The Ambrosini Critique

A certain Wall Street Journal opinion piece set of a mini-blog storm about the roll of policy in the cause and length of the Great Depression. The piece presented five myths. Here’s my take on them:

1. Herbert Hoover, elected president in 1928, was a doctrinaire, laissez-faire, look-the-other way Republican who clung to the idea that markets were basically self-correcting.

   UNQUALIFIED MYTH – Rauchway tells us so.

2. The stock market crash in October 1929 precipitated the Great Depression.

   MYTH – There have been many stock market crashes that didn’t result in a depression. In fact, there appears to be no relationship between stock returns and GDP growth. But don’t take my word for it, here’s Ben Bernake:

   [T]he market crash, rather than being the cause of the Depression, as popular legend has it, was in fact largely the result of an economic slowdown and the inappropriate monetary policies that preceded it. Of course, the stock market crash only worsened the economic situation, hurting consumer and business confidence and contributing to a still deeper downturn in 1930.

   “Ah,” you say, “Ben says the crash precipitated the depression by hurting consumer confidence.” True, but that’s a bit like saying the noose precipitated the hanging.

3. Where the market had failed, the government stepped in to protect ordinary people.

   QUALIFIED MYTH – It depends on what you mean by help. If you mean policy was efficient, then certainly much government policy was inefficient. Inefficiency comes in the form of unemployment and low GDP. Those things hurt. If, on the other hand, you mean policy prevented people from starving, you have a case. There’s a trade-off between efficient policy and policy aimed at reducing economic depravity; this is a trade-off between short-term pain and long-term gain. I haven’t seen a case that said the short term pain was so great it was worth the hit in the long-run. And for the above statement to not be a myth, you’d have to show the extreme short-term pain was caused by market failure.

4. Greed caused the stock market to overshoot and then crash.

   UNCHALLENGED MYTH

5. Enlightened government pulled the nation out of the worst downturn in its history and came to the rescue of capitalism through rigorous regulation and government oversight.

   QUALIFIED MYTH – Certainly market forces got us into a mess in the late 1920s. The interesting question is how much was Hoover’s bad policies responsible for the depression that followed and how much did various New Deal policies work to prolong the depression. That’s a big knot to untangle. Would have policies meant to alleviate economic deprivation been necessary if Hoover hadn’t have screwed up so bad?

Yes. I know this from reading Eric Rauchway’s great book The Great Depression and the New Deal. He provides a lot of data in support of the idea that Roosevelt implemented inefficient policies. Granted it takes a little bit of economic reasoning to get from that data to the conclusion that Roosevelt prolonged the depression, but its basically Econ 101 stuff so bare with me.

Roosevelt created an “alphabet soup of bureaucracies” (pg. 66) that provide direct aid to the unemployed, created public works programs, enacted price controls in agriculture and implemented various forms of industrial policy reminiscent of that sort of policy in the first World War. The CCC was created early in the administration (pg. 64) and the WPA later (pg. 67) to employ young men in projects that, Rauchway assures the reader, didn’t compete with the private sector and where jobs creating the “comforts of civilization” (pg. 68). The Public Works Administration was created in 1933 with a budget 6% of the GDP. Rauchway informs us this program wasn’t big enough to put a dent in unemployment so the Civil Works Administration was created the next year and soon employed nearly 10% of the labor force (pg. 65).

I’ll make the case that these new programs were inefficient, but to do so I need to appeal to a little economic theory. I apologize in advance. Imagine you’re unemployed and you’re looking for a job. You have a desired wage in mind and you can’t find a job. There can be two reasons why you can’t find a job. There’s not many job offers out there or all the job offers you’ve entertained haven’t been good fits for you (meaning you think you can be more productive, and higher paid, somewhere else). In either case, if you lower the wage you expect, you’d eventually find a job and the lower the wage you’d expect the faster you’d find a job.

Now, suppose the government comes in and offers a job with a “security wage” (pg. 69, basically a minimum wage). With this outside offer, you can afford to look longer for a job that pays that higher wage or you can go ahead and take the job with the government. If you take the job, you have to assume the work you do in it is just as valuable as the work you’d do in a private sector job at the same wage or you have to conclude the government job offer is inefficient¹. If you don’t take the job and wait longer in the private sector, that’s time resources, namely you, are spent idle and that too is inefficient.

