Great Depression

The Great Depression was the longest and deepest downturn in economic activity in the history of the modern industrial world. It was the unintended consequence of practices that were unquestioned at the time of its outset, and it has since prompted a critical examination of those practices that has had a profound influence upon both economic theory and the practice of economic management.

In the United States, where it began in 1929, there was a deep and prolonged decline in production and a damaging rise in unemployment. Businesses and banks closed, people lost their jobs, homes, and savings; and in the absence of welfare programmes, many depended on charity to survive. By 1933, American unemployment had risen to a poverty-inducing 25 per cent of the working population, and it did not fall below a debilitating 15 per cent until the outbreak of the second world war.

Beyond the United States, it affected most of world’s industrial countries, many of which also experienced severe and prolonged declines in economic activity with similar - though often less severe - effects upon unemployment and poverty.

Studies of the great depression have attempted to discover why it had been deeper and more prolonged than anything that happened before or since, and although some uncertaities have been reduced, a definitive answer to that question has yet to be established.

(For the international effects of the great depression see the Addendum subpage, for the sequence of main events, see the Timelines subpage and for a discussion of economic theories concerning causes and remedies, see the Tutorials subpage.)

The crisis in summary

The Great Depression started in the United States in 1929, reached its zenith in 1932 and lasted there until 1939. It spread to most industrialised countries, in most of which it was less severe and of shorter duration. In the United States it was accompanied for part of that period by the stock exchange crash of 1929 and the banking crisis of 1931 and a severe deflation; and resulted in a massive loss of output, with a 47 per cent fall in industrial production and a 30 per cent reduction in GDP, and persistently high unemployment, that peaked in 1933 at 25 per cent of the working population and was still about 15 per cent in 1939.

The development of the depression

Although it ended eleven years earlier, there are reasons to suppose that the first world war played a part in the development of the great depression. Professor Temin of MIT argues that it , in fact, the shock that set the process in motion, by producing a disruptive changes to its structure that required a difficult period of adaptation. The pattern of international capital movements in particular had been disrupted by the fact that when the war ended, the American economy was much stronger and European economies were much weaker, and by the fact that Britain had to repay the debts to America that it had incurred during the war. After a turbulent post-war period, during which there were deep but short-lived recessions on both sides of the Atlantic, growth returned to the United States economy but the German

according to John Maynard Keynes "...the world was enormously enriched by the constructions of the quinquennium from 1925 to 1929; its wealth increased in these five years by as much as in any other ten or twenty years of its history" .

Explanations: the question of causation

There have been a great number of attempts to establish the cause of what has come to be seen as an unprecedented self-inflicted injury, and a great deal of disagreement. However, the unprecedented feature of the great depression was not its initiation (there had been a succession of recessions in the United States throughout the previous eighty years , and it was no worse in its early months than the preceding recession of 1921 ) - but, rather, its unprecedented severity and persistent depth. That consideration and others suggest that any search for a single cause is likely to be confusing and inconclusive. For example, although the popular view that it was initiated by the stock market crash can be shown to be mistaken , it must be presumed to have contributed to its subsequent severity. Similarly, it can reasonably be presumed that although the 1931 banking panic could not have started the great depression, it intensified its subsequent severity.

Contributory factors

(the discussion in the following paragraphs is based upon material that is set out in more detail on the tutorials subpage)

Trade protection

U.S. imports from Europe declined from a 1929 high of $1,334 million to just $390 million in 1932, while U.S. exports to Europe fell from $2,341 million in 1929 to $784 million in 1932. Overall, world trade declined by some 66% between 1929 and 1934.

The New Deal in the United States

In the early 1930s, before John Maynard Keynes wrote The General Theory, he was advocating public works programs and deficits as a way to get the British economy out of the Depression. Although Keynes never mentions fiscal policy in The General Theory, and instead advocates the need to socialise investments, Keynes ushered in more of a theoretical revolution than a policy one. Keynes's basic idea was simple: in order to keep people fully employed, governments have to run deficits when the economy is slowing because, under unemployment, the private sector won't invest to increase production and reverse the recession.

