Wednesday :: Jan 21, 2009

Lessons from FDR


by eriposte

It's hard to describe how satisfying and wonderful it is to see the nation's first African-American President. I must say it is even more moving and joyous to see the emotions of so many African-Americans who have long waited for this day - emotions that appear to also hint at a rightful sense of pride that has been denied to the African-American community for centuries. No words can adequately describe the magic of yesterday and I am glad that history has been recorded in a million videos and pictures for eternity. Congratulations to President Obama! May this be the beginning of a transformative Presidency that changes America for the better in a million ways.

In keeping with the urgency of the moment we face I'm going to write a bit about FDR today because, the opportunity that President Obama has, arguably resembles the opportunity that FDR had in reshaping America in a progressive direction. Moreover, just as FDR inherited a terrible economic situation from his predecessor, so did President Obama (though we are not facing a depression, yet). FDR's "New Deal" was nothing short of a sweeping change in America, but not as commonly known is the fact that a few key aspects of FDR's policies diluted the positive impact of the New Deal and scuttled further, sharp progress on New Deal legislation in the late 1930s. It is this topic that I discuss in this post for it is important to learn from and avoid those mistakes as we look forward to the Obama Presidency.

As historian Jean Edward Smith discusses in his book "FDR", in the first 100 days of his Presidency FDR managed to push through an astonishing number of key initiatives: the Emergency Banking Act, a revision of the Volstead Act (prohibition), the Economy Act, the Civilian Conservation Corps, the Federal Emergency Relief Act,  the Agricultural Adjustment Act, the Emergency Farm Mortgage Act, the establishment of the Tennessee Valley Authority, the Truth-in-Securities Act, the de-linking of the US dollar from the gold standard, the Homeowners Refinancing Act, the Glass-Steagall Act, the Farm Credit Act, the Emergency Railroad Transportation Act, and the National Industrial Recovery Act. The positive impact of many of these initiatives would be felt in the coming years. Yet, the efficacy of the New Deal's economic policies was also inadvertently compromised - partly because of some of the legislation and partly due to flaws in execution. Columbia Historian Alan Brinkley discussed some of these issues recently in a good piece at TNR - although, as I point out below, he appears to have missed one of the major problems that FDR faced initially with his spending program.

The most significant issues that slowed or reversed New Deal economic progress during FDR's Presidency can be divided into the following three groups (emphasis mine, throughout this post).


1. Sharp Cuts in Government Spending

In his TNR piece, Brinkley pointed out that:

One of the first acts Congress passed for Roosevelt in 1933 was the Economy Act, which slashed government spending in ways that reduced economic activity. It cut the salaries (and, in some cases, the jobs) of government employees and dramatically reduced payments to World War I veterans, taking $500 million from the economy in a single stroke.

In his book, "FDR", Jean Edward Smith pointed out that the Economy Act was FDR's second measure after the Banking Act, mainly because Roosevelt, at the time, was a strong believer in reducing budget deficits. FDR evidently believed then that budget deficits were partly the cause of the economic stagnation and the banking collapse that led to the Depression. Although he publicly acknowledged in early 1933 that the Economy Act would not help get the country out of depression, he failed to realize that the massive budget cuts in the Economy Act significantly ran counter to the needs of economic expansion. Thankfully, this deflationary act was countered by Roosevelt through inflationary spending and relief measures in the same year.

Yet, FDR would repeat this mistake yet again in 1937 to costly effect. To see why, let us begin with Brinkley's observation that:

Roosevelt's initiatives did not, in the end, lift the country out of the Great Depression. At no time in the first eight years of the New Deal did unemployment drop below 15 percent. At no time did economic activity reach levels comparable to those of a decade earlier; and, while there were periods when the economy seemed to be recovering, none of them lasted very long.

This appears, at least in part, to be incorrect. According to Smith (page 396):

In the spring of 1937 American production pulled above pre-Depression levels for the first time. The New York Times' Weekly Business Index reported output at 110 - 10 percent higher than in the corresponding week in 1929...Unemployment shrank to 12 percent, barely a third of the March 1933 percentage. Subtract the young men in the Civilian Conservation Corps together with those at work in the job creation programs of the PWA and WPA, and the unemployment figure stood at 4 percent. [22*]

[...]

