LECTURE 20: THE GREAT DEPRESSION AND BUSINESS RESPONSES

THE GREAT DEPRESSION:

The Great Depression was a severe worldwide economic depression that took place mostly during the
1930s. This crisis is considered to be the most important crisis suffered by rich capitalist economies of the
20th century and of the history until the crisis of 2008. The great depression is often compared to the current
crisis, although they differ in the monetary system (flexible/fixed exchange rate) and the policies used
(conventional/unconventional policies), because they affected the whole economy and were characterized
by deflation (low prices) and recession (reduction in GDP).

The relevance of the 30’s crisis lies in the fact that the banking system was connected to the financial system
(because it was providing loans to make investments), so the financial crisis affected the banking system.

The famous crush of the 29 wasn’t the start of the crisis, but an evidence or consequence of it. The problem
started during the last decade, in which America had had a deflationary tendency due to overproduction
(heavy investments and production higher than demand). After the crush, the government’s response wasn’t
the correct one and it make the crisis even worst, as they didn’t avoid the American banking system going
bankrupt.

In the 20’s a financial bubble was created in New York stock market. People started to invest a lot in the
stock market and, the more people invested, the higher prices were. This speculative bubble was fuelled by
the excess of liquidity provided by banks.

Economic policy (continued and concluded)

The FED tried to solve the bubble. In the 1920s it began to use the monetary policy as an implement to
stabilize business cycle fluctuations (in USA).

Friedman and Schwartz (1963): “In retrospect, we can see that this was a major step toward the
assumption by government of explicit continuous responsibility for economic stability.”

As the decade wore on, the System took - and perhaps even more was given - credit for the generally stable
conditions that prevailed, and high hopes were placed in the potency of monetary policy as then
administered”

Depression and recovery

 Depression: The Great Depression caused:

o Banking crises
o Agricultural distress
o Unemployment
 Recovery policies: In order to achieve economic recovery:
o New deal - first and second

It supposed a challenge to America: agricultural crisis, high level of unemployment...

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Depression - Banking crises:

The crash of the stock market led to the bankruptcy of the banking system.

Susan Previant Lee and Peter Passell: A new economic view of American history, p 374:
“By early 1932, everyone with an IQ above 80 - and most members of the Fed board of Governors -
knew something was dreadfully wrong with the economy”.

There was liquidity run (banking panic and crisis of expectations) because many savers hurried to withdraw
their deposits, causing bankruptcy. Fed purchased government bonds - $1billion. It attempted to increase
liquidity and to stimulate economic expansion. “In any event, after a few months the Fed stopped trying”.
The drizzle of bank failures became a downpour.

Depression - Bank failures:

NB: Structure of the US banking industry and impact of local failure

Tom Kemp (1990: Longman): The climax of Capitalism: The US Economy in the Twentieth Century

1930 1.352

1931 2.294

1932 1.456

1933 4.004

Susan Previant Lee and Peter Passell: A new economic view of American history, p 375:
“Thus we got the worst of both worlds: a banking system dependent on government for its stability
and a government with little sense of its powers or responsibilities”

Depression - Agricultural distress:

In America, the depression produced farmers to be getting lower and lower incomes, investing and having to
pay high interests… Therefore, many farmers started to lose their farms.

 After the war, prices began to fall: prices fell in absolute terms (dollars), but much more in relative
terms. Between 1928 and 1933 the terms of trade shifted the prices farmers received fell by a half,
and the prices farmers paid for goods fell by a third.
 Collapse of incomes: bankruptcy and repossession (adds to problem of banks)
 Agricultural demand for other goods and services fell.

Ironically, the most help that farmers received came not from Hoover’s government, but from severe
weather - harsh winter and “dust bowl” - which provided natural support to the agricultural prices.

