- Yes, says a minority of economic seers, whose warnings
also remind us that enlightened government is the best protection against
- "Prosperity is just around the corner," President
Herbert Hoover infamously remarked in 1930. How wrong he was. Hoover's
prognostication has gone down in history as a monumental goof, but what
is forgotten is that, at the time, his utterance seemed quite reasonable.
- Business activity in the U.S. had fallen in only seven
of the years from 1869 to 1929 (excluding the years of the World War I).
The average annual decline in real gross domestic product (GDP) during
this period was 1.6%, with one downturn of 5.5%, according to Peter L.
Bernstein in Against the Gods: A History of Risk. But 60 years of economic
history proved irrelevant during the catastrophe known as the Great Depression,
when GDP fell 55%, from a peak in 1929 to a trough in June, 1932.
- After the terrorist attack of September 11, the U.S.
economy has sunk into a recession. But the recent rally in the stock market
shows that investors remain optimistic that fiscal stimulus and monetary
easing will pull the economy out of the doldrums sometime in 2002. "The
recovery should be robust during the second half of next year in response
to the strong stimulus provided by monetary and fiscal policies,"
says Edward Yardeni, chief investment strategist of Deutsche Banc Alex.
Brown. Adds James Paulson, chief investment strategist at Wells Capital
Management: "The massive economic policy easing implemented since
the terrorist attack has caused many to expect a 'V-type' economic recovery."
- THE OTHER NEW ECONOMY.
- Are Yardeni and Paulson repeating Hoover's mistake? As
anyone who reads this column regularly knows, I don't think so. Yet a minority
of economists and investment analysts do. They point to ominous parallels
between now and the interwar period. For instance, a new economy emerged
in the 1920s, led by the automobile and electric power. The government
plowed budget surpluses into paying off the national debt.
- Worker productivity soared some 40%, and business invested
enormous sums in new plants and equipment. Wall Street went on a long speculative
binge. The Saturday Evening Post poetically captured investor irrational
exuberance in 1929:
- Oh, hush thee, my babe, granny's bought some more shares
Daddy's gone out to play with the bulls and the bears, Mother's buying
on tips, and she simply can't lose, And baby shall have some expensive
- Then, as we all know, the stock market boom went bust,
and the Great Depression of the 1930s followed the Great Crash of 1929.
While all this is fascinating to think about, the odds of another Great
Depression in the U.S. seem remote. After all, a whole set of institutions
from federal deposit insurance to unemployment insurance was established
after the Depression to prevent another calamitous breakdown.
- That said, a recent introduction to a collection of economic
essays suggests that great depressions are far from relics of the past.
The contributors to Great Depressions of the Twentieth Century study nine
severe downturns around the world.
- Several papers delve into the classic interwar depression
of Europe and the U.S. But other scholars look into the depressions of
Argentina, Brazil, Mexico, and Chile in the 1980s. These countries all
suffered declines in economic activity comparable in magnitude to Canada,
France, Germany, and the U.S. in the 1930s. New Zealand and Switzerland
may have experienced depressions, and Japan is certainly sinking into an
economic abyss. "The notion that the Great Depression is from the
1930s, and we don't have to worry about that now is wrong," says Timothy
J. Kehoe, economist at the University of Minnesota and a contributor to
- DEFINING DEPRESSION.
- How do Kehoe and co-author Edward C. Prescott define
a great depression in the introduction? They take the U.S., the world's
technological and economic leader, as their baseline. The long-term secular
growth rate in output per working-age person in the U.S. is 2% a year.
A great depression is defined as a sharp and huge deviation from this 2%
trend -- a drop of at least 20%. They only include in their study nations
with a relatively modern economy. For example, their database includes
Mexico but excludes Botswana.
- By their definition, New Zealand experienced a depression
from 1974 to 1992 since output per working-age person fell 32%. But Japan
has steered clear of a depression after taking trend growth into account.
Japan's output per working age person is down 13% from 1992 to 2000. The
economists are quick to add that if the Asian giant's economy continues
to stagnate its downturn will become a great one.
- The authors use the classic general-equilibrium growth
model as their framework for studying great depressions. They find that
the quantity of savings isn't a problem. Nor are subsidies to investment
the solution. Labor policies do matter, but not in all cases. Collectively,
however, the economists are most intrigued that government policies that
affect productivity and hours per working-age person are critical when
examining great depressions. Their suspicion is that keeping competition
among firms intense and letting inefficient companies fail has major positive
consequences for productivity. Government attempts to limit competition
and failure can backfire badly.
- SIMILAR SHOCKS. For instance, both Chile and Mexico
had great depressions in the early '80s, with output falling 30% below
trend within a few years. Both countries were large international debtors.
They were also hit by similar shocks: higher real interest rates (the interest
rate after taking inflation into account), and lower commodity prices (copper
for Chile and oil for Mexico). Yet productivity growth recovered fairly
quickly in Chile but not in Mexico. The reason, the authors speculate,
is that Chile reformed its banking and bankruptcy procedures and Mexico
did not. Chile let unproductive firms go bankrupt while the government-dominated
banking system in Mexico channeled low interest-rate loans to unproductive
- Kehoe and Prescott's contribution is a welcome reminder
that depressions are not an economic catastrophe of the distant past. Their
paper is also a timely nod that government policy combating a downturn
is much more than fiscal and monetary stimulus. Open borders and a well-functioning
bankruptcy system matter, too. Policymakers should continue to stimulate
the economy. But they should also ignore calls to close borders to goods
and immigrants, as well as calls to bail out the many industries hammered
by the drop-off in economic activity since September 11. ___
- Farrell is contributing economics editor for BusinessWeek.
His Sound Money radio commentaries are broadcast over National Public Radio
on Saturdays in nearly 200 markets nationwide. Follow his weekly Sound
Money column, only on BW Online. Edited by Beth Belton.