New Takes on the New Deal

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Interesting dialog between Arnold Kling and Brad DeLong on the legacy of the New Deal


New Takes on the New Deal
February 7, 2007
When it released its budget proposal Monday, the Bush administration -- and its congressional critics -- focused anew on the country's giant Social Security program. Treasury Secretary Henry Paulson has said "significant political differences" will make it tough to close the gap expected to develop between contributions to Social Security and promised benefits.

The roots of those differences stretch back some 70 years, to President Franklin D. Roosevelt, who introduced Social Security in 1935 as a plank in his New Deal economic recovery program. Economists have long debated how effective the New Deal was. Now as the country again considers its fiscal priorities, WSJ.com asked economists Arnold Kling, an adjunct scholar with the Cato Institute and Brad DeLong, a professor of economics at the University of California, Berkeley, to type out their different takes on FDR's deal.

What do you think? Share your comments on our discussion board.

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Brad DeLong writes: Imagine the press discovered and published the extent of FDR's polio injuries and details of his irregular family life. Herbert Hoover is reelected in November 1932 and vows to "stay the course" with his first-term economic policies. In that alternate universe, a group of Harvard economists advises Mr. Hoover on the banking crisis in the winter of 1933. They argue that banks are failing because their fundamentals are unsound, and that it would be improper to rescue bankers who have run their businesses into the ground or depositors who have not been prudent enough to watch where they deposit their money. They say a full-fledged panic would not be a bad thing, as it would purge the rottenness from the system. High costs of living -- and high living itself -- will be tamed. People will work harder and live cleaner. Values will be adjusted and enterprising people will pick up the wrecks from less the competent.

It wouldn't have worked. People would not just work harder and live cleaner. Instead -- using Ben Bernanke's 1983 analysis of the Depression as a guide -- we could surmise that the depression would have gotten worse. (Other excerpts from Bernanke's research)

Under our imagined scenario, more and more banks would fail and more and more of the deposits of Americans would vanish. The downward spiral of economic activity would have continued through 1933, 1934, and 1935. We can guess that increasing economic uncertainty would drive faster gold outflows from the U.S. through 1933 and 1934. The Federal Reserve -- under Treasury Secretary Andrew Mellon's control -- would have responded by following gold standard orthodoxy, which interprets the outflow of gold is a sign interest rates are too low and need to be raised. Rising interest rates would have further cut money supplies. The falling money supply was a key way the depression spread, according to Milton Friedman and Anna Schwartz's "Monetary History of the United States." Under our imagined scenario, the Depression would have been worse than it was in our actual history.

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Arnold Kling writes: What would have happened in the U.S. without the New Deal? My father answers with one word: Fascism.

Given the climate of the time, which included intense despair alongside revolutionary fervor, a government that was seen as doing nothing could not have survived. When it comes to perspective on the Great Depression, I have a lot of respect for the views of people who, like my father, lived through it. I also have a lot of respect for the views of Brad DeLong, who is an authority on macroeconomics and economic history. Randall Parker's Reflections on the Great Depression, is based on interviews with eminent economists who lived through it. As I have pointed out, the consensus is that the New Deal failed to restore the economy back to full health.

Unemployment and what we would now call the "output gap" were still unusually high in 1940, after which our statistical perspective becomes distorted by the fog of war. In Parker's book, economists tended to give mixed -- and sometimes surprising -- reviews to New Deal policies. Milton Friedman, the recently-deceased Nobel Laureate who was famous for his opposition to Keynesian expansion of government, and many New Deal programs -- approved of "the series of monetary measures that Roosevelt took, including the bank holiday, the going off gold, the program to purchase gold, the silver purchase program." Even James Tobin, a leading Keynesian, was critical of the National Recovery Administration and other New Deal programs that promoted cartels and restrictions on supply.

Another useful perspective comes from the current Fed Chairman. Ben Bernanke's Essays on the Great Depression, which makes the point that financial intermediaries matter, and that the wave of bank failures might have been a major factor in the Depression. This may seem obvious, but Bernanke's views contrast with those found in the sterile models of economists, where funds flow immaculately from savers to investors. All of that is very interesting to professional economists. But what I think is relevant to ideological debates today is this: Are Social Security, farm price supports, Federal Housing programs, legalization of trade unions, securities market regulation, and other major legacies of the New Deal necessary for macroeconomic stability? What did they contribute to recovery in the 1930s? What do they contribute today? Over to you, Brad.

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Brad DeLong writes: Arnold wants to talk about the legacy of institutions created in the New Deal. For example, do we really need a Securities and Exchange Commission in the form it was cast in 1933 and 1934? Back then everybody -- unfairly -- blamed Wall Street for the Great Depression. Of course, there was some financial chicanery. Take executive Albert Wiggin of Chase National Bank, who massively shorted Chase's stock and gave himself a financial windfall.