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Depression - Unemployment in the USA, 1929-1936

Millions %

1929 1.6 3

1930 4.3 9

1931 8 16

1932 12.1 24

1933 12.8 25

1934 11.3 22

1935 10.6 20

1936 9 17

LECTURE 21: BUSINESS RESPONSES AND CONDUCT DURING THE

1930s
After the Great Depression in 1929, some policies were needed in order to recover the economy of the
country. This set of policies consisted in:

1. Banking and finance reorganization

2. Agricultural support
3. Industrial support
4. Unemployment relief
5. Assessment of the New Deal
6. Changes from the unitary form to the multidivisional form

1. Banking and finance reorganisation

The New Deal was a package of measures, some of which, notably the National Labor Relations Act, were
intended to increase the bargaining power of workers and employers and to prevent nominal wage declines.

The recovery of the financial sector was mainly characterized by the re-organization of the banking and
finance sectors. An important ingredient in recovery in the United States was rehabilitation of the banking
system to put an end to the waves of bank failures and to ease the credit crunch; this was, indeed, a major
priority for legislators. Both re-capitalization and re-regulation of the banks were required. Following a
compulsory closure of all banks for 3 days for inspection of their books, the Roosevelt Administration passed
an Emergency Banking Act in March 1933 and this was followed by the Banking Acts of 1933 (Glass–Steagall)
and of 1935. About 4,000 banks were declared insolvent and not allowed to re-open after the ‘bank holiday’.

Furthermore, these banking acts empowered the Reconstruction Finance Corporation (RFC), a government
agency, to buy preferred stock in banks with voting rights that frequently entailed effective control,

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introduced federal deposit insurance, separated investment from commercial banking, and imposed
interest-rate ceilings on bank accounts. Deposit insurance, made permanent under the auspices of the
Federal Deposit Insurance Corporation (FDIC), was important in ending the threat of further bank runs. The
RFC provided substantial capital and imposed conditions on banks which were a good substitute for market
discipline on risk taking.

Bank lending, however, remained far below pre-Depression levels and deposit-to-reserve ratios continued to
fall. This reflected continued efforts by banks to reduce default risk at a time when they found it costly to
raise new equity. The regulatory response to the banking crises was highly unsatisfactory. Calomiris notes
that the legislation was designed to support unit banking, yet this was the main structural weakness of the
system which inhibited diversification of risks, prevented coordinated responses to shocks, restricted
competition, and was a major source of banking instability. In contrast, the Glass–Steagall Act mandated the
separation of commercial and investment banking, whereas the evidence is that banks which did both were
better diversified and less likely to fail.

The New Deal was largely financed by tax increases and notes that the direct effects of fiscal stimulus were,
at most, a very small part of the recovery. So, fiscal policy was not really tried.

For countries in the rest of the world, a key factor in recovery was exit from the gold standard, as would be
expected on the basis of the earlier discussion. On average, the earlier this happened the shallower was the
downturn and the sooner recovery began: leaving gold meant permitting monetary expansion and leading to
big declines in real interest rates.

2. Agricultural support

Farmers were facing low prices. In order to guarantee a price stability, the major interventions in the market
by the government were:

-Agricultural Adjustment Act (AAA) (1933) → Price support, purchase and federal credit agencies
-Soil conservation and domestic allotment (1936) → Stop-gap after Supreme Court ruled on AAA.
-Agricultural Adjustment Act (1938) → Retrieved and restored measures from 1933 Act

Farmers tried to improve practices by creating, for example, the TVA (Tennessee Valley Authority). The
Tennessee Valley Authority (TVA) gave people jobs building dams on the Tennessee River.

3. Industry support

Similarly, support was given to the industrial sector with the aim to produce price stability: The National
Industrial Recovery Act, 1933-5, ruled by the National Recovery Administration.

However, the Administration had to deal with the hostility of the courts regarding economic intervention:
new laws were enacted and interventionist were measures introduced. Unfortunately, all those issues were
challenged in counts since they were often found unconstitutional by the Supreme Court. The
Administration, though, continued to reintroduce new interventionists Acts.

Example of a measure which gave support to the domestic products:

1) In the 1960 the government pushed the idea that manufacturers put the identification of
American products to the American goods with the intention to encourage Americans to
consume domestic goods and services.
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4. Unemployment relief: “make job schemes” (not only the state but also local agencies)

- Federal emergency relief administration (FERA) 1933-5

- Civil Works Administration (CWA) 1933

- Civilian Conservation Corps (CCC) 1933. This association gave jobs that conserved and protected the
natural environment.

