EH.net is owned and operated by the Economic History Association
with the support of other sponsoring organizations.

The Defining Moment: The Great Depression and the American Economy in the Twentieth Century

Author(s):Bordo, Michael D.
Goldin, Claudia
White, Eugene N.
Reviewer(s):Cain, Louis P.

Published by EH.NET (September 1998)

Michael D. Bordo, Claudia Goldin, and Eugene N. White, editors, The Defining

Moment: The Great Depression and the American Economy in the Twentieth

Century. An NBER Project Report. Chicago: The University of Chicago

Press, 1998. xvi + 474 pp. $60.00 (cloth). ISBN: 0-226-06589-8

(cloth), 0-226-06589-8 (paper).

Reviewed

for EH.NET by Louis P. Cain, Departments of Economics, Loyola University of

Chicago and Northwestern University.

The “moment” is the Great Depression; what is being “defined” is public policy.

The editors have assembled twelve papers from a distinguished cast of authors

who are closely associated with their subject. The papers discuss almost all

of the programs that persisted from the First and,

particularly, the Second New Deals, but few of those that did not. In their

introduction,

the editors discuss that this is potentially a controversial hypothesis, but

most of the papers simply explain why they agree or disagree with the

proposition, and some do find this was NOT a

“defining moment.” Whether each reader ultimately accepts or

rejects the hypothesis may be little more than a matter of definition.

In any event, each of the papers makes a substantial contribution to our

understanding of the depression. Most will be widely cited. Many readers,

including undergraduates, will want to consult the volume for more than one

paper. Thus, in the interest of disclosure, a thumbnail sketch of each of the

papers is appropriate. These brief synopses emphasize the relation of each

paper to the volume’s general theme. Each contains much more.

The

collection is divided into four sections of three papers each. The first is

entitled “The Birth of Activist Macroeconomic Policy.” Charles Calomiris

and David Wheelock ask whether the substantial changes in the monetary

environment of the 1930s had lasting effects? Those familiar with Wheelock’s

work will not be surprised to note they find little change in the thinking of

the Federal Reserve System. One effect of the New Deal banking laws was to

shift power from the Fed toward the Treasury,

a shift they feel imparted an inflationary bias, especially when conjoined with

the more activist approach to policy that was undertaken concurrently. The

most important legacy of the depression was the departure from gold creating

“the permanent absence

of a ‘nominal anchor’ for the dollar” (63).

The Bretton Woods dollar system allowed the Fed to “stumble” into the inflation

of the 1960s, and the continued absence of something like the gold standard

“provides an enduring legacy of uncertainty” (63) as to monetary policy in the

long run.

Brad De Long notes that the U.S. did not have a fiscal policy

in the

contemporary sense of the term before the Great Depression. It borrowed

heavily during periods of war and tried to redeem the debt as quickly as

possible during periods of peace. Government deficits in peacetime were rare

until

the 1930s, when they proved unavoidable despite the fiscal conservatism of both

Hoover and FDR. Yet, even before Keynes, there was an understanding that

“deficits in time of

recession helped alleviate the downturn” (83). After the second World War, a

fiscal policy consensus emerged that De Long characterizes as: “set tax rates

and expenditure plans so that the high-employment budget would be in surplus,

but do not take any steps to neutralize automatic stabilizers set in motion by

recession” (84).

That consensus proved hard to maintain: “The U.S. government simply lacks the

knowledge to design and the institutional capacity to exercise discretionary

fiscal policy in response

to any macroeconomic cycle of shorter duration that the Great Depression

itself” (82). What has persisted is the willingness to adopt a fiscal policy

stance that imposes a cost — perhaps higher than necessary (higher inflation,

lower saving and productivity) — to insure that there is no return to

Depression-era conditions.

Deposit insurance, the topic of Eugene White’s essay, was a result of the

Depression and is generally considered to be one of its great successes.

Banks became a scapegoat, and the

restrictions placed on the banking business diverted part of what they once

did to other parts of the financial sector. Banking became smaller than it

might have been. Deposit insurance was an attempt to insure the banking system

did not fail again.

White attempts to estimate bank failures under the assumption that deposit

insurance was not adopted. He finds that a stronger, larger banking system

would have resulted in lower failure rates and higher recovery rates.