Still, financial markets only work well when they find and transmit information about the likely future of companies and industries and bake information into prices. To do that, there must be incentives for uncovering important scraps of information and clear lines between what you can and can't do -- that is, between research and illegitimate insider trading.

J. Bradford DeLong is professor of economics at the University of California at Berkeley, co-editor of the Journal of Economic Perspectives, a research associate at the National Bureau of Economic Research and visiting scholar at the Federal Reserve Bank of San Francisco. He was deputy assistant secretary of the Treasury for economic policy from 1993 to 1995, where he worked on the federal budget and trade issues. His major current projects are two books: an intermediate macroeconomics textbook and an economic history of the 20th century. He received his master's and doctorate at Harvard University. He writes regularly for his blog, Brad DeLong's Semi- Daily Journal.
Arnold Kling is an adjunct fellow with the Cato Institute. His most recent book is "Crisis of Abundance: Rethinking How We Pay for Healthcare," published by Cato in 2006. He has worked for the Federal Reserve Board and the Federal Home Loan Mortgage Corporation. He founded Homefair.com, one of the first commercial Web sites, which was bought out in 1999 at the height of the Internet bubble. Since 2000, he has taught high school economics and statistics as a volunteer. His personal Web site is arnoldkling.com. His economics blog is EconLog. He writes frequently for TechCentralStation.com, and he has published two books: "Learning Economics" and "Under the Radar: Starting Your Internet Business Without Venture Capital." He has a doctorate in economics from the Massachusetts Institute of Technology.The SEC has always found it tough to draw such a clear line. That's because its crisis origins have led it to focus on a different, though important, problem: shoring up investor confidence. Besides transmitting information, markets need to bundle great masses of savings from scattered individuals. To do that, investors must be confident investments can be bought and sold fairly. This doesn't work if you buy a share of a company from the corporate director's cousin, who happens to know the firm's market share collapsed during quarter. It also doesn't work if you sell a drug company's shares to someone who knows that, say, the latest test of a potential blockbuster treatment was extremely encouraging.

Financial regulation is a balancing act. And some worry that New Deal left us with a system that's too focused on leveling the field for buyers and sellers, and not focused enough on having the best informed buyers and sellers in the market. That, in turn, might give too much power to entrenched managers and not enough power to insurgent financiers.

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Arnold Kling writes: The New Deal is a mythical event in history. Just as we revere the constitution as the basis for our government and we revere Abraham Lincoln for ending slavery and preserving the union, we are supposed to revere the New Deal as somehow providing the basis for our modern prosperity. Yet the policies of the New Deal are quite a mixed bag, to say the least. Most were discarded by 1950. The survivors include agricultural policies that were almost certainly wrong then and are almost certainly wrong now. Most of the financial regulations, such as interest rate ceilings on bank deposits, proved unworkable by the 1970s. Social Security, and its offspring Medicare, are going to be the next great financial crisis in this country.

I would argue that deposit insurance -- which was adopted nationwide in 1933 -- was the most constructive of all of the New Deal reforms. But even it was badly handled. Ill-conceived accounting standards, capital standards, and supervisory rules created tremendous moral hazard in the deposit insurance system, in spite of warnings from economists. This barn door was not closed until the Savings and Loan Crisis of the early 1980s, which cost taxpayers upward of $175 billion.

Social Security was set up as an intergenerational transfer from those of working age to the elderly. But its soundness has been undermined by improvements in longevity and reductions in fertility. For a relatively nonpartisan critique, see Daniel Shaviro's new book. Medicare, enacted in 1965 in the spirit of the New Deal, adopted the transfer mechanism of Social Security. Because of its sensitivity to secular trends in medical technology and the demand for medicine, Medicare is in even worse shape than Social Security. Just as economists knew in the 1960s and 1970s that deposit insurance was badly structured, we know that Social Security and Medicare constitute a fiscal time bomb. However, the mythical status of the New Deal has handcuffed efforts at needed reforms.

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Brad DeLong writes: I agree with Arnold that deposit insurance was badly handled. But even badly-handled, it was a big improvement over none at all. In fact, that's a good thumbnail summary of the entire New Deal: badly-handled, but a vast improvement. (That is, with the exception agricultural subsidies and the National Recovery Administration. They did little good -- if any -- at immense long-run cost.)

Arnold writes: "Social Security, and its offspring Medicare, are going to be the next great financial crisis in this country." Let me protest the phrase "its offspring, Medicare." Medicaid and Medicare are Lyndon Johnson's Great Society -- not FDR's New Deal.

