invisible Hand. I've no idea where Samuelson came up with his view, but it wasn't from these guys.

I didn't see a lot of facts in the paper you referenced. I did see a lot of opinions, like 'it was monetary', 'business was cowered', and a counterfactual 'it made things worse'. That's fine. But a lot of things were going on during the 30s that influenced employment and production. The story is actually very complicated.

BTW, I was not serious when I said you'd fallen into that camp. I was pointing out to you that the idea that collectivists captured FDR was wrong and simplistic.

Be well,


4:37 pm  
Blogger Don said...

Gavin, I think you misunderstood the tone of my comments, as well. That was my fault. Don

4:53 pm  
Blogger Gavin Kennedy said...


Many thanks for your comments I was interrupted several times while composing the post and in my fluster missed completely the repetitious rendering of my points.

It did, indeed, need "some editing". Thanks for pointing this out.

The link you provided was read by me in a correspondent's reference to it on from "Naked Capitalism" Blog earlier today. I commented (as I have to Emma) on Emma Rothschild's reference to the "ironic joke" of the metaphor that my correspondent on the Washington Post piece drew to my attention.

Thanks again.


6:09 pm  

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