- Works Progress Administration & Social Security 1935-1941. They gave people jobs building streets,
parks, libraries and schools, and the latter provided money to people who were over 65 years old or
who had disabilities.

5. Assessment of the New Deal:

1- A coherent programme?

Roosevelt acted as if he was recovering the country from the Great Depression, but, at the end, no coherent
programmes were done to make the economy work again. He proposed and planned new interventions, but
in reality those measures were neither effective nor productive, since they had not a good planning to
implement them.

The Government tried to neglect the blame on themselves and behaved as if they solved everything, but not
acting as they should.

Consequently, there was no New Deal but it was the Government taking action.

2-Innovation use of deficit spending?

Americans were more prone to Keynesian policies (run deficit, incentivize spending), not like German, who
were not using deficit spending: there was a program of designed deficit spending. Roosevelt suggested that
running deficit was a good idea, but never planned it up. John Maynard Keynes arrived later and had counter
ideas with Roosevelt. There was a link between the New Deal and Keynes, even thought, since they both had
a big ego, they could not get an agreement about the policy.

There were plenty and hundreds of ideas which didn’t have a well-functioning planning.

It was proved that the Federal Government was trying to get deficit to improve the economy. However, as
soon as the national government aimed to spend money, individual states and authorities at the local level
(State Government) attacked back with taxes to the population this spending, the one that the government
was trying to stimulate. The New Deal was largely financed by tax increases from which the direct effects of
fiscal stimulus were, at most, a very small part of the recovery. So, fiscal policy was not really tried.

3-Political imperative? or log-rolling?

It consists in a process where American politicians requested for support for a specific project. If they got the
support, they would be able to run the project they had previously proposed.
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Logrolling is the trading of favours, or quid pro quo, such as vote trading by legislative members to obtain
passage of actions of interest to each legislative member. It enables policymakers to achieve their public
goals. These policymakers logroll to ensure that their district policies and pork barrel packages are put into
practice regardless of whether their policies are actually efficient

It is quite clear that it was a lot of political influence allocating money. With this economic support, people
got new infrastructures, such as schools, highways, and so on. Apparently, locally, they achieved some
successes, but from a macroeconomic perspective, the net effect was neutral.

6. Changes from the unitary form to the multidivisional form (U-from to M-form)

The first most affected to the change of the firms’ framework were those who carried out their expansion
during the WWI. One of the most affected firms was Dupont.

The management of Dupont faced a serious problem, it needed a reorganization. They introduced new
divisions, distributed according to products, and they gave more power to the managers, who in turn
organised the different departments as business units.

Investment allocations were made by the directors - board. They only chose those projects which generated
more cash. This separation of power and management let to some conflicts over strategic decisions: board
focused on getting more cash while managers thought about the day-to-day functioning of the firm.

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General Motors was also a great example, together with Du Pont, of an expanding firm during the war.
However, in 1920, the lack of an internal and accurate accounting system left the company bankrupted,
since nobody was able to be aware of the economic issues. It was notorious thanks to its division in sectors
of the market -> specialization.

The bankruptcy of General Motors resulted in the loss of an important client for DuPont meaning serious
problems for the latter company since it was a significant supplier. Thus, DuPont forced GM to change its
form.

By the 2nd WW very few firms had adopted the multidivisional form. Even in the depression, few American
firms tried to adapt.

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 APPENDICES
1. Introduction and measures of the New Deal (Spanish)