Thus, it is possible the FDIC increased bank losses. A more important outcome

is that the FDIC changed the distribution of losses. The cost of those losses

is now “distributed to all depositors and hidden in the premialevied on banks”

(119). Thus, even if losses increased, they were unseen by individual

depositors, with the result that a marginal institution remains extremely

popular.

The second part, “Expanding Government,” begins with a paper by Hugh Rockoff on

the expansion of the government sector, largely as a result of a large number

of new federal programs. As Rockoff notes,

“it is easy to see that there was an ideological shift … it is harder to see

what produced it” (125). This ingenious article looks back at the publications

of economists in the 1920s and earlier and finds there were champions for

almost all of the New Deal programs. Curiously, one of the programs economists

did not endorse, one measure that FDR did not champion, was deposit insurance.

When the Depression came and the economic doctors were called, microeconomists

had what they considered successful prescriptions. Some part of that must have

been conditioned by the role of the government in World War I. But another

part is something that Rockoff does not discuss, and it surely is one of the

factors producing an ideological change within the profession.

Even before the Great Depression, the competitive paradigm was under attack.

The merger movement at the turn of the century called into question the

assumptions of constant returns to scale and easy entry and exit. The

emergence of a consumer society called into question the assumption of

homogeneous products. Robinson and Chamberlin’s models are independent of the

Depression, and what impact they would have had in the absence of the

Depression is unclear. It is clear that FDR came into the White House with a

mandate to do something, and the economic doctors had a long list of things to

try, things that had been used successfully elsewhere.

John Wallis and Wallace Oates argue persuasively that the New Deal had a

profound effect on the nature of American federalism through its use of a

little used fiscal instrument — intergovernmental grants. Before the

Depression, different levels of government operated with a much greater degree

of independence than they would thereafter. Intergovernmental grants created

the necessity for cooperation that has characterized the fiscal federalism ever

since; “fiscal centralization and administrative decentralization” (170). They

argue that the new structure was conducive to the growth of government. Like

Rockoff, they note the growth of the federal government did not come at the

expense of state and local governments; both grew. They show how this new

pattern was “the result of the struggle between state and national

governments, and also between the president and Congress, for control over

these programs” (178). How much of this has to do with a states rights’ bias

in the legislative and judicial branches, and how much with the depression

itself, is uncertain.

Gary Libecap examines the regulatory laws effecting agriculture between 1884

and 1970 and the budgetary expenditures that were derived from those laws

between 1905 and 1970. His contention is that “the New Deal increased the

amount and breadth of agricultural regulation in the economy and …

shifted it from providing public goods and transfers to controlling supplies

and directing government purchases to raise prices” (182).

Acreage restrictions and government purchases were the most apparent of what

he terms, “unprecedented, peacetime government intervention into agricultural

markets” (216). Abstracting from those policies, Libecap asks what

agricultural policy might have been in the absence of the Depression.

He believes it would have been more like it had been, but that is the result

of an exercise in which he subtracts laws passed after 1939 with a direct link

to “key New Deal statutes.” One wonders how many any of those statutes would

have been passed in any event; some represent ideas that pre date the

depression.

In the first paper of Section III, “Insuring Households and Workers,”

Katherine Baicker, Claudia Goldin, and Lawrence Katz note that there are three

differences between the system of unemployment compensation in the U.S. and

elsewhere: experience rating, a federal-state structure, and limitations on

benefit duration. The question they address is how that system would have been

different had it not been created during the New Deal. There is an implicit

assumption the U.S. ultimately would have adopted some form of unemployment

compensation in the absence of the Depression. To how many other New Deal

programs is this assumption relevant? The authors point to the federal-state

structure as the key difference. Their counterfactual

system is strictly a federal system with no experience rating, a system

consistent with the administration’s recommendation. We got the system we did

because, “The federal-state structure and the manner in which the states were

induced to adopt their own

UI legislation assured passage of the act and guaranteed its

constitutionality” (261). They criticize the system for not having

“changed with the times,” but that is no surprise after reading Wallis and

Oates.

