Saturday, October 18, 2008

The Great Depression: what really happened?

Jon Taplin points to a fascinating article on the Great Depression by James Livingston. As ever with this topic it raises as many questions as it answers, but it makes for interesting reading:

...the Great Depression was the consequence of a massive shift of income shares to profits, away from wages and thus consumption, at the very moment—the 1920s—that expanded production of consumer durables became the crucial condition of economic growth as such.

This shift produced a tidal wave of surplus capital that, in the absence of any need for increased investment in productive capacity (net investment declined steadily through the 1920s even as industrial productivity and output increased spectacularly), flowed inevitably into speculative channels, particularly the stock market bubble of the late 20s;

when the bubble burst—that is, when non-financial firms pulled out of the call loan market in October—demand for securities listed on the stock exchange evaporated, and the banks were left holding billions of dollars in “distressed assets.”

The credit freeze and the extraordinary deflation of the 1930s followed; not even the Reconstruction Finance Corporation could restore investor confidence and reflate the larger economy.
Livingston basically seems to be arguing that Milton Friedman's view of the Great Depression as being exacerbated by government intervention was incorrect.

Livingston also argues a fundamental idea of supply-side economics (as advocated by Reagan et al) is incorrect.

The idea is that if you cut taxes on the rich they will use the additional money to invest in new factories, research, job-creation and infrastructure.

It seems they don't, and in fact invest in speculative (often property-based) securities, and create a speculative bubble. According to James Livingston:

The “underlying cause” of the Great Depression was not a short-term credit contraction engineered by central bankers who, unlike Ferguson and Bernanke, hadn’t yet had the privilege of reading Milton Friedman’s big book. The underlying cause of that economic disaster was a fundamental shift of income shares away from wages/consumption to corporate profits that produced a tidal wave of surplus capital that could not be profitably invested in goods production—and, in fact, was not invested in good production.. In terms of classical, neoclassical, and supply-side theory this shift of income shares should have produced more investment and more jobs, but it didn’t.

Livingston claims that during the 1920s the growing demand for consumer durables meant that massive economic growth was created with almost no investment in factories or job-creation.

At the same time weaker trade-unions meant the owners of capital could increase their share of revenue at the expense of workers.

So profits went up, but wages didn't. As increasing the wages of consumers was the only practical way of growing consumption, this lead to problems.

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