El New Deal fue un conjunto de medidas económicas puestas en marcha por el presidente
norteamericano Franklin D. Roosevelt entre 1933 a 1937, para actuar de forma enérgica sobre lo que se
consideraban las causas de la grave crisis económica de 1929.
Esta nueva política económica se fundamentaba en el intervencionismo estatal y en la firme creencia en las
teorías del subconsumo.
Entre las medidas llevadas a cabo destacan:
Devaluación del dólar.
Recuperación del valor adquisitivo del sector agrícola.
Reactivación de la producción industrial aumentando los salarios, reduciendo la jornada laboral y con una
subida de precios para corregir descensos provocados por la depresión.
Política de subvenciones a fondo perdido a los bancos en dificultades.
Política dirigida para luchar contra el desempleo.
Para contrarrestar el ciclo económico depresivo existente en Estados Unidos, Keynes propuso políticas
económicas anticíclicas. Keynes sostenía los principios del liberalismo económico clásico, pero proponía la
intervención del Estado en aquellos casos en que se viera perjudicado. Creía que una redistribución de los
ingresos y el aumento de la tasa de empleo, reactivaría la economía. Las ideas de Keynes se publican en
1936 en su libro Teoría general del empleo, el interés y el dinero.
Estas políticas anticíclicas consisten en una intervención masiva del Estado en la economía. Esta
intervención se dio a partir de 1933, cuando en marzo gana las elecciones el demócrata Roosevelt. Al
conjunto de medidas políticas, sociales y económicas adoptadas por la administración Roosevelt entre
1933 y 1937 para sacar a Estados Unidos de la situación de depresión en la que se encontraba desde 1929
es a lo que se llamó New Deal; que consistió en una regulación de la economía favoreciendo las
inversiones, el crédito y el consumo, lo que permitiría reducir el desempleo.
Se crearon 6 grandes grupos de medidas, generales, en agricultura, industria, obras públicas, inversión
privada y acciones sociales. Los objetivos principales de estas medidas eran la reflación (fuerte subida de
los precios, inflación, junto con una recesión), devolver la confianza a los inversores y distribuir el poder de
compra.
NOMBRE FINALIDAD MEDIDAS
Políticas Generales fomentar Devaluación del dólar, Acuñación
tendientes a exportaciones, monedas plata, Ley bancaria, seguro
recuperar la aumentar precios, sobre depósitos bancarios
confianza en el Remediar deficiencias
sistema económico estructurales anteriores
y bancario

Política agrícola Sostenimiento precios Reducir oferta (Federal Farm Relief

agrarios Board desde 1929) almacenamiento de
alimentos.
Limitación cosechas: indemnización
por no cultivar.
Se establecieron unos precios
mínimos mayores que los precios
mundiales: subvenciones a las
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 exportaciones.
Política industrial Reactivar actividad Fijación precios mínimos.
económica evitando Semana laboral de 40 horas.
sobreproducción Salarios mínimos.
Potenciación de sindicatos.
Política de obras Mejorar situación Plan de electrificación rural.
públicas económica de zonas (Propuesta para otros 6 organismos,
deprimidas, pero fueron denegados por el
Reconversión industria congreso.)
de guerra. Construcción de 122.000 edificios
públicos, más de 1 millón de km de
carreteras, 77.000 puentes y 285
aeropuertos.
Política de
inversión privada
Desconfianza del
mundo de los
negocios hacia la
acción
gubernamental.
No pudo
aumentar la
inversión privada,
pero sin inversión
pública, la
depresión hubiese
sido más grave
Políticas sociales Ayuda a los parados Organismo de trabajos públicos, en
1938 empleó a 1/3 de los
resultados
desempleados. El Estado favoreció la
positivos
creación de empleo de dos formas.
Directamente mediante la oferta de
empleo público e indirectamente
encargando a empresas la construcción
de obras públicas.
Se establece un seguro de desempleo
financiado por los empresarios y un
seguro de jubilación financiado entre
los empresarios y trabajadores.
Planes de asistencia sanitaria y salud
pública.

El New Deal no acabó con el desempleo y la inversión privada no aumentó significativamente, pero la
sustitución de la inversión privada, por inversión pública contribuyó a que la depresión no fuese aún más
grave.