While most people look to the labor legislation of the 1930s as “a defining

moment,” Richard Freeman argues that to be defining an event must “lock in

certain outcomes that persist … when, given a blank slate, society could have

developed something very different” (287). This test creates two interesting

dichotomies in Freeman’s story. The first concerns the framework versus the

results. The legal framework for private sector labor relations has persisted,

and Freeman considers that framework to be

“outmoded.” On the other hand, the unionization attendant to the adoption of

that framework “looks more like a diversion from American

‘exceptionalism’ … than a critical turning point in labor relations”

(287). The density of private sector unions today is similar to what it was

just after the

turn of this century; the voice of those unions in national political discourse

is barely audible. The second dichotomy concerns private versus public unions.

State regulation of the latter has resulted in a relatively stable environment

in which collective bargaining proceeds with less confrontation, but that may

be because public sector managers are not as accountable to the taxpayers as

private sector managers are to the company’s profits. In sum, Freeman

acknowledges that the framework in which lab or relations takes places was

defined during the Depression, but that was not a “defining moment” for labor

relations.

In their study of the creation and evolution of social security, Jeffrey Miron

and David Weil do not examine the role the Great Depress ion might have played

in the program’s adoption. Their emphasis is on the evolution of the program

since its inception. They find that “in a mechanical sense,

there has been a surprising degree of continuity in social security since the

end of the Great

Depression” (320). That is, there has been little change in what each of the

parts does; it is clear the balance between them has changed and that change

has had an impact on the economy. As the population has aged, the balance

between the old-age assistance component,

the basic response to the depression, and the old-age and survivors insurance

component has transformed what was an insurance program benefiting few to a

transfer program benefiting many.

Doug Irwin’s paper on trade policy begins the final section, “International

Perspectives.” Irwin shows that, during the 1930s, the locus of control of

trade policy passed from the legislative to the executive branch of government

largely as a result of “the depression as an

international phenomenon”

(326). Smoot-Hawley marked the end of the old approach. By the end of the

1930s, the average tariff rate had decreased from over 50% to less than 40%.

In another ten years it would be below 15%. While part of this change is

attributable to trade policy,

part should be attributable to fiscal policy (a return to the days of the

Underwood tariff) as the federal income tax came to play a much larger role,

especially in the 1940s. Similarly, the Reciprocal Trade Agreements Act was

passed during the depression, but it was not “institutionalized”

until after World War II. When, during the war, Republicans moved to seek

congressional approval and to protect domestic firms competing with imports, it

was clear that the policy changes of the 1930s would persist. Then, after the

war, “the new economic and political position of the United States in the world

… made a return to Smoot-Hawley virtually unthinkable” (350).

The paper by Maurice Obstfeld and Alan Taylor is in many ways the most

expansive in the volume. They begin by investigating more than a century of

data on capital mobility, then propose a framework in which both the downtrend

initiated by the Great Depression and the uptrend of recent years can be

understood. The framework is a policy “trilemma” faced by all national

policymakers: “the chosen macroeconomic policy regime can include at most two

elements of the ‘inconsistent trinity’ of (i) full freedom of cross-border

capital movements, (ii) a fixed exchange rate, and (iii) an independent

monetary policy oriented toward domestic objectives” (354). To the authors,

the

Great Depression was caused by subordinating the third element to the second.

Under the classic gold standard, monetary policy was concerned with exchange

rate stability, not

domestic employment, and capital mobility was facilitated. The abandonment of

gold led to a system

“based on capital account restrictions and pegged but adjustable exchange

rates, one whose very success ultimately led to increasingly unmanageable

speculative flows and floating dollar exchange rates….” (397).

The gold standard plays an equally prominent role in the paper by Michael Bordo

and Barry Eichengreen. To address the question of what the Great Depression

meant for the international monetary sy stem, they examine a counterfactual

world without the Great Depression — but with World War II and the Cold War.

They assume the gold standard would have persisted through the 1930s, been

suspended during the war, and resumed in the early 1950s. Under

these assumptions, “the depression interrupted but did not permanently alter

the development of international monetary arrangements”

(446). The system that did develop in the U.S. was very different than the

hypothesized one, but the factors that ultimately led to the collapse of the

Bretton Woods arrangements would have caused the collapse of the gold standard

– and possibly at an earlier date. Those factors include “the failure of the

flow supply of gold to match the buoyant growth of the world economy and hence

of government’s demand for international reserves” (447).