*In his 2003 biography of FDR, Conrad Black took issue with the school of historiography that asserts that recovery in the United States lagged behind that of other industrial countries. As Lord Black points out, American employment figures did not distinguish between those who had no job whatever and those working for the WPA, in the public works program, or enrolled in the CCC. All were lumped together as "unemployed". When the relief workers were factored in, American unemployment totals dropped by almost 60 percent...

[NOTE: Also worth reading on the issue of New Deal jobs is Media Matters: "Conservatives cherry-pick 1930s unemployment figures in continued assault on New Deal" and "Conservative media peddle a raw deal"]

Smith goes on to point out that it was in response to the nascent economic recovery that FDR mistakenly assumed that the U.S. economy was on sound enough footing that he could go back to a policy of cutting spending to balance budgets. This proved to be a huge mistake, as Brinkley notes:

In 1937, deluded by a weak economic recovery, Roosevelt (urged on by his Treasury secretary) set out to balance the budget through severe spending cuts. The result was a sudden and dramatic economic downturn--a recession within the Depression that produced some of the highest levels of unemployment and lowest levels of production of the decade.

In the aftermath of the 1937-1938 setback, Roosevelt launched a new $5 billion spending plan to try to shock the economy back to life. This infusion of funds helped undo the damage that the 1937 budget cuts helped to create, spurring a modest recovery that at least got the economy back to the weak and fragile condition of a year earlier.

According to Smith, FDR initially made the situation worse by procrastinating in response to the sharp downturn - largely due to some of the deficit hawks in his cabinet. However, as Smith writes, eventually stung "by continued press reference to the "Roosevelt recession," FDR reluctantly jettisoned the balanced budget approach." The new spending program in 1938 evidently amounted to a special appropriation of $3.4B which allowed the U.S. to recover, by years-end, half of the ground that had been lost. Eventually, World War II provided a huge spending stimulus to bring up the economy further, as Paul Krugman has noted.


2. Flawed Spending Plan

FDR's implementation of the National Industrial Recovery Act was flawed. Brinkley argues that:

The National Recovery Administration (NRA), created in 1933 to help stabilize the volatile economy, was enormously popular for a time, mostly because it created the illusion of forceful action. The NRA sought to help corporations cooperate with one another in keeping production low and prices up, effectively creating cartels. This effort proved almost impossible to administer: No one in the federal government had any experience or expertise in managing an economic project of this magnitude; control quickly moved to the corporations themselves, with no better results. But the NRA was even worse when it worked as it was supposed to, because its goal was exactly the opposite of what the economy needed: Instead of expanding economic activity, the NRA worked to constrict it. At the same time, the Federal Reserve Board--operating under classical economic assumptions--saw the economic wreckage around it and responded by raising interest rates so as to protect the solvency of the Federal Reserve Bank itself. No one today would even consider high interest rates in a slumping economy, but the Fed of the early 1930s had not absorbed new economic ideas that would later become almost universally accepted. (In fairness, this catastrophic mistake was not a product of New Deal policy, but few New Dealers recognized the magnitude of the error for years.)

In part, Brinkley's assertion here is incorrect. It is true that the production/price control and industry code clauses of the NRA were a nightmare to manage (and were later struck down by the SCOTUS as unconstitutional). However, the other part - spending the appropriated funds through the Public Works Administration (PWA) - was not that difficult. Brinkley's piece missed perhaps the most important reason why the PWA was much less effective than it could have been. The appropriated money was hardly spent due to tight-fisted administration, as Smith points out (pages 343-346):

...the act established two complementary agencies: the National Recovery Administration (NRA) to coordinate economic recovery, and the Public Works Administration (PWA), authorized to spend $3.3 billion in punp-priming construction projects....But FDR made the fatal error of dividing responsibility. To head the NRA, Roosevelt brought in former brigadier general Hugh "Iron Pants" Johnson...For PWA, the president turned to Harold Ickes...Ickes, on the other hand, was pathologically prudent. As he saw it, the problem of the public works program was not to spend money quickly but to spend it wisely. Obsessively tightfisted, personally examining every project in minute detail, Ickes spent a minuscule $110 million of PWA money in 1933...