2. New Deal for a Depression That's Getting Old

Shortly after taking office in 1932, Roosevelt announced the "3 Rs" of the New Deal program to
the American people—it was a package deal of relief, recovery, and reform. Just what the doctor ordered.
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In the field of relief, the New Deal proved to be highly successful. Millions of Americans, unable to find work
in an economy that was still badly broken four years into the Great Depression, might have literally starved
to death if not for the government checks they earned by working for new agencies like the Civilian
Conservation Corps and the Works Progress Administration.
But in retrospect, it's kind of an obvious solution: if the private sector isn't making jobs, maybe the
government should.
In terms of reform, the New Deal legacy may have been unmatched in American history. For better or worse,
Roosevelt's program drastically altered the relationship between the capitalist market, the people, and their
government, creating for the first time in this country's history, an activist state committed to providing
individual citizens with a measure of security against the unpredictable turns of the market.
Some believe this vast enlargement of the government's role in American society helped the country's long-
run prospects. Others think we should allow the free market decide who starves. In any case, it remains a
question of great political controversy to this day, but there can be no denying the magnitude of change
wrought by FDR's presidency.
But when it came to recovery, the New Deal's performance lagged. It was certainly successful in both short-
term relief, and in implementing long-term structural reform. However, as Roosevelt's political enemies
fought him, the New Deal failed to end the Great Depression. Throughout the decade of the 1930s,
unemployment remained brutally high, while economic growth remained painfully slow.
Recovery only came about, at last, in Roosevelt's third term, when the heavy demands of mobilization
for World War II finally restored the country to full employment, in essence by doing exactly what the New
Deal had been attempting: providing government-created jobs.
Ironically, then, Adolf Hitler probably did more to end the Great Depression in America than Franklin
Roosevelt did.
Still, despite failing in its most important objective, the New Deal forever changed the country. Roosevelt
built a dominant new political coalition, creating a Democratic majority that lasted for half a century. The
structural stability and social security provided by the New Deal's reforms underlay a post-war economic
boom that many historians and economists have described as the "golden age of American capitalism."

3. Carta de Keyness a Roosevelt

El 31 de diciembre de 1933 el economista John Maynard Keynes dirigió una carta abierta a Franklin
Roosevelt, el único presidente de Estados Unidos que se ha enfrentado al capital financiero.

Escribió Keynes al mandatario: Usted se enfrenta a una doble tarea: recuperación de la crisis y la aprobación
de reformas económicas y sociales que debieron haber sido introducidas hace mucho. El objetivo de la
recuperación es incrementar el producto y el empleo. En nuestro mundo el producto se destina a ser
vendido y su volumen depende del poder de compra que le hará frente en el mercado. Un incremento en el
producto requiere de por lo menos uno de tres factores. Las personas deben ser inducidas a gastar una
mayor parte de su ingreso, o las empresas deben ser persuadidas, ya sea por una mayor confianza o por una
menor tasa de interés, a contratar más personal y así crear más ingresos en manos de sus empleados.
Alternativamente, la autoridad pública debe ser llamada a crear ingresos adicionales a través del gasto
público. Cuando los tiempos son malos no se puede esperar que el primer factor funcione a una escala
adecuada. El segundo factor no podrá operar sino hasta que el gobierno haya revertido la situación a través
del gasto público. En consecuencia, el mayor impulso para salir del bache sólo puede provenir del tercer
factor.

Keynes replantea hasta aquí su teoría de la demanda efectiva para indicar que en tiempos de crisis, cuando
el gasto y las expectativas se deprimen, la inversión privada se contrae y no puede ser el motor para sacar
una economía adelante. El gasto público es la alternativa para suplir la deficiencia en la demanda agregada.
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Las políticas de austeridad que hoy se aplican en Europa son la antítesis de esta visión y representan el
regreso a una ortodoxia que niega la realidad.

Sigue diciéndole Keynes a Roosevelt: Hay indicios de que dos falacias técnicas están afectando las políticas
de su administración. La primera tiene que ver con el papel que juega el incremento de precios en la
recuperación. Keynes aclara que el aumento de precios normalmente acompaña al crecimiento y la
expansión del empleo. Pero existe una inflación provocada por manipulaciones de costos o de la oferta y no
tiene nada que ver con el aumento de precios que se espera de una expansión saludable del poder de
compra y de la demanda agregada.

En el terreno de las recomendaciones, Keynes insistió: la prioridad está en otorgar crédito para el gasto bajo
los auspicios del gobierno. Una preferencia estaría en obras que pueden madurar rápidamente y en gran
escala, como la rehabilitación de la red ferroviaria. En segundo lugar yo colocaría el crédito barato y
abundante, así como la reducción de la tasa de interés de largo plazo a través de la intervención de la
Reserva federal.

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