Much as generals make the mistake of fighting the last war, politicians are prone to recycle old nostrums that were previously successful in getting us (and them) out of one crisis or another. For liberal Democrats, this typically involves the dream of replaying the New Deal and FDR's first 100 days. So strong is the hold of the New Deal over the liberal imagination that few stop to consider how different the world is today from the one Roosevelt faced when he took office in 1933 at the very bottom of the Great Depression.
It was to be expected that following Barack Obama's election there would be a flurry of calls from liberal pundits and Democrats in Congress for another New Deal, one even more ambitious than that FDR engineered. The president-elect has been called "Franklin Delano Obama" by one influential columnist who wrote that the problem with Roosevelt's New Deal was that it was too timid and lacking in vision. A recent issue of Time magazine carried a photo of the president-elect on the cover wearing an FDR-style top hat accompanied by an article drawing parallels between Roosevelt's leadership during the Depression and the opportunities now arrayed before Obama. Many are saying (with much relief) that the financial collapse combined with Democratic electoral sweeps marks the end of the Reagan-Thatcher era with its focus on free markets, open trade, and low taxes.
Neither the president-elect nor any of his close advisers has yet embraced the comparisons to FDR and the New Deal, perhaps for fear of creating expectations they cannot fulfill. He has, however, embraced the concept of an ambitious New Deal-type stimulus package that will include funds for public works programs, "clean" sources of energy, and other projects designed to stimulate consumer demand and create new jobs. The Wall Street Journal reported that "President-elect Obama is promising to intervene in the economy in ways that Washington hasn't tried since the 1970s, favoring some industries and products while hobbling others." It is sobering to recall that the policy experiments of the 1970s, which gave us a decade of alternating recession and inflation, were drawn from the lessons of the Depression and the New Deal. There is little reason to think that they will work any better today.
The New Deal metaphor in wide circulation today is based on the illusion that, since New Deal interventions were effective in dealing with the Depression, they are the right medicine for dealing with today's financial crisis and economic slowdown. This illusion is driven by a deep misconception: that the market-oriented policies of the past quarter century were a great mistake and should be replaced by a more coordinated set of policies that (it is argued) will yield more stable growth and a fairer distribution of income. Thus the New Deal metaphor is now invoked as a call to overturn the free-market revolution of the 1980s, just as the New Deal threw overboard the Wall Street-favored policies of the 1920s. Such hopes are based on a fairy tale version of the New Deal and a highly ideological interpretation of recent history. In combination, they provide a shaky foundation for current policy and are a trap for Democrats.
Much in contrast to President-elect Obama, who will enter office in the midst of a recession, FDR came into office in 1933 at the very bottom of the worst economic calamity in American history. The New Deal was erected in an unprecedented circumstance when the American economy had come to a near standstill. Between 1929 and 1933, unemployment rose from 4 to 25 percent of the work force, national output fell by more than 30 percent, the dollar value of U.S. exports fell by more than two-thirds, the stock market dropped close to 90 percent, and more than a third of the nation's banks failed. The Great Depression, as it came to be called to distinguish it from the mini-depressions of the 1870s and 1890s, was a catastrophe on a scale far beyond what anyone previously thought was possible. No one knew what to do about it, certainly not FDR who had campaigned on a platform calling for a balanced budget. When he took office, things were about as bad as they could possibly get, and there was little reason to worry about what today we would call "downside risk." Thus, Roosevelt took an experimental approach to the crisis, adopting various policies (many of them contradictory) in the hope that some might reverse the slide.
He also had more room to maneuver than is the case with policymakers today, operating as he did in an environment in which the federal government spent (in 1932) only about 3 percent of GDP (it's 20 percent today). The economic collapse had removed the traditional political restraints on federal spending, there were no social programs to speak of, and international factors of trade and exchange rates did not significantly restrict choices. There was thus much room to increase federal spending, and, by blaming the rich for the catastrophe, FDR had a justification for raising their taxes. At that time, however, the federal government did not command a large enough share of the economy to "prime the pump" with Keynesian style deficits (that would come later). Since most workers were employed on farms or in factories, they could be diverted in a time of high unemployment to public works programs to build roads, bridges, and schools. FDR did not have to worry about putting back to work hordes of unemployed investment bankers, lawyers, or accountants. Any public works program proposed today on the model of Roosevelt's WPA would have to be tailored to the characteristics of the unemployed in a service economy and to the objections of public sector unions that hardly existed at all in the 1930s.