This, in turn, led to questions about U.S. official foreign liabilities and the

gold convertibility of the dollar. Bordo and Eichengreen believe that,

in these circumstances, a floating system would have resulted leaving us with

more or less what we have today. If one accepts the “ifs” in their argument,

the institutional structure that emerged in the wake of the Great Depression

postponed the transition.

This is a remarkable thought on which to end this volume. Calomiris and

Wheelock discuss the Fed’s recent emphasis on price stability as a short-run

policy concern as a “throwback.” Obstfeld and Taylor discuss the deregulation

and recent growth of the financial sector as creating

a barrier to the reimposition of capital controls. Both discussions concern

long-run adjustments the economy has made as a result of the abandonment of

gold, but both would have taken place had there been no Great Depression if

Bordo and Eichengreen are

correct.

The editors point to four common themes supporting the “defining moment”

hypothesis (6). “First, skepticism about the efficacy of government

intervention withered as the public adopted the attitude that the government

could ‘get the job done’

if the free market did not.” It is unquestionably the case that there was a

loss of faith in the tenets of the competitive model. While this faith was

wavering among social scientists well before the depression, the general

bewilderment of the 1930s created a search for someone who was willing to try

anything. To paraphrase the late John Hughes, before the Great Depression the

federal government only knew how to spend money on rivers, harbors, and post

offices. As Rockoff documents, there were a number of other projects waiting

in the wings.

“Second, many innovations introduced by the New Deal were forms of social

insurance.” While much of the First New Deal took the form of World War I

programs modified for peacetime use, many of the Second New Deal programs were

aimed at ameliorating specific types of suffering, particularly those where

successful experiments had been tried elsewhere. Some undoubtedly would have

been adopted eventually; the depression meant they started earlier than

otherwise would have been the case.

“Third, the character of federalism moved from ‘coordinate’ to

‘cooperative’ with extensive intergovernmental grants, giving greater influence

to centralized government.” This change in form, it is argued,

was necessary to get them through Congress and the Supreme Court, but that is

not necessarily a result of the Great Depression; the states rights’ bias was

present much earlier.

“Last, the conduct of economic policy … changed to give more weight to

employment targets and less

to a stable price level and exchange rate.”

These changes in turn imparted what several authors refer to as a bias in favor

of inflation, but, in a simple Phillips curve world, what developed was a bias

against a return to the conditions of the 1930s. To put it as simply as

possible, those who lived through the Great Depression defined for

policy-makers then and for their grandchildren today that all possible steps

should be taken to avoid repeating the trauma.

Louis P. Cain Departments of Economics Loyola University of Chicago and

Northwestern University

Louis Cain and the late Jonathan Hughes are the authors of American Economic

History published by Addison Wesley. Cain’s article with Dennis Meritt,

Jr., “The Growing Commercialization of Zoos and

Aquariums,”

appeared in the Journal of Policy Analysis and Management, Spring 1998.

His article with Elyce Rotella, “Urbanization, Sanitation, and Mortality in the

Progressive Era, 1899-1929,” will appear in Gerard Kearns, W.

Robert Lee, Marie C. Nels on, and John Rogers, editors, Improving the

Public Health: Essays in Medical History.

Subject(s):Economic Planning and Policy
Geographic Area(s):North America
Time Period(s):20th Century: Pre WWII

Guns, Germs and Steel: The Fates of Human Societies

Author(s):Diamond, Jared
Reviewer(s):Mokyr, Joel

EH.NET BOOK REVIEW

Published by EH.NET (May 1998)

Jared Diamond, Guns, Germs and Steel: The Fates of Human Societies. New York: W. W. Norton, 1997. 480 pp. $27.50 (cloth), ISBN: 0-393-31755-2.

Reviewed for EH.NET by Joel Mokyr, Departments of Economics and History, Northwestern University.

Jared Diamond is a physiologist and evolutionary biologist with a passion for archaeology and linguistics. That, by itself, should seem to make him irrelevant to economic history. Yet his widely read and admired recent book, honored last month with a Pulitzer Prize, is one of the more important contributions to long-term economic history and is simply mandatory to anyone who purports to engage Big Questions in the area of long-term global history. He starts off his account with what he calls “Yali’s question.” Yali is a New Guinea notable, who one day poses to the author the question why white people have so much ‘cargo’ (western manufactured goods desired by New Guineans), but New Guinea produces no cargo that Westerners are interested in.