And let's remember that back in 2000 -- before Bush II -- the long-run, non-health-program-related finances of the federal government looked to be in fine shape, at least as I did the math. Even factoring in the recession that hit between 2001 and 2003 and the then-current tax laws, long-run projected budget surpluses significantly outweighed the long-run Social Security deficits. It's more accurate, I think, to say the federal government has two fiscal problems:

1. The Bush II administration -- with its insistence on not paying for the spending it insists on undertaking. This includes the Iraq war and Medicare Part D.

2. Our long-run health-financing problem.

As far as health programs are concerned we could look at this not as a problem, but as an opportunity. If we only let Medicare and Medicaid beneficiaries get the levels of care they received in 2000, we wouldn't have a long-run healthcare financing problem. But we expect Medicare and Medicaid to pay for more care in the future because we expect our doctors to develop more amazing treatments. We also expect these amazing treatments will be amazingly expensive. And finally we expect Americans will want to provide access to the amazing medical miracles of the future to more than just the rich. Does our general belief that medical care shouldn't be rationed according to ability-to-pay spring from the New Deal, or does it have deeper cultural roots?

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Arnold Kling writes: Brad writes, "and finally we expect Americans will want to provide access to the amazing medical miracles of the future to more than just the rich." But Medicare is not a transfer from the rich to the poor. It is a transfer from the young to the old. One legacy of the New Deal is that it changed the way we think about income transfers:

1. We now think of it as a federal responsibility first, a state and local government responsibility second, with private charity barely significant.

2. Most of the transfers payments are received by the middle class and the affluent, and a fair amount of the taxes are levied on people at the median income or below.

3. Most of the transfers are intergenerational, from people of working age to people in retirement.

4. As individuals, we no longer are incented to have children to take care of us in our old age (although collectively we do).

5. As individuals, we no longer are incented to save as much for our old age. (Although, again, looking at the trends in demographics and health care technology, we probably need to find a way to save more in the aggregate.)

Going forward, we need a frank discussion about whether or not this is good policy.

* * *

Brad DeLong writes: Arnold thinks the partial success of the New Deal taught Americans bad lessons about the role of government, or lessons that hurt us in the future. First let's remember that the New Deal's partial success includes:

• The recovery from 25% unemployment to roughly 10% unemployment

• The rebound from 50% of 1929 industrial production to approximately 120% of 1929 industrial production -- before WWII began

• The boom in production and employment -- albeit not private consumption -- of World War II, accompanied by total victory


Nevertheless, Arnold thinks that because of the New Deal we now believe it's the government's job to care for us when we're sick, old, and when things go wrong at work or at home. Therefore we save too little, have too few children to support us when we get old, and work too little (Because we face substantial marginal tax rates). In short, we would be a better society if people:

• Knew they would be poor in their old age if they didn't save for retirement

• Understood they would die prematurely if they didn't save for future medical care

• Thought they would be old, alone and uncared for if they didn't have dutiful children

• Presumed they would lose their middle-class status if they had a heart attack, lost their job, or got divorced and hadn't piled up large lumps of precautionary savings


I'm reminded of a teacher's lectures on early Victorian economics. To the Victorians, she noted, private charity should be ample -- because that was what Jesus taught and it kept the poor from starving en masse the streets -- but never comprehensive. There should always be at least a few poor people starving in the streets to make it clear the poor couldn't count on charity. It drove people to work, save, stay married, have children and bring them up properly. Under this philosophy, the economy's purpose is to create morally prudent servants who live in the fear of the lord. Her students -- hedonists living in the California sun -- found it very strange: The purpose of the economy is obviously to enable people to realize their human potential and to satisfy their needs, wants, and dreams.

I admit moral hazards -- people gaming the system and not contributing their share -- are a danger in all insurance programs, especially social insurance. But consider: America is already on the libertarian end of the spectrum of advanced industrial economies. Further leaps in that direction would make us more the odd one out. And increased savings from making the old and the sick -- who haven't saved -- impoverished must be very large before I would conclude that incentives facing Americans in the economy are too soft and encourage too much slacking. And I haven't seen that demonstrated yet.

* * *

Arnold Kling writes: Consider two utopias:

In a libertarian utopia, most families take care of themselves by working, saving, and purchasing insurance. Taxes are low, but charitable contributions are high, and most people who cannot take care of themselves are served by charities. As James Bartholomew points out in "The Welfare State State We're In," private charities have many advantages over government programs. Finally, if people slip through the cracks of charity, government programs could be a last resort.

In the progressive/New Deal utopia, we are all wards of the state. Clever technocrats use the coercive power of the state to put all of us into government-run savings and insurance programs. Brad DeLong and others who believe in the technocratic, welfare-state utopia will point to Europe as an example for the U.S. to follow. However, Europe is in demographic decline. Even the clever technocrats lack a plan for dealing with the pending surge in the ratio of pensioners to workers. The work ethic in Europe is slowly melting away. Among young people, the unemployment rate reaches 20% in several countries. There is something rotten in Denmark, and indeed in the entire concept of the technocratically-run welfare state.