The failure of the Public Works Administration to provide economic stimulus doomed NRA's recovery efforts from the start. Without a significant infusion of construction money, the NRA could not expand the economy. Johnson labored mightily to create industry codes that would control production, fix prices and regulate working conditions. But without money to prime the pump, he was simply redistributing scarcity...

[...]

FDR realized his error and sought to correct it by the end of the year:

As the winter of 1933-34 approached, Roosevelt recognized that Ickes' caution in spending PWA money was creating few jobs...FDR turned to Hopkins. Could he provide temporary jobs for 4 million people? Hopkins said he could if he had the money. Roosevelt ... decided to tap Ickes' underused Public Works budget for the funds....on November 9, 1933, [he] issued an executive order establishing the Civil Works Administration with Hopkins as director [47].

As Roosevelt anticipated, Hopkins moved quickly. He shifted staff from FERA to CWA, raided Army warehouses for tools and equipment, and dragooned the Veterans Administration - the one federal agency with a national disbursement system in place - into becoming the CWA's paymaster. Unlike relief programs, the Civil Works Administration provided jobs. Within ten days Hopkins had put more than 800,000 people to work, 2.6 million by mid-December, and by early January he was well over the 4 million mark. The CWA paid the prevailing minimum wage for unskilled labor, and the work was seasonal. When it went out of existence in April 1934, the CWA had pumped close to $1 billion into the ailing economy. Eighty percent of that had gone directly into workers' wages, with the bulk of the remainder paid out for equipment and material [49]. Less than 2 percent went for administrative overhead - another Hopkins hallmark.

In the bitter winter of 1933-34, with record low temperatures gripping the nation, the CWA laid 12 million feet of sewer pipe and built or upgraded 500,000 miles of secondary roads, 40,000 schools, 3,700 recreation areas, and nearly a thousand airports. It employed 50,000 teachers to keep rural schools open and to provide adult education in the cities. It hired 3,000 artists and writers - and they worked as artists and writers....The CWA did more than provide an overdue cash infusion to the economy; it restored a nation's self-respect. "We aren't on relief any more," said a proud woman in Iowa. "My husband is working for the government." [51]


3. Tax Increases During the Depression

Brinkley points out that:

The Social Security system, so valuable over the long term, was in the short term a drag on the economy. It began collecting taxes in 1936 but paid out few benefits until the 1940s.

Smith explains further in his book (pages 351-352):

The downside of FDR's insistence that social security pay its own way was the immediate adverse effect on the economy. To build the reserve fund from which to pay benefits required withdrawing money from workers' wages - money that would otherwise be spent. Roosevelt understood that the payroll tax would be deflationary. But he was more concerned about what he called "legislative habits and prejudices." "Those taxes were never a matter of economics," FDR said later,. "They are politics all the way through. We put those payroll contributions there so as to give the contributors a legal, moral, and political right to collect their pensions and their unemployment benefits. With those taxes in there, no damn politician can ever scrap my social security program."

Prescient words, yet, it is important to note that the taxation did depress economic output in part. As Paul Krugman also observed:

But the definitive study of fiscal policy in the ’30s, by the M.I.T. economist E. Cary Brown, reached a very different conclusion: fiscal stimulus was unsuccessful “not because it does not work, but because it was not tried.”

[...]

Well, [stimulus] wasn’t as major as you might think. The effects of federal public works spending were largely offset by other factors, notably a large tax increase, enacted by Herbert Hoover, whose full effects weren’t felt until his successor took office. Also, expansionary policy at the federal level was undercut by spending cuts and tax increases at the state and local level.