Indeed, the question of questions. Diamond joins such heavyweights in economic history as Eric Jones, Douglass North, Nathan Rosenberg, and recently David Landes in asking why “we” are so rich and “they” are so poor. Is it institutions? Culture? Technology? Religion? Diamond does not reject any of these answers altogether, but instead formulates models in which they become endogenous variables. The real exogenous variable, when all is said and done, is geography. Diamond, to put it bluntly, is a geographical determinist. The shape and location of continents, flora, fauna, microbes, water, climate, topography, all are truly exogenous to history. The rest is endogenous.

Geography has of course a terrible reputation. David Landes, in Wealth and Poverty of Nations (New York, 1998) starts off by recounting how geography departments were closed around the country without a tear, and notes that “no other discipline has been so depreciated and disparaged.” Simple models that submit that “Britain had an Industrial Revolution because it had coal” have long been abandoned. Yet before we dismiss this as another simplistic model, we have to face the fact that Diamond knows his stuff inside out, to the point where any thought of using the adjective “crude” (traditionally preceding “determinist”) evaporates as we turn the pages. Diamond fires off a barrage of facts and observations based on half a dozen disciplines most economic historians this side of Eric Jones are unschooled in: archaeology, botany, linguistics, anthropology among them. The story he tells is one of a trajectory in which the world’s population bifurcated for geographical reasons. Once on different paths, Africa, America, and “Eurasia” diverged more and more through positive feedback effects, in which geography fed into technology, technology fed into power structures and culture, feeding back into technology and growth until we got a world of Western economic hegemony. Such “autocatalytic” models which view economic history as a disequilibrium process once were shunned by the neoclassical cliometric orthodoxy. Today, thanks to the efforts of scholars as diverse as Douglass North and Paul David, we are getting used to them, and the intellectual gains are substantial.

What, then, are the geographical factors that Diamond thinks determined the course of economic history? Above all, it is that human wealth and success depends on interaction with the environment. Economic history in his view is a game against nature, not primarily a social process. Production– especially in agriculture– depends on the geographical hand we have been dealt. Yet Diamond’s emphasis is not on soil fertility and minerals as in the writings of most geographers, but on the ability of homo sapiens to domesticate plants and animals. His view is that all societies and cultures have approximately similar abilities to manipulate nature, but the raw materials with which they had to work were different. Diamond points out in his witty prose that domestic animals are much like Tolstoy’s view of happy marriages: all happy marriages are the same, each unhappy marriage is different in its own way. Domesticable animals are all domesticable in the same way, but recalcitrant animals are all different. To exploit large animals for food, energy, or other services, domesticable wild animals need to exist, a condition that did not obtain in Precolumbian America (where the arrival of homo sapiens 13,000 years ago had led apparently to their extinction). But even if they existed, they needed to satisfy some conditions such as being able to breed in captivity, safe for children and other living beings, and so on. He argues, with great conviction, that the hippos and giraffes of Africa, the jaguars of the Amazon, and the kangaroos of Australia did not meet those conditions. The domesticated llamas, turkeys, and dogs of America could not pull it off either. Eurasia, on the other hand, was lucky enough to have had the wild animals from which our cows, sheep, horses and chickens could be bred. This gave the Europeans huge advantages, not only in terms of the development of technology (e.g. mixed farming and wheeled transport) but also in providing them eventually with immunity against infectious diseases caused by the proximity of these animals. When they then established sudden contact with non-Europeans, the “Plagues and Peoples” effect simply overwhelmed the unprepared victims.

A similar and perhaps less well-known effect occurred with respect to domesticable plants. Eurasia was simply lucky in that its environment provided a much larger stock of plants that lent themselves to domestication, and plants that had better quality in terms of the nutrients supplied, resistance to disease, ease of cultivation and so on. Botanical wealth, constrained by the local flora, determined agriculture, agriculture determined everything else, says Diamond. Eurasia won because the supply of wild plants that provided the gene pool for domesticated crops was larger, richer, and better. If you feel that this is a bit simplistic, read his chapters on “How to Make an Almond” and “Apples and Indians.” It is a serious, informed, and well-thought out argument, and if in the end we are not wholly convinced, thinking of how to refute Diamond will make us wiser and better informed.