Chapter five in Rauchway’s book is devoted to showing agriculture and industrial policies in the Roosevelt administration were inefficient and because of this, they were subsequently dropped by him by his second term. The AAA was created in 1933 with the explicit instruction to decrease the “severe and increasing disparity between the prices of agriculture and other commodities” (pg. 77). The AAA asked farmers to destroy their crops and the “spectacle of … government destroying food in the midst of hunger positively hurt” (pg. 79). Needless to say, having farmers plant crops and then destroy them isn’t the best use of resources.

As for industrial policy, the NRA was created in the spirit of Hoover’s managed economy to have “management, labor, government, and consumer representatives negotiating regulatory codes” and to fix prices (pg. 83). This increased monopoly power irked businesses not in on the deal and workers complained about increasing prices, as prices are wont to do in consolidated industries (pg. 84). Beyond the political economy and backlash against the NRA, standard economic theory tells us efficiency suffers with an increase in monopoly power.

So, Rauchway has given us data that makes us think some of the New Deal policies were inefficient. Even if you don’t think the “emergency” work programs were inefficient, its pretty clear that the agriculture and industrial policy were.

Why does the inefficiency of these policies imply Roosevelt prolonged the Depression? In the macro economy unemployment is a measure of inefficiency². By any measure of unemployment, it was much higher in the 1930s than any other decade before or since. New Deal policies created inefficiencies, which created unemployment which prolonged the Great Depression.

But you don’t have to believe all this hocus pocus economic theory because Rauchway says as much when he concludes: the agriculturial and industrial policies were intended “to promote not a speedier, but a better distributed, recovery” (pg. 82). Many New Deal policies were meant to redistribute wealth not generate more of it. There’s no shame in that, but if you admit it, you’re admitting Roosevelt prolonged the Great Depression.

UPDATE: Krugman thinks Roosevelt prolonged the depression, too… by not doing enough. Who you going to believe some two-bit Nobel laureate… or me?

1. The key assumption for inefficiency of the government job is that the government job generates at most as much value as private sector job and most likely it creates less value. I won’t spend much time substantiating this assumption, but it seems likely to be true because if the government job provided a lot of value, you have to wonder why a private firm didn’t create the job in the first place. [↩]
2. As is GDP being far from its trend, which is was in the ’30s, but let’s ignore that for now. [↩]

The Bill of Mortality, to all our griefs, is encreased 399 this week, and the encrease generally through the whole City and suburbs, which makes us all sad.

— Pepys

Etymology: Middle English suburbe, from Anglo-French, from Latin suburbium, from sub- near + urbs city

I had no idea.

This is the neatest graph I’ve seen in a while (from Davis et al 2006):

The bottom numbers are the hazard rates, e.g. if you’re employed, every month you have a 2.6% chance of getting a new employer, a 2.7% chance of leaving the labor force and a 1.3% chance of becoming unemployed.

(h/t Kling)

Delong thinks the WSJ article and Prof. Tabarrok’s post are about:

What did the New Deal do to relieve economic distress–i.e., was the New Deal a failure?

They’re not. The WSJ article is about Hoover being a tool and Roosevelt prolonging the depression (which isn’t to say the New Deal, on net, was a bad thing). Tabarrok’s post was about neither of those things.

We live on a strange, strange planet.

No. I know this from reading Eric Rauchway’s great book The Great Depression and the New Deal. Right on page three¹ he says, “Contrary to Democratic accusations, the Republicans did not do nothing” and chapter two is devoted to chronicling the many things Hoover did (and didn’t) do in response to the worsening economic situation. In that chapter, Rauchway chronicles episode after episode of Hoover’s interventions in the economy including wage supports, imposing tariffs, massive public works programs, limitations on immigration and increasing the Fed’s control of key interest rates.