Key Lessons

Following the success of the CWA in 1934, FDR subsequently got nearly $5B from Congress and created another work program through the Works Progress Administration (WPA) in 1935 - also administered by Hopkins. Smith points out that Hopkins found this far more challenging and had to get the help of the U.S. Army Corps of Engineers to administer this program. On the efficacy of the WPA, he writes (page 355):

In the first year of its existence the WPA put more than 3 million people to work, and over a span of eight years it employed upward of 8.5 million while pumping some $11 billion into the economy.

Unsurprisingly, the WPA was a major focus of criticism (pages 356-357):

When Congress amended the Work Relief Bill to require senatorial confirmation for appointees earning over $5,000, Hopkins realized his apolitical days were over....Republicans complained that the WPA was a gigantic patronage boondoggle operated for the benefit of the Democratic party. [97] Critics on the left, led by The Nation, bellyached [that] the WPA was a misguided attempt to aid America's "crippled capitalist system" by forcing workers to settle for "depressed wages in a federal work gang." [98] Conservative southerners bridled at what they perceived to be the breakdown of white supremacy and a mixing of the races in various WPA programs.

Despite his spending/relief programs, FDR's major mistakes - the misguided attempt to balance the budget by slashing Government spending during the depression, a large amount of apportioned funds never getting spent in the early 1930s, and the initiation of social security taxes during the Depression - ended up partly countering the effectiveness of his New Deal in speeding up economic recovery. In some ways, the failure to realize that massive economic growth from a low base takes years of focused investment - not just a burst of temporary spending - compromised the results of the New Deal

To make matters worse, even though FDR had created the New Deal in the mid-1930s largely based on his strong popular support and his solid partnership with the Democratic-led Congress, he subsequently squandered his credibility because of his hubris - as reflected in his terrible attempt to pack the courts following the Supreme Court's overturning some New Deal legislation (partly because of the flawed text of the legislation, as Smith points out) and his extraordinary intervention in Democratic primaries to defeat a few foes of some New Deal legislation. This furthered deep divisions within the Democratic Party which had already been weakened politically in the late 1930s due to the disastrous spending cuts.

As we review this history, it is instructive to contemplate some pertinent lessons for President Obama from FDR's experience. President Obama was correct to observe in his speech yesterday that:

What the cynics fail to understand is that the ground has shifted beneath them - that the stale political arguments that have consumed us for so long no longer apply. The question we ask today is not whether our government is too big or too small, but whether it works - whether it helps families find jobs at a decent wage, care they can afford, a retirement that is dignified. Where the answer is yes, we intend to move forward. Where the answer is no, programs will end. And those of us who manage the public's dollars will be held to account - to spend wisely, reform bad habits, and do our business in the light of day - because only then can we restore the vital trust between a people and their government.

He would be well advised to be bold and not let the inevitable criticism deter him from being aggressive in investing in America - for our future's sake. It is also worth remembering what FDR said in 1935 (Smith, p. 359):

You cannot borrow your way out of debt, but you can invest your way into a sounder future....Over three years ago, realizing that we were not doing a perfect thing but that we were doing a necessary thing, we appropriated money for direct relief. But just as quickly as possible we turned to the job of providing actual work for those in need.

I realize that gentlemen in well-warmed and well-stocked clubs will discourse on the expenses of Government and the suffering that they are going through because their Government is spending money on work relief. Some of these same gentlemen tell me that a dole would be more economical than work relief. That is true. But the men who tell me that have, unfortunately, too little contact with the true America to realize that...most Americans want to give something for what they get. That something, which in this case is honest work, is the saving barrier between them and moral degradation....

It is critical that the American public understands that what the Obama administration is about to embark upon is not merely "Government spending" - it is a solid, multi-year investment in America's future. That is how the spending program should be designed and communicated. Usually, large companies survive recessions and emerge stronger by choosing to invest during downturns - something that smaller competitors can ill afford. The United States needs a bold, sound, multi-year investment plan and I hope President Obama will work with Congress to deliver on it within the first 100 days.

eriposte :: 6:35 AM :: Comments (3) :: Digg It!