Lessons from the Depression: Emergency Policies Can Prolong Weakness

Lynne Kiesling

When Steve Horwitz says that we have to control the narrative in the wake of the bailout plan’s approval, here’s one example: following up on a link to a 2004 UCLA press release, I found this paper:

“New Deal Policies and the Persistence of the Great Depression: A General Equilibrium Analysis”

Harold Cole and Lee Ohanian, UCLA

Journal of Political Economy Vol. 112, No. 4 (2004), pp. 779-815

Abstract: There are two striking aspects of the recovery from the Great Depression in the United States: the recovery was very weak, and real wages in several sectors rose significantly above trend. These data contrast sharply with neoclassical theory, which predicts a strong recovery with low real wages. We evaluate the contribution to the persistence of the Depression of New Deal cartelization policies designed to limit competition and increase labor bargaining power. We develop a model of the bargaining process between labor and firms that occurred with these policies and embed that model within a multisector dynamic general equilibrium model. We find that New Deal cartelization policies are an important factor in accounting for the failure of the economy to recover back to trend.

In English: Cole and Ohanian find that policies meant to cushion the effects of the Great Depression by raising wages actually prolonged it. Recovery was weak and prolonged, and wages were higher than is consistent with the levels of labor productivity at the time. Policies that did not allow wages to adjust downward contributed to the weakness of the recovery.

The origins of these “cartelizations” and higher-than-optimal wages were in the National Industrial Recovery Act (NIRA), one of the New Deal provisions that President Roosevelt implemented in 1933. NIRA relaxed antitrust prosecutions and encouraged labor’s collective bargaining with employers until the Supreme Court declared it unconstitutional in 1935. But the high wages persisted; why?

On May 27, 1935, the Supreme Court ruled that the NIRA was an unconstitutional delegation of legislative power, primarily because of the act’s suspension of the antitrust laws. Roosevelt opposed the court’s decision: “The fundamental purposes and principles of the NIRA are sound. To abandon them is unthinkable. It would spell the return to industrial and labor chaos” (quoted in Hawley [1966, p. 124]). This subsection shows that the government continued anticompetitive policies through new labor legislation and by ignoring the antitrust laws.

The primary post-NIRA labor policy was the NLRA [National Labor Relations Act — LK], which was passed on July 27, 1935. The act gave even more bargaining power to workers than the NIRA. The NLRA gave workers the right to organize and bargain collectively through representation that had been elected by the majority of the workers. It prohibited management from declining to engage in collective bargaining, discriminating among employees on the basis of their union affiliation, or forcing employees to join a company union. The act also established the National Labor Relations Board (NLRB) to enforce the rules of the NLRA and enforce wage agreements. The board had the authority to directly issue cease and desist orders.

The NLRB exists to this day.

These New Deal “bailout” policies were labor-related, not financial-related, but there’s still an embedded lesson: policies designed to cushion and modulate natural feedback effects in economic processes can have negative unintended consequences, and can prolong downturns. It happened in the 1930s when New Deal policies prolonged and weakened those feedback effects, and it can happen again today.

An ungated version of the Minneapolis Fed working paper version is available.

Hat tip to Glenn Reynolds for the original link, and I second his recommendation of Amity Shlaes’ The Forgotten Man: A New History of the Great Depression.

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