Friday, December 21, 2007

A Raw Deal - The Forgotten Man: A New History of the Great Depression

A Raw Deal
Charles W. Calomiris
From Foreign Affairs, September/October 2007

The Forgotten Man: A New History of the Great Depression . By Amity
Shlaes HarperCollins, 2007, 464 pp. $26.95

Summary: Amity Shlaes' The Forgotten Man is a useful antidote for
those whose knowledge of the Great Depression comes from textbooks
that lionize Franklin Roosevelt's New Deal and paper over his serious
policy errors.

Charles W. Calomiris is Henry Kaufman Professor of Financial
Institutions at Columbia University's Graduate School of Business.

Of Related Interest

Economics, trade and finanace
U.S. policy and politics

William Graham Sumner, who at the turn of the twentieth century
practically invented the field of political economy in the United
States, was the first to coin the phrase "the forgotten man." It was
his term to describe the citizen who loses out as a result of
government interventions that favor special interests. The forgotten
man, according to Sumner's definition, is someone looking for a chance
to make it on his own -- and who the government can help most by
protecting economic freedom, providing a stable currency, and limiting
the burden of taxation.

Franklin Roosevelt's -- and, to a lesser extent, Herbert Hoover's --
forgotten man was based on a new idea, one largely antithetical to
Sumner's. By 1933, the forgotten man had become someone who was
unemployed and increasingly desperate, who was forgotten by the market
and could be lifted up only by a beneficent government that took
control of the economy, through such measures as the economic planning
initiatives of the New Deal era: the National Industrial Recovery Act,
the Tennessee Valley Authority, the Agricultural Adjustment Act, the
Works Progress Administration, and model agricultural communities.

After 1935, in the wake of continuing policy failures and Supreme
Court rulings against his initiatives, Roosevelt used the phrase in
his appeals to particular classes of people whose political support he
sought, people who felt disenfranchised within larger society: the
unemployed, the underprivileged, and the generally disaffected. But
there were others who sought to reclaim the original meaning of "the
forgotten man" as Sumner had formulated it, not least Wendell Willkie,
who made the concept part of his platform when he ran against
Roosevelt as the Republican candidate for president in 1940.

The title of Amity Shlaes' new history of the Great Depression refers
to a concept whose changing meaning mirrored the shift in ideology
about the role of government during the 1930s. "To justify giving to
one forgotten man," writes Shlaes, "the administration found, it had
to make a scapegoat of another. Businessmen and businesses were the
targets. Roosevelt's old mentor, the Democrat Al Smith, was furious.
Even [John Maynard] Keynes was concerned. In 1938 he wrote to
Roosevelt advising him to nationalize utilities or leave them alone --
but in any case cease his periodic and politicized attacks on them.
Keynes saw no point 'in chasing utilities around the lot every other
week.' Roosevelt and his staff were becoming habitual bullies, pitting
Americans against one another. The polarization made the Depression
feel worse. Franklin Roosevelt's forgotten man ... perpetually tangled
with Sumner's original forgotten man." On the most basic level, The
Forgotten Man is a comprehensive history of economic policymaking in
the United States during the Great Depression. Shlaes seeks to explain
why the Depression lasted as long as it did (over a decade) despite a
panoply of aggressive policy experiments, especially by Roosevelt's
administration. Each chapter of the book begins with bleak and
sobering figures that highlight the Depression's persistence.
Unemployment, which stood at roughly 5 percent in the fall of 1929,
skyrocketed to 23 percent four years later and was still above 17
percent as late as January 1938. Industrial production peaked in
September 1929 and, with the exception of a few months in 1937, did
not reach the same level again until 1939. The Dow Jones industrial
average, which had reached 343 on October 1, 1929, was still worth
less than half that amount in January 1940. The main theme in Shlaes'
account of the policy experiments that are collectively known as the
New Deal (along with other measures related to monetary- and
exchange-rate policy and banking system interventions) is their
failure to restore economic activity to the levels of the 1920s.

But there is much more to the book than that narrative. It is also a
history of the development of U.S. culture, politics, and economic
policy, which were uniquely and inextricably intertwined during the
Depression. Shlaes explores the changing popular conceptions during
this period of what the roles and powers of government and business
ought to be. As such, it is a work of great skill, even brilliance.

