Dr Patrick Nolan, Chief Economist, Reform
Tomorrow is 81 years since “Black Tuesday,” 29 October 1929, the day when prices on the US stock market collapsed and a range of events were set in motion that led to the Great Depression. This Depression devastated the world economy and some countries did not recover until the late 1930s or early 1940s.
The Great Depression provides lessons for the economic challenges we face today. Yet these differ from those we often hear. In particular, rather than purely being a failure in markets, recent scholarship has shown how policies that reduced competition and labour market flexibility made the Depression longer and more severe. This highlights the real danger of policy that damages the business environment and why, as Rt Hon David Cameron noted this week, encouraging private sector growth must be central to the Coalition’s economic policy.
To explain how government policy extended the Depression it is necessary to look at the detailed policy response in the US. The major policy response, the New Deal, created the system of Social Security in the US, contained steps to build confidence in the banking industry, strengthen banking regulation and curtailed speculation (the Glass-Stegall Act), and strengthen depositor and investor confidence (creating the Federal Deposit Insurance Corporation and the Securities and Exchange Commission).
However, the New Deal also included a National Industrial Recovery Act, which weakened competition laws and allowed industries to collusively increase prices. Although this Act was struck down as being unconstitutional in 1935, the policies of collusion it introduced continued. As Cole and Ohanian noted:
“There was no antitrust activity after the NIRA, despite overwhelming FTC evidence of price-fixing and production limits in many industries, and the National Labor Relations Act of 1935 gave unions substantial collective-bargaining power. While not permitted under federal law, the sit-down strike, in which workers were occupied factories and shut down production, was tolerated by governors in a number of states and was used with great success against major employers, including General Motors in 1937.”
The result was, as Cole and Ohanian go on to argue:
“a deepening of New Deal polices that raised wages even further above their competitive levels, and which further prevented the normal forces of supply and demand from restoring full employment. Our research indicates that New Deal labor and industrial policies prolonged the Depression by seven years.”
This can help explain why, as Milton Friedman has observed, “this was the only occasion in our record when one deep depression followed immediately on the heels of another.”
These findings are, not surprisingly, controversial. A range of other explanations have been given for the severity of the Depression, including the effect of government action following 1929 (or earlier inaction during the 1920s) on the money supply and the reduction in international trade and rise in tariffs following the Smoot-Hawley Act.
Yet what Cole and Ohanian highlight is the importance of the business environment and how a poor business environment can make the chance of a double dip more, not less, likely. To avoid the policy mistakes of the Great Depression we need supply side reforms that encourage competition and flexible labour markets. As Reform argued in our alternative Budget, “This requires broad-based and low rate taxation, deregulation and a flexible labour market. Targeted support for business should be time limited and focused on where the economic case is strongest.”