Diamond’s argument makes serious use of counterfactuals, to the point of wondering in the last chapter what would have happened if a German truck driver in 1930 would have hit his brakes a second later and killed Hitler in a head-on collision. But in the chapters on agriculture his imagination abandons him. How much of the performance of non-Europeans was really constrained by their environment and how much their own making? In Diamond’s view, the answer is “all and nothing.” Yet one can imagine crops that were manipulated and selected to produce crops that are as unimaginable to us as poodles and sweet corn would have seemed 10,000 years ago. Take one example: among the disadvantages that the indigenous plants of what is now the Eastern U.S. suffered from is a lack of founder crops. Yet he does concede that some of them on the surface could have done nicely, such as a flower named sumpweed, “a nutritionist’s ultimate dream” with 32 percent protein. Sumpweed, Diamond explains, did not make it to the rank of corn, potatoes, and rye because it causes hayfever, does not smell good, and handling it can cause skin irritation (p. 151). Are we really sure that these vices could not have been bred out of them? After all, all domesticated plants had originally undesirable characteristics, but through deliberate and lucky selection mechanisms they eventually got over them. Wheat, rye, and maize, which feed much of the world’s population, all had humble beginnings. Diamond points out that much of our ability to improve plants depended on whether certain characteristics were the result of epistatic effects, that is, caused by more than one gene. People could select for a particular trait as long as it was caused by one of very few genes; if it was controlled by many genes, breeding specimens that displayed the traits would be unlikely to fix it in the population. But apart from a few examples, Diamond does not persuade us that this lay at the heart of the geographically challenged societies.

A somewhat similar problem exists with Diamond’s view of technology. In a chapter cleverly named “Necessity’s Mother” he notes the many links between geographical constraints and technical options. Why would a society produce wheels if it had no horses or oxen to pull them? Wheelbarrows and rickshaws might have been an option, but maybe draft animals came first. Not all questions can be answered that way: some indigenous populations in America might have built seaworthy ships, or managed to develop some technology we cannot imagine today. If they did not, is this because they tried but failed, or because they never tried?

Yet Diamond points out two elements that suggest that links between geography and technological progress may be significant. One is that geography constrains mobility of knowledge. Assume, somewhat implausibly, that the idea of a wheelbarrow only occurred to one person in history, but that it spread to people seeing their neighbors use. If this happened in Central Asia, it may well have reached China, France and Yemen in a few centuries, but before 1500 it would never get to America or Australia. Agricultural technology, he notes, also diffuses easier from East to West than from North to South, as changing longitude has a stronger effect on climate and seasonality than changing latitude– giving Eurasia an advantage over America and Africa. Furthermore, Diamond resurrects the late Julian Simon’s argument that technological success depends on population density and the ability of a society to produce a surplus beyond subsistence, so that there are resources available for thinking and experimenting. Maximum population density was largely a function of the ability of the environment to feed the population. Writing, for instance, required large and dense settlements with complex hierarchical institutions, much different from hunting and gathering tribes.

The notion that much economic history is a game against nature, in which people form certain views about its regularities and use these to manipulate them to improve material conditions is a powerful one. Diamond’s insight is that nature differs from place to place and that certain environments are easier to manipulate than others. The economic historian must add two qualifications to this. One is that environments can be manipulated or abandoned. While Diamond describes in detail pre-historic population movements (which he deduces from linguistic evidence), he does not realize that he tells the story of regions, not necessarily of people who always had the option to move to a more generous and flexible area. Secondly, it could be argued that much technology emerges precisely because the environment is not generous and requires hard work and ingenuity. What is the partial derivative of technological creativity with respect to initial geographical endowment? In the final analysis, this is still unknown.

The book is full of other clever arguments about writing, language, path dependence and so on. It is brimming with wisdom and knowledge, and it is the kind of knowledge economic historian have always loved and admired. If you teach economic history, any kind of economic history, go read this book. Or else you are taking a serious risk that a clever undergraduate who has read it will ask you a question you don’t know the answer to. Nothing worse is imaginable, short of organizing a world conference and canceling at the last moment.

Joel Mokyr Departments of Economics and History Northwestern University

Joel Mokyr is author of The Lever of Riches: Technological Creativity and Economic Progress (Oxford University Press, 1990).

?

Subject(s):History of Technology, including Technological Change
Geographic Area(s):General, International, or Comparative
Time Period(s):General or Comparative