The Forgotten Man will also be a popular book, because it does all
that while still managing to be a fun read. Alongside the highbrow
ideological, economic, and political history are entertaining
vignettes of individuals great and small. These insightful portraits,
with their revealing facts and anecdotes, bring the policy history to
life. At the same time, the portraits are absent of heavy doses of
opinionated interpretation, leaving room for the reader to judge the
characters based on their own words and actions instead of the
author's pronouncements.

By the end of the book, the reader will be familiar with the author's
admiration for Willkie's common sense and good manners (he is the hero
of the book), the financier Andrew Mellon's forbearance and
selflessness, and the courage of the Schechter brothers, kosher
butchers from Brooklyn who stood up to dictatorial National Industrial
Recovery Act policies prescribing how chickens should be sold and
triumphed in a landmark 1935 Supreme Court case. Not all the
portrayals are loving, of course, but even the negative ones are
balanced; none of the characters is made of cardboard. Roosevelt is
correctly portrayed as a pragmatist who began as an economic
experimenter (1933-35) but then became a class warrior (1935-38) as
his economic policies failed and he focused on the narrower goal of
seeking to assemble a winning coalition for the 1936 presidential


Some readers -- those whose prior knowledge of the economic history of
the Depression comes from high school or college textbooks -- may find
the basic facts about the economy and economic policy reviewed by
Shlaes a bit surprising. Most basic treatments of the Depression and
the New Deal are written by social and political historians with
limited knowledge of economics. They tend to view the Depression as an
inevitable consequence of alleged market excesses of the 1920s and see
the New Deal as having substantially aided economic recovery. (A
notable exception to this rule is the recent best-selling textbook A
Patriot's History of the United States, by Larry Schweikart and
Michael Allen, which offers a detailed review of the deficiencies of
other textbook treatments of the Depression and the New Deal.)
However, the research of economists and economic historians tells a
very different story, one consistent with Shlaes' account. The
Depression resulted primarily from poor monetary policy by central
banks, including the Federal Reserve, and was perpetuated by a
combination of disastrous fixed-exchange-rate policies (which
transmitted deflation around the world), protectionism, and the severe
problems with the balance sheets of banks and firms. In the United
States, added damage was done by the wrong-headed policy responses of
the Hoover and Roosevelt administrations, including New Deal policies
that raised prices and wages (phase 1 of the New Deal, before 1936)
and those that raised taxes and increased the costs of hiring laborers
(phase 2, after 1936). Whatever the desirability of the New Deal
policies from other perspectives, they did not provide an effective
boost to the economy.

Shlaes' criticisms of these policies will be familiar to economists
and economic historians who have studied the Depression. (For a recent
overview of the academic literature, see Randall Parker's The
Economics of the Great Depression and Michael Bordo, Claudia Goldin,
and Eugene White's The Defining Moment.) It is well known among
scholars of the Depression that there was no consistent theme or
philosophy underlying New Deal policies but rather that Roosevelt and
his changing team of experts innovated in ways that were hard to
predict and impossible to explain from the perspective of any coherent
macroeconomic theory. Even economists at the time, including Irving
Fisher and Keynes, recognized this.

Economists and economic historians today, echoing Fisher and Keynes in
the 1930s, generally see the abandonment of the gold standard in 1933,
which allowed the money supply and the economy to begin to grow, as
Roosevelt's major contribution to economic recovery. Other New Deal
policies are generally understood to have set back the recovery of
production, employment, and asset prices, as Shlaes argues. The
National Recovery Administration's price and wage hikes have long been
seen as mistakes (and a continuation of Hoover's bad policies) that
contributed to unemployment and the slow recovery of production from
1933 to 1935. The tax hikes and labor legislation of 1935-37 have been
widely considered by scholars as having prolonged the economy's slow
recovery and meager job growth during those years and as having helped
caused the relapse into recession in 1937. Shlaes' contention that
policy errors -- and, more important, the unpredictability of policy
-- fed economic uncertainty and discouraged businesses and consumers
from investing and consuming is not a new view of the New Deal.

