"The depression ... was endemic to the system: the
economy was not self-regulating and needed to be controlled."
David Colander and Harry
Landreth1
The Great Depression of the 1930s may be a dim memory
now, but its impact is still being felt in policy and theory. The
prolonged depression created an environment critical of laissez-faire
policies and favorable toward ubiquitous state interventionism
throughout the Western world. The depression led to the Welfare State
and boundless faith in Big Government. It caused most of the
Anglo-American economics profession to question classical free-market
economics and to search for radical anti-capitalist alternatives,
eventually converting to the "new economics" of Keynesianism and
"demand-side" economics.
Prior to the Great Depression, most Western economists
accepted the classical virtues of thrift, limited government, balanced
budgets, the gold standard, and Say's Law. While most economists
continued to defend free enterprise and free trade on a microeconomic
scale, they rejected traditional views on a macroeconomic level in the
postwar period, advocating consumption over saving, fiat money over the
gold standard, deficit spending over a balanced budget, and active state
interventionism over limited government. They bought the Keynesian
argument that a free market was inherently unstable and could result in
high levels of unemployed labor and resources for indefinite periods.
They blamed the Great Depression on laissez-faire capitalism and
contended that only massive government spending during World War II
saved the capitalist system from defeat. In short, the depression opened
the door to widespread collectivism in the United States and around the
world.
Fortunately, free-market economists have gradually
punctured holes in these arguments and the pendulum has slowly shifted
toward a re-establishment of classical free-market economics. Three
questions needed to be addressed: What caused the Great Depression? Why
did it last so long? Did World War II restore prosperity? Economic
historian Robert Higgs had dubbed these three arenas of debate the Great
Contraction, the Great Duration, and the Great Escape.
The Cause of the Great Contraction
Many free-market economists had attempted to answer the
first question, including Benjamin M. Anderson and Murray N.
Rothbard,2 but none had the impact equal to Milton Friedman's
empirical studies on money in the early 1960s. His was the first
effective effort to destroy the argument that the Great Depression was
the handiwork of an inherently unstable capitalistic system. Friedman
(and his co-author, Anna J. Schwartz) demonstrated forcefully that it
was not free enterprise, but rather government - specifically the
Federal Reserve System - that caused the Great Depression. In a single
sentence underlined by all who read it, Friedman and Schwartz indicted
the Fed: "From the cyclical peak in August 1929 to a cyclical trough in
March 1933, the stock of money fell by over a third." 3(This
statement was all the more shocking because until Friedman's work, the
Fed didn't publish money supply figures, such as Ml and M2!)
Friedman and Schwartz also proved that the gold
standard did not cause the depression, as some Keynesian economists have
alleged. During the early 1930s, the U.S. gold stock rose even as the
Fed perversely raised the discount rate and allowed the money supply to
shrink and banks to collapse. 4
The Prolonged Slump
Economic activity and employment stagnated throughout
the 1930s, causing a paradigm shift from classical economics to
Keynesianism. Friedrich Hayek, the Austrian economist who challenged
Keynes in the thirties, was so disheartened about the state of the
free-world economy that he abandoned the study of economics in favor of
political philosophy.
Why did the depression last so long? Many free-market
economists have picked up where Murray Rothbard's America's Great
Depression left off, at the time Franklin Delano Roosevelt took office
in 1933. Gene Smiley (Marquette University) attempted an "Austrian"
perspective on the perverse role of fiscal policy in the 1930s. I
summarized the causes of stagnation and persistent unemployment, such as
the Smoot--Hawley Tariff, tax increases, government regulation and
controls, and pro-labor legislation.5
More recently, Robert Higgs of the Independent
Institute has made an in-depth study of the 1930s' malaise and focused
on the lack of private investment during this period. According to
Higgs, private investment was greatly hampered by New Deal initiatives
that destroyed investor and business confidence, the key to recovery.
6 In short, the New Deal prolonged the depression.
What Got Us Out?
In another brilliant study, Higgs attacked the commonly
held view that World War II saved us from the depression and restored
the economy to full employment. The war gave only the appearance of
recovery, when in reality private consumption and investment declined
while Americans fought and died for their country. A return to genuine
prosperity - the true Great Escape - -did not occur until after the war
ended, when most of the wartime controls were abolished and most of the
resources used in the military were returned to civilian
production.7 Only after the war did private investment,
business confidence, and consumer spending return to form.
In sum, it has been a long and hard - fought war to
restore the case for free-market cap-italism. Finally, through the
path-breaking work of Friedman, Rothbard, Smiley, Higgs, and other
scholars, we can now say the battle has been won.
At the time of the original publication, Dr. Skousen
was an economist at Rollins College, Department of Economics, Winter
Park Florida 32789, and editor of Forecasts & Strategies, one of
the largest investment newsletters in the country.
1. David C. Colander and Harry Landreth, eds., The
Coming of Keynesianism to America (Edward Elgar, 1996), p. 16.
2. Benjamin M. Anderson, Economics and the Public
Welfare (Indianapolis: Liberty Press, 1979 [1949]) and Murray N.
Rothbard, America's Great Depression (Princeton: D. Van Nostrand, 1963).
3. Milton Friedman and Anna J. Schwartz, A Monetary
History of the United States, 1867-1960 (Princeton: Princeton University
Press, 1963), p. 229.
4. Friedman and Schwartz, Monetary History, pp.
360-361. See also my May 1995 Freeman column, "Did the Gold Standard
Cause the Great Depression?"
5 Gene Smiley, "Some Austrian Perspectives on Keynesian
Fiscal Policy and the Recovery of the Thirties, " Review of Austrian
Economics (1987), 1:146-79, and Mark Skousen, "The Great Depression," in
Peter Boettke, ed., The Elgar Companion to Austrian Economics (Edward
Elgar, 1994), pp. 431-439.
6. Robert Higgs, "Regime Uncertainty: Why the Great
Depression Lasted So Long and Why Prosperity Resumed After the War," The
Independent Review (Spring 1997), 1:4, pp. 561-590.
7. Robert Higgs, "Wartime Prosperity? A Reassessment of
the U.S. Economy in the 1940s," Journal of Economic History 52 (March
1992), pp. 41-60. See also Richard K. Vedder and Lowell Gallaway, "The
Great Depression of 1946," Review of Austrian Economics 5:2 (1991), pp.
3-31.
Reprinted with permission from The
Freeman, a publication of the Foundation for Economic Education, Inc.,
July 1997, Vol. 47, No. 7.
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