The New Deal gave the American people new faith in large, powerful central government. However, the results of the New Deal did not justify that faith in the 1930s, nor do the results of the welfare state justify such faith today.

http://online.wsj.com/public/article/SB ... 70213.html

[RebLem]

I agree that the New Deal did not do much to end the Depression. We have Hitler, Mussolini, and the Japanese to thank for that. But the economic infrastructure set up during the Depression was what has prevented another Depression from happening, and that was a great achievement. In some ways, an even greater achievement was that of the Truman Administration in preventing a post-war Depression for the first time in human history. This was accomplished, granted, partly by the decision, in the face of Soviet , Maoist, and N Korean expansionism, to establish a robust permanent military establishment for the first time in our history. But the G.I. Bill helped, too. Besides being an expression of gratitude to those who had won the war, it was an investment in our economic future, and, its most immediate effect was to keep many returning vets in school and out of the labor market, so that, by the late forties, the greatest economic concern of the day was a labor shortage. They had a destiny which was a far cry from the fate which had befallen the Bonus Marchers.

You know, I'm getting a little tired of all this handwringing about how it character eroding it is to provide medical care to people who can't afford it. Let me describe the situation as I see it--rich people sometimes get organ transplants. Where do they get their organs? Often from people who died because they couldn't afford medical care. Is that good for the moral character of the rich? I don't think so.

Still, I too am concerned about moral decay all all economic levels of society. I think the first thing we should take away is street sweeping machines. Tell everyone they simply must stop using their cities and the whole wide world as their personal trash and garbage cans. Give litterers serious penalities of community service for the first few offenses, jail time if they don't reform. Tell people they are sponsible for keeping the sidewalks and the streets in front of their houses and businesses clean. Then, by not investing millions in street sweepers, we will have money to provide medical care for some people who are not getting it now. AND, it will be good for character development, too.

I think if you think kicking the Bonus Marchers around was character building, and the G.I. Bill was character-eroding, there is something fundamentally wrong with YOUR character.

[Kevin R]

I agree that the New Deal did not do much to end the Depression. We have Hitler, Mussolini, and the Japanese to thank for that. But the economic infrastructure set up during the Depression was what has prevented another Depression from happening, and that was a great achievement. In some ways, an even greater achievement was that of the Truman Administration in preventing a post-war Depression for the first time in human history. This was accomplished, granted, partly by the decision, in the face of Soviet , Maoist, and N Korean expansionism, to establish a robust permanent military establishment for the first time in our history. But the G.I. Bill helped, too. Besides being an expression of gratitude to those who had won the war, it was an investment in our economic future, and, its most immediate effect was to keep many returning vets in school and out of the labor market, so that, by the late forties, the greatest economic concern of the day was a labor shortage. They had a destiny which was a far cry from the fate which had befallen the Bonus Marchers.

You know, I'm getting a little tired of all this handwringing about how it character eroding it is to provide medical care to people who can't afford it. Let me describe the situation as I see it--rich people sometimes get organ transplants. Where do they get their organs? Often from people who died because they couldn't afford medical care. Is that good for the moral character of the rich? I don't think so.

Still, I too am concerned about moral decay all all economic levels of society. I think the first thing we should take away is street sweeping machines. Tell everyone they simply must stop using their cities and the whole wide world as their personal trash and garbage cans. Give litterers serious penalities of community service for the first few offenses, jail time if they don't reform. Tell people they are sponsible for keeping the sidewalks and the streets in front of their houses and businesses clean. Then, by not investing millions in street sweepers, we will have money to provide medical care for some people who are not getting it now. AND, it will be good for character development, too.

I think if you think kicking the Bonus Marchers around was character building, and the G.I. Bill was character-eroding, there is something fundamentally wrong with YOUR character.

I can agree with a few things here, but not many. Of course, the "economic infrastructure" FDR put in place didn't stop the depression of 1937-38 from occurring. His policies (it is important to recall that FDR lurched to the left during the 2nd New Deal) probably played a large role in creating it.

FDR's great error (and that of his advisers) was seeing the original downturn as somehow the fault of the marketplace. It wasn't. The problem was the government (look at Hoover's effort to inflate prices and wages during 1930, or the Smoot-Hawley Tariff, or the insane revenue increases, or, most importantly, the Fed's squeezing off the money supply). FDR gave us the terrible lesson that the government should come and rescue us from the vagaries of the market. While in many ways different from the Great Society that LBJ would burden us with, the New Deal helped give us the Nanny State we enjoy today.

And DeLong's whining about inequality (you can see this especially on his blog) is one of the great charades of American politics. Of all the pressing issues American needs to confront, this is near the absolute bottom.