Depression, War, and Cold War: Studies in Political Economy

There’s a story that most Americans of my and later generations have grown up with. It goes something like this: in the late 1920’s our economy spontaneously dropped off a cliff due to an (unexplained) failure of capitalism and free enterprise. Although the situation was initially made worse by the laissez faire ideology of the Hoover administration, from 1933 onward FDR boldly enacted needed government policies to compensate for the inability of free markets to generate full employment and to self-correct. Thus government “demand” substituted for the absence of private “demand” and the grave situation was ameliorated through the 1930’s. Then World War II arrived and provided just the Keynesian stimulus the economy really needed to come out of the Great Depression once and for all. Prosperity returned with the War, and America never looked back. Trouble is, the story is almost entirely wrong. In this collection of essays, all written well before our current crisis-driven expansion in government power, Higgs logically and systematically explodes all of the myths and provides new insights as to how the state response to the Great Depression and Second World War permanently changed both the size and dynamics of government spending in relation to the private economy, and in particular how the larger share of GDP devoted to military spending evolved through the Cold War period. He starts with the late 1930’s and “Great Duration”: the question of why the Great Depression lasted so long, much longer than any previous downturn, even ones that were substantially deeper. In fact, it is becoming increasingly accepted in the economics profession (ok, with the exception of DeLong and Krugman) that the policies of the New Deal directly served to prolong the misery. Higgs’ contribution to this debate is his focus on “regime uncertainty” as a deterrent to the private investment necessary to restore genuine prosperity. In FDR’s second term, the hostility to private enterprise was turned up dramatically as compared to FDR’s own policies in his first term and to his own rhetoric theretofore. Scapegoating of “economic royalists”, punitive tax rates, and ongoing battles with both a friendly Congress and an (initially) less-friendly judiciary over expansions of executive power to regulate, and a pattern of ad-hoc policy zigzagging all added up to create a genuine fear for the security of private property rights. In this environment, private capitalists were made reluctant to invest because they could not be certain or even confident in their future rights to harvest the fruits of investment. America appeared headed down the road to fascism. Thus private investment both in real dollars and as a percent of GDP remained below its pre-Depression level throughout the 1930’s and through the war years. Higgs uses contemporaneous survey data to support the thesis that businessmen genuinely feared for the future of free enterprise. The turnaround in opinion seemed to come as FDR shifted his focus to mobilization for the war effort, beginning in 1940. There was a changing of the guard in the Administration away from the “economic planners” and towards the “dollar a year men” who came from private industry with the organizational capabilities to direct the large scale war effort that was approaching. This was a group that was friendlier to business and the focus on war mobilization led to a lessening of the open hostility to enterprise. This changing of the tone of the Administration, combined with a change in control in Congress in 1944 (and the fact that FDR was gone by the end of the war) set the stage for the “Great Escape”, the surge of private investment and return to real prosperity that ensued almost immediately after the conclusion of the war. The poll data provided by Higgs to demonstrate these changes in the climate of opinion are corroborated by the financial markets which began to surge as the war wound down. The regime uncertainty hypothesis is thus