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Shlaes Corrects Krugman

12:14 PM, Sep 7, 2010 • By DANIEL HALPER
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Former Enron adviser Paul Krugman's Labor Day column essentially boiled down to this argument, according to Amity Shlaes:

Dr. Krugman depicts 1937 as a year when FDR tried to slash the deficit. Dr. Krugman suggests that stimulus, especially fiscal stimulus, ought to have been applied. Instead, the Roosevelt administration ``pulled back stimulus too soon.” Voters sided with caution as well, Dr. Krugman notes. A Gallup poll of 1938 that more than half of voters wanted no stimulus and more than half backed tax cuts.  But they were wrong, says Dr. Krugman. The economy crashed. Only when the war came, and the federal government borrowed massively to spend, Dr. Krugman suggests, did the economy recover.

Shlaes goes on to pick apart Krugman's analogy

Dr. Krugman’s argument is a strange one, worth retracing year by year.  For a systematic review of that period does not suggest that massive spending at the current point in U.S. history makes sense.

Dr. Krugman starts out right: it is true after the election of 1936, policy changes were made that yielded an effective tightening of money. Some of the changes were intended and some were policy half-accident.  The first of these was the staged doubling of bank reserve requirements, which had the effect of pulling money out of the economy. A second factor was Social Security payments; the Social Security Act became law in 1935, but 1937 was the first year government collected, taking spending cash from consumers. In 1936 and 1937 large bonuses were given to veterans; no such bonuses were scheduled for 1938.  For 1937, total government spending as a share of GDP was 13.2%, down from the 15.4% of the preceding year.

But Dr. Krugman fails to tell of other policy changes, some of which were also made as far back as 1935. These other changes also dragged down the economy in 1937 and 1938.

The first of these was change in wage policy. In 1935, Congress had passed the Wagner Act, the basis for modern labor law. The Wagner Act of the 1930s was a tiger compared to the kitty cat we call labor policy today. John L. Lewis of the CIO and others shortly used their new power to launch sit-down actions against steel companies and the automakers. The phrase “sit down” sounds vague to us now, but it is important to remember that what it meant was that the workers might occupy employers’ private property. Violent strike actions accompanied the sit-downs. Employers, squeezed by unions as never before, lost days of production. Whenever they could, companies raised wages to appease the unions and Washington. This was the period when U.S. Steel and all auto producers but Ford were unionized. It seemed organized labor had no limits.

Read it here, courtesy of e21.

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