As the Depression wore on, Franklin D. Roosevelt tried public works, farm subsidies and other devices to restart the economy, but he never completely gave up trying to balance the budget. According to the Keynesians he had to spend much more money; they were unable to say how much more. With fiscal policy, however, government could provide the needed Keynesian spending by decreasing taxes, increasing government spending, increasing individuals' incomes. As incomes increased, they would spend more. As they spent more, the multiplier effect would take over and expand the effect on the initial spending. The Keynesians did not estimate what the size of the multiplier was. Keynesian economists assumed that poor people would spend new incomes; in reality they saved much of the new money, that is they paid back debts owed to landlords, grocers and family. Keynesian initial ideas of the consumption function were harshly questioned in the 1950s by the monetarist Milton Friedman and have since been considerably refined by Franco Modigliani who, with help from the Hicks-Hansen IS-LM model, created the nucleus of the Neoclassical Synthesis of Keynesianism which was embraced and further developed by Paul Samuelson, James Tobin, Wassily Leontief an his pupil Robert Solow to became the mainstream economic thought until the early seventies.

Gold Standard

Britain departed from the gold standard in September 1931, allowing the pound sterling to float. As a result, the value of the pound dropped significantly and British exports became cheaper. In 1933, the United States followed suit and dropped the gold standard.

Madsen (2004) provides an econometric analysis from an international perspective on the consequences of inflexible wages and prices on the length and depth of the Great Depression beginning in 1929. In order to analyze the sources and consequences of the supply-side failure during the Great Depression, it is necessary to create a supply model consisting of price and wage settings in which, in addition to using instruments and alternative estimators, the sensitivity of the estimation results to different data sources, data coverage, instrument set, and restrictions imposed on the estimates are examined. The analysis indicates that inflexibility of prices in the manufacturing sector of the industrialized and semi-industrialized countries in the data set was the primary factor for the extent of the Great Depression.

Aldcroft (2004) notes the 1930s are often seen as a time of almost continuous currency disorder around the world, particularly between 1931 and 1933, when many countries went off the gold standard and allowed their currencies to float free. However, the wild fluctuations of the early years in the decade began to subside, and stability returned to the currency market due, in part, to the emergence of the sterling bloc; the name given to a group of countries that pegged their currencies to the value of the British pound. The arrangement worked well, in spite of there being no constitution or administrative regulations governing the operation of the system. The creation of the sterling bloc helped Britain to regain its position in international finance, accelerated its recovery from the Depression, and helped to stabilize international trade generally.

Rearmament and recovery

The massive rearmament policies to counter the threat from Nazi Germany helped stimulate the economies of many countries around the world. By 1937 unemployment in Britain had fallen to 1.5 million. The mobilization of manpower following the outbreak of war in 1939 finally ended unemployment.

In the United States, the massive war spending doubled the GNP, helping end the depression. Businessmen ignored the mounting national debt and heavy new taxes, redoubling their efforts for greater output as an expression of patriotism. Patriotism drove most people to voluntarily work overtime and give up leisure activities to make money after so many hard years. People accepted rationing and price controls for the first time as a way of expressing their support for the war effort. Cost-plus pricing in munitions contracts guaranteed that businesses would make a profit no matter how many mediocre workers they employed, no matter how inefficient the techniques they used. The demand was for a vast quantity of war supplies as soon as possible, regardless of cost. Businesses hired every person in sight, even driving sound trucks up and down city streets begging people to apply for jobs. New workers were needed to replace the 12 million working-age men serving in the military. These events magnified the role of the federal government in the national economy. In 1929, federal expenditures accounted for only 3% of GNP. Between 1933 and 1939, federal expenditure tripled, and Roosevelt's critics charged that he was turning America into a socialist state. However, spending on the New Deal was far smaller than on the war effort.