Some of the most constructive and long-lasting features of the New Deal are those that today's would-be reformers ignore when calculating its achievements--most particularly, the broad financial reforms that FDR engineered during his first 100 days. FDR moved quickly in 1933 to address the failures in the financial system that were obvious sources of the continuing deflation and downward spiral in the economy, immediately declaring a bank "holiday" (to stop bank panics) and removing the United States from the gold standard to free the Federal Reserve from its deflationary restrictions. In short order, Congress approved a series of reforms that created a system of deposit insurance, brought more banks under the supervision of the Treasury and the Federal Reserve, established standards of transparency in the public sale of securities, and built the wall of separation between commercial and investment banks (in part to curtail the speculation with bank deposits that many saw as a cause of bank failures). In combination, these measures stopped the slide and reestablished the banking system on stronger and more stable foundations. Most continue to function today as pillars of the financial system (save for the split between commercial and investment banks which was repealed in 1999) and, indeed, they have been called into action recently to deal with the current financial crisis.
At the same time, many of the New Deal measures most favored by reformers today were either unhelpful or counter-productive in addressing the economic crisis. FDR's farm programs, designed to raise prices by cutting agricultural production, may have helped some farmers, but they did not promote farm exports nor did they help consumers with tight family budgets. In a misguided effort to raise prices, New Deal functionaries destroyed meat and produce and took cropland out of production even as hungry Americans stood in bread lines. The National Industrial Recovery Act (NIRA), designed to bring unions and corporations together to set prices, production levels, and working conditions, proved to be a bureaucratic tangle as businessmen tried to use it to guarantee profits, unions to drive up wages, and government officials to expand public power. Through its complex codes, NIRA succeeded not only in raising prices--a dubious achievement--but also in sowing confusion throughout the economy as to what business practices were and were not permitted. It was soon declared unconstitutional by the Supreme Court and never revived.
The pillars of the so-called Second New Deal (the Social Security Act, the National Labor Relations Act, and the Revenue Act of 1935) added new burdens to business in the form of payroll taxes, higher corporate taxes, and collective bargaining for labor unions. Whatever their long-term benefits, these measures did not improve the climate for investment and job creation in the 1930s. The NLRA, predictably, led to greater union organization and to a spike in industrial strikes. The passage of these measures was accompanied by a good deal of anti-business rhetoric, which was not helpful either. Indeed, the Revenue Act, because it raised the highest marginal tax rate to 78 percent, was sometimes called the "soak the rich tax." When a severe recession followed in 1937 and 1938 that sent the unemployment rate from 14 percent to 19 percent, FDR attributed the crisis to a "capital strike" engineered by business leaders exercising "monopoly power." Such demagoguery may have succeeded as a political strategy in deflecting blame from the administration to the business community, but it failed miserably as an approach to economic growth, as Amity Shlaes argued in The Forgotten Man, her fine history of the Depression era. Unemployment remained high throughout Roosevelt's second term, never going below 14 percent until 1941 when the nation began to mobilize for war.
The anti-business rhetoric of the New Dealers had its source in a misguided understanding of the causes of the Depression, which they located in industrial concentration and monopoly and overproduction of goods that drove down prices (the latter being the source of New Deal farm programs and the attempts to control supply) after the 1929 crash. Lurking behind all of these were the rich bankers and industrialists whose malefactions in the form of speculation and the abuse of monopoly power caused the entire system to collapse. None of these factors, as economists now agree, could have caused a collapse on the scale of the Depression, nor could they have accounted for the generalized deflation that had occurred. As for the market crash, by April of 1930 stocks had regained much of the value that had been lost in the meltdown of the previous October.
The real causes of the Depression, on the other hand, are highly instructive for today's problems. Though economists and historians still debate the subject, several interconnected factors appear to have combined to turn a serious stock market correction in late 1929 into a full-scale depression by 1932: (1) an ill-advised tariff policy passed by Congress in 1930 to protect U.S. manufacturers but which had the unintended effect of shutting down international trade and U.S. exports; (2) a monetary policy adopted by the Federal Reserve, which raised the discount rate and allowed the money supply to shrink through 1931 even as the economy faltered; and (3) a cascade of bank failures which wiped out savings and credit for large swaths of the economy. The economic collapse was thus accelerated by policy errors from Congress, and especially by financial authorities who stood by as money contracted and banks failed. Such lessons seem foremost in the minds of financial authorities today who seem determined to stop any parallel sequence of falling dominoes lest we repeat the experience of the 1930s.