A few scholars may quibble with some of Shlaes' claims. She argues
that Roosevelt's ad hoc management of the dollar's value after March
1933 and his decision to abandon multilateral efforts to reestablish
the international gold standard created unnecessary price-level
uncertainty. This may be true, but the point seems a bit
overemphasized in light of the positive effects of abandoning gold
parity -- namely, the growth that came from decoupling monetary policy
from worldwide deflation. Similarly, Shlaes' mainly tangential
discussion of banking crises in the early 1930s exaggerates the impact
of depositor panic, underestimates the difficulty of solving the
problems that were then gripping banks, and overstates the ability the
Federal Reserve had to prevent financial distress by pumping more
liquidity into the system. The abolition of gold clauses in bonds in
1933 (which allowed creditors to repay their debts in depreciated
paper dollars rather than in a fixed quantity of gold) was not, as
Shlaes argues, merely a redistribution of wealth from creditors to
debtors; as the economist and current Federal Reserve governor,
Randall Kroszner, has shown, the measure benefited creditors -- and
the whole economy -- by increasing the likelihood that depreciated
debt would be repaid.

In spite of these few shortcomings, however, Shlaes' overall analysis
of the economic history of the Depression is remarkably well informed
and balanced. Her emphasis on the disastrous effects of higher
taxation of corporate profits and retained earnings in the mid-1930s
is especially incisive. In the areas where the analysis is a bit weak
(especially pertaining to financial-sector issues), the controversies
surrounding those matters are largely beside the point of the book.

Shlaes' main contribution is not the novelty of any one of her views
about economic policy but rather her ability to synthesize the story
of policy failure with a cultural and ideological history. In doing
so, she tells the tale of the Depression in a way that allows readers
to understand how leaders as intelligent as Hoover and Roosevelt could
have failed to get the economy back on track for so long.
Inconsistencies in economic policy over time reflected political
leaders' basic lack of understanding of economics, upheaval in the
composition of President Roosevelt's pool of most influential
advisers, and the schizophrenic nature of those advisers' political
and economic ideologies (alternating as they did between budget
balancing and aggressive spending, between attacking big business and
supporting corporate consolidation). Moreover, Supreme Court rulings
that rejected the constitutionality of many actions from the first
wave of the New Deal and, later, partisan strategies designed to favor
particular groups that Roosevelt believed would deliver his reelection
further hampered meaningful reform and economic recovery.

Shlaes properly attributes the persistence of the Depression in part
to a new ideological orientation toward government intervention that
gained credence in the 1930s: the idea that there is great potential
gain and little harm in ad hoc policy experiments designed to plan and
shape the economy. Shlaes believes that this ideology reflected a lack
of understanding of the damage that state intervention can wreak on
the economy -- especially when applied in an incoherent and
unpredictable way -- and a failure to appreciate the ability of the
market to successfully respond to economic challenges on its own when
it is permitted to do so. Ill-advised government plans during the
Depression were often destructive to recovery and damaged
private-sector initiative either willfully or unwittingly by imposing
high taxes and creating an environment of high political and
regulatory risk.


As the 2008 presidential election nears, Shlaes' book will make good
bedtime reading. During the campaign, the candidates will offer
hundreds of new policy ideas for ways to make the economy perform
better and to help the new generation of "forgotten" men and women.
The Forgotten Man offers the useful reminder that seemingly bright new
government initiatives can cause harm as well as good. It especially
highlights the unintended risks of class warfare in the formulation of
public policy. Policies that cater to disadvantaged constituencies,
perhaps, as in 1936, as part of a political strategy for electoral
victory, can sour the economy and end up harming those whom they were
intended to help. A protectionist backlash against China, for example,
could result in a major global growth slowdown and the destruction of
millions of U.S. jobs.

The Forgotten Man is history with a point of view -- a moral history
in the best sense of the term. For economists and economic historians,
the book offers a synthetic view that places the myriad policy errors
of the 1930s within a coherent narrative about the evolution of U.S.
culture and ideology and that is full of insightful commentary about
the main players in this drama. For nonspecialists, many of whom may
be suffering from fundamental misconceptions about the New Deal, the
book will be an eye opener.

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