Economist: Hoover’s pro-labor policies created the Depression

posted at 5:55 pm on August 31, 2009 by Ed Morrissey

In times of economic crisis, the temptation for public officials to do something is both overwhelming and tremendously dangerous.  UCLA’s Dr. Lee Ohanian makes that point plain in his latest research on the Great Depression and its primary causes, in which Herbert Hoover’s reputation as a free-market politician gets serious revision.  Hoover’s deal with manufacturing giants to keep wages high turned what should have been a deep but temporary recession into an economic disaster:

Pro-labor policies pushed by President Herbert Hoover after the stock market crash of 1929 accounted for close to two-thirds of the drop in the nation’s gross domestic product over the two years that followed, causing what might otherwise have been a bad recession to slip into the Great Depression, a UCLA economist concludes in a new study.

“These findings suggest that the recession was three times worse — at a minimum — than it would otherwise have been, because of Hoover,” said Lee E. Ohanian, a UCLA professor of economics. …

After the crash, Hoover met with major leaders of industry and cut a deal with them to either maintain or raise wages and institute job-sharing to keep workers employed, at least to some degree, Ohanian found. In response, General Motors, Ford, U.S. Steel, Dupont, International Harvester and many other large firms fell in line, even publicly underscoring their compliance with Hoover’s program.

Designed to placate labor and safeguard workers’ buying power, the step had an unintended effect: As deflation eventually did set in, the inflation-adjusted value of these wages rose over time, effectively giving workers a raise precisely at the time when companies were least in a position to afford such increases and precisely when productivity was beginning to fall.

“The wage freeze effectively raised the cost of labor and, by extension, production,” Ohanian said. “If you artificially raise the price of production, your costs go way up and you pass them on to the customers, and they buy that much less.”

As with other big government interventions, Hoover made the situation worse by attempting to control one part of the economic picture.  When he froze wages, it amounted to across-the-board increases in buying power as deflation set in — and made their companies unable to pass along the costs of production to consumers.  After two years, employment had dropped 35% and GDP by 27% as the American economy collapsed.  Ohanian argues that two-thirds of that GDP decline can be directly attributable to this deal.

In comparison, Ohanian notes that the agricultural sector — exempt from the Hoover deal — performed much better.  Agricultural wages dropped 30% in that period, but hours worked remained fairly constant through 1931.  In fact, the ag sector continued to do (comparably) well until the 1935 Dust Bowl, which ravaged American farming and touched off the nation’s first large-scale homelessness.

Hoover wanted to avoid the political fallout of high unemployment and deflation at the same time.  He hoped that his deal would arrest the fall of prices as well as wages by artificially keeping the latter frozen.  That only works if people have capital to continue to buy; otherwise, it creates a kind of Ponzi scheme in which the manufacturers get left holding the bad, and in which workers get their hours cut progressively until they are in de facto unemployment.

We have seen the results of other large-scale government interventions the last few years, too.  In the case of housing, however, the government didn’t respond to a crisis, but to prosperity.  The Clinton administration — and more than a few Republicans — wanted to expand home ownership and distorted the lending markets to create a demand bubble, and essentially another Ponzi scheme in which buyers were encouraged to overreach and then refinance on equity gains.  Congress fueled it through mandates to Fannie Mae and Freddie Mac to buy and securitize marginal loans that eventually collapsed and poisoned the entire financial sector.

Government has a legitimate role in regulating markets to prevent fraud and abuse.  It does not have a legitimate role in manipulating markets for social engineering, no matter how well-intentioned that social engineering might be.  Be sure to read the entire report.

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How do you determine that the “consensus” is actually holding a valid view and not a “consensus” via manipulation to push an agenda?

How do you determine who is an “expert” and who isn’t.

Says things I want to hear doesn’t count.

MarkTheGreat on September 1, 2009 at 10:16 AM

I can’t think of a single “expert” who feels that the minimum wage helps the poor. Nor can I think of a single, non-discredited study, that finds the minimum wage helps the poor. (Note, Krugman-Card is a thoroughly discredited study, it’s methodology was one of the worst ever.)

MarkTheGreat on September 1, 2009 at 10:18 AM

I thought this had already been established?

Hoover didn’t make things worse by leaving things alone, but by monkeying with things.

Aronne on August 31, 2009 at 9:56 PM

Hoover also dramatically raised tax rates.

MarkTheGreat on September 1, 2009 at 10:20 AM

You are assuming that the meltdown has been averted.

Vashta.Nerada on September 1, 2009 at 9:36 AM

Worse, he is assuming that there was an incipiant melt-down in the first place, and not just a serious panic.

It’s more likely that these actions made a bad situation a little bit better, but at the cost of a worse crash later.

MarkTheGreat on September 1, 2009 at 10:23 AM

The Federal Reserve created the Great Depression through its loose money supply practices. The Fed was created to reduce the drastic contraction and expansion of the markets prior to its creation, which was the free market. The Fed job was to reduce risk to corporate investors. Congress outsourced its constitutional obligations of controlling the value of and printing currency.

The Great Depression started just as the current financial downturn – over saturation of the market place with dollars. Inflation and higher taxes are coming to reduce the amount of dollars available on the internation market, has too or we become a banana republic. Which I am beginning to believe that is exactly what liberals / progressives desire – the total destruction of America.

AASLT on September 1, 2009 at 10:51 AM

Hmmm…who’s engaging in pro-union policies these days…think, think!

Nope, nope, I got nothing.

I R A Darth Aggie on September 1, 2009 at 12:24 PM

Of course, modern day libs try to paint Hoover as being a right wing free market conservative, which he was not. Republicans of that era were NOT conservatives, actually the democrats tended to be. It was after World War II that the “progressive” movement shifted from the Republican to Democrat party.

wildcat84 on August 31, 2009 at 6:23 PM

I agree. It’s yet another example of people redefining terms to suit their own prejudices.

Whether Hoover was personally conservative or not, the actions he took in response to the stock market crash made it worse. He never went to the extremes that FDR did, but it’s difficult to lay the blame all on FDR when Hoover meddled in almost exactly the same ways … first!

But FDR is a hero to modern libs, and FDR was pretty strongly socialist, so naturally the FDR fans want to blame it on Hoover. And since they’re left wing, Hoover must be a right-winger free-market purist.

Look at what Hoover actually did, though, and it’s quite clear these are not the actions of someone who believed in the free market.

tom on September 1, 2009 at 12:32 PM

Hoover also dramatically raised tax rates.

MarkTheGreat on September 1, 2009 at 10:20 AM

Sounds strangely…familiar.

Aronne on September 1, 2009 at 2:54 PM