Admirers of the New Deal point to the prosperity of the 1950s and 1960s as evidence that FDR's reforms, rather than undermining American capitalism, actually smoothed out its rough edges and permitted it to operate with greater efficiency. FDR himself claimed that his New Deal had saved market capitalism from its own inherent excesses. On October 14, 1936, during a campaign speech in Chicago, he responded to critics from the business community: "It was this administration which saved the system of private profit and free enterprise after it had been dragged to the brink of ruin by these same leaders who now try to scare you." That viewpoint was later developed by mainstream economists and historians, perhaps most cogently by John Kenneth Galbraith in a series of popular works. In American Capitalism (1952), The Affluent Society (1958), and The New Industrial State (1967), Galbraith argued that the New Deal put into place a modern economy in which large corporations and labor unions control markets and work with government to maintain demand for products and to set wages and prices. Such a system, he argued, was ordained by technological advances that required large business enterprises, which in turn had to be regulated by government in the public interest.
The corporatist ideal, along with the bipartisan foreign policy of the period, represented one of the pillars of the postwar consensus of the Eisenhower and Kennedy-Johnson eras. Conservative Republicans, operating outside this consensus, were sorely disappointed when, following his landslide election, Eisenhower maintained the essential contours of the New Deal. Richard Nixon also endorsed that consensus, proclaiming "We are all Keynesians now." In 1971, he removed the dollar from the international gold standard and slapped wage and price controls on the American economy in hopes of battling inflation. The consensus was finally shattered during the 1970s when the policy prescriptions of the New Deal--stimulus packages, loose money, job-training programs, corporate and governmental bailouts--failed to stem the accelerating "stagflation."
The postwar consensus was built upon a temporary and artificial situation in which America's chief competitors in Asia and Europe were on the sidelines as a result of the war. It took at least two decades for those economies to recover (with American aid) to the point where they could compete with American industry in fields like automobiles, steel, and energy. The U.S. economy operated at high levels during the 1950s and 1960s, exporting products around the world and maintaining balance of payments surpluses, notwithstanding the high personal and corporate taxes, the regulatory structure, and the adversarial labor unions that were the legacies of the New Deal.
That system came under increasing stress in the 1970s as the global economy began to impinge on those comfortable postwar arrangements, as European and Japanese companies challenged our industrial supremacy with high quality and efficiently produced exports, and as the oil shocks of 1973 and 1979 caused immediate increases in energy prices. By early 1980, unemployment was running at 7.5 percent, inflation at 14 percent, and interest rates at 21 percent, thus punctuating a decade of slow growth and inflation.
While Ronald Reagan's policies of low marginal tax rates, deregulation, and free trade are often blamed by liberals for reversing key features of the New Deal, those policies should rather be viewed not as ideological thrusts but as adaptations to a changing global economy and as remedies for an economic crisis in many ways more severe and prolonged than the one we face today. Sooner or later some such measures would have had to be adopted to break the cycle of inflation and unemployment. Those adjustments in policy have been ratified, not only by two decades of robust growth, but also by the tacit endorsement of leading Democrats. After all, despite much weeping and wailing, prominent Democrats gradually accommodated themselves to the new framework, much as President Eisenhower adapted his administration to the New Deal reforms. President Clinton, elected to reverse the Reagan-era policies, signed the North American Free Trade Agreement, kept marginal tax rates low, did little to promote unionization, and signed a welfare reform bill that reversed a main feature of FDR's Social Security Act of 1935. As a consequence of these steps, he left office with a strong economic record.
The desire to overturn the market revolution that began in the 1980s and replace it with an up-to-date version of the New Deal is thus the ultimate snare for Democrats now fully in control of the apparatus of national policy. High marginal and corporate tax rates, managed trade and protectionism, reversal of NAFTA and other trade agreements, private-sector unionization, new health care mandates on business, subsidies for politically favored industries, increases in public-sector employment--all of which have been proposed in one form or another--are a recipe for an extended period of slow growth and stagnation of the kind not seen since the 1970s. Such an outcome would discredit Democrats, once again, as hamfisted on the economy and deprive them of resources required to fund their agenda of social programs. While this would be much to the advantage of Republicans, such an outcome might take years to reverse and would do immeasurable harm in the meantime.
A wiser though less exciting course would be to accept the inherited framework of policy with its emphasis on growth rather than redistribution, while finding other avenues by which to address Democratic priorities. If the president-elect wishes to find some inspiration in the New Deal, he could do worse than look to FDR's constructive and successful efforts to modernize the financial system as a foundation for economic recovery. FDR understood, even if many of his aides and advisers did not, that if a party in power cannot deliver economic growth, there is little else that it can hope to accomplish.
James Piereson, a senior fellow at the Manhattan Institute, is the author of Camelot and the Cultural Revolution: How the Assassination of John F. Kennedy Shattered American Liberalism (Encounter Books).