Hoover was known to be a logistical genius (pg. 23) and future President Roosevelt said of Hoover, “He certainly is a wonder and I wish we could make him President.” This genius led Hoover to believe the economy could be organized by the government and then managed by a cabal of business owners who would work together with “intelligent cooperation”. For example, meetings with big business were held to get their agreement to not lower wages (pg. 26). He created the Federal Employment Stabilization Board to help local governments fund public works and decrease unemployment (pg. 32).

A central tenet of laissez-faire ideology is free trade. As the President that signed the Smoot-Hawley tariff bill into law, Hoover was far from a free trader (pg. 28). Another pillar of laissez-faire is the free movement of people. “Hoover also ordered stricter enforcement of anti-immigration legislation” (pg. 33) leading to a hundred thousand less immigrants.

It seems President Hoover was ideologically amenable to government intervention and he did intervene in a number of ways. Rauchway makes a persuasive case that Hoover was not laissez-faire in thought or deed.

1. all page numbers and unattributed quotes in this post come from Rauchway’s book [↩]

Krugman says something consistent with the WSJ opinion and historians take that as proof they were right and said opinion was wrong. We live on a strange planet.

“Take care, sir,” cried Sancho. “Those over there are not giants but windmills.”

If you actually want to persuade folks who haven’t made up their mind already on ideological grounds — that is, the crowd that is open to persuasion –invective won’t cut it. You need real arguments, and you need credibility, and you can get that only by taking arguments seriously and evaluating them on the merits free of insults and abuse. You don’t need to express “outrage” to make the point; in fact, outrage only takes away from it. My approach doesn’t sell a lot of books, I realize, but I think it does get to the bottom of things.

— Orin Kerr

Professor Rauchway now seems to be ok with the idea that Roosevelt’s policies prolonged the depression. There’s a trade-off between policy oriented towards increasing economic efficiency and policy oriented towards reducing economic depravity.

There’s a larger sense in which we’d like to know if Roosevelt got this trade-off right. Yes, make-work programs helped ensure people didn’t starve to death, but was there too many make-work programs in the sense that a lot more people were unemployed for longer of periods of time because of them? How to talk about optimal policy when the trade-off itself bridges normative frameworks?

Tim Lee says so:

It should be remembered that every contract signed is a prelude to possible state coercion if the contract is broken. Like all other kinds of coercion, the possibility of contract-related litigation creates uncertainty and other deadweight costs. In addition, the act of offering contracts imposes a deadweight cost. Every time I’m presented with a contract, I have to at least skim through it to make sure that the terms are acceptable. A society in which contract formation is extremely cheap for one party will be a society in which other people have to spend a lot of time scrutinizing the contracts they offer. Finally, contracts impose costs on the court system. A legal system that makes contracts to cheap to create will lead to too much taxpayer money being wasted on contract litigation.
…
In contrast, if things are structured so that each party bears roughly half the costs of contract negotiation, then each party is only going to propose a formal, written contract if he believes that the benefits of doing so will outweigh the costs to both parties. This is one of the good things about paper contract negotiations between flesh-and-blood people: If you give me a long contract to sign, you’re going to have to stand there and wait while I read the contract and decide if I want to sign it. Since standing around is a waste of your time, you’re only going to do that if you believe the transaction can’t happen without it. And you’re going to try to make the contract as short as possible so you don’t have to stand around too long.

I’m not so sure about this. EULA’s impose a cost on customers, but they’re willing to pay those costs so I’m not sure why these would be dead weight losses. I agree that if I read every contract offered me, that would entail high costs, but I don’t read every contract offered me. There’s a risk that if I don’t read the contract I’ll be signing away my life, but clearly if I buy the software I’m willing to bare this risk.

I agree legal costs are dead weight losses but its an empirical question as to how much cost EULA’s impose on our court system. I’m guessing not very many of these contracts are contested in courts so the cost is really low.

Standards of fairness may argue against EULA’s (e.g. both contracting parties should bare equal contracting related costs), but the efficiency based argument against them doesn’t work for me.

As a complete aside: what’s so bad about leasing software vs buying it? This is the same question I have for folks that go nuts over copy-protection in games. So what if those schemes result in psuedo-ownership of games? If the game isn’t fun enough to lease, then don’t lease it.