Cycles of booms and bursts are an inherent part of capitalism. There was the oil shock and stagflation of the 1970s and the so-called dotcom bubble in the early 2000s which saw the technology-dominated Nasdaq index falling by 76% and wiping away trillions of dollars in investment. Then there was the 2008 financial crisis that led to a 2% decline in global GDP (total value of goods and services produced in the world). Nobody thought the world would ever see again an economic slowdown like the Great Depression of 1929/39 – longest, deepest, and most widespread decline in production and incomes in living memory. Until the new coronavirus emerged from Wuhan and shutdown economies all over the world.
The Trigger in 1929 -The Stock Market Crash
Prior to the early 2000s dotcom bubble collapse, technology firms sucked in trillions of investment which was pumped into the economy as payment for advertising, furniture, office complexes, cars etc. Something similar happened in the 1920s – everyone from millionaire tycoons, to cooks and hotel page boys poured their savings into stocks on the New York Stock Exchange until the market crashed on October 29, 1929 (Black Thursday) along with the savings of millions of people. The stock became worthless as no one was willing to buy. This translated into a run on the banks with people rushing to withdraw deposits fearing that the banks who had lost a lot of money with the stock market crash may not be able to pay them. Banks thus had little money to loan to industry. Soon there was a slump in consumer spending and in production. Between 1929 and 1933, GDP declined by 30% and unemployment reached more than 25% in the United States of America. Over a million Americans lost their jobs and so many went hungry. The impact in Europe was similar – industrial output fell by 40% in countries like Germany, Austria and Poland. German industry had been propped up by loans from American banks, half of which failed during the Depression, in the 1920s.
Disastrous Policy Response
The response of the government to the Great Depression was to dramatically curtail its expenditures, slash taxes, reduce its debt, and restore a balanced budget. The government laid off one-third of its civil servants and reduced wages for the rest. At the same time, it introduced new taxes that increased the cost of living by approximately 30 percent. The government also slashed spending on health and education. This reflected the state of economic policy knowledge – the belief in balanced budgets or “tight money” and the idea government spending cannot create demand or employment. The American as well as European countries also increased tariffs or introduced import quotas, impeding trade and thus economic production.
President Franklin D. Roosevelt’s New Deal
Franklin D. Roosevelt was elected American President in 1933 and announced a “New Deal” for the American people i.e. an opportunity to share in the distribution of national wealth. The programme set out to achieve what became known as the “3 Rs”- providing Relief for the poor and unemployed, Recovery of normal levels of economic production and Reform of the financial system to prevent it triggering another depression. The main objectives and programmes of the New Deal were:
Public Works Administration: Funds were provided for private companies to build government buildings, airports, hospitals, schools, roads, bridges and dams, thus increasing employment.
Boosting Rural Incomes: The Government paid farmers to destroy crops and animals or leave farmland unused so as to reduce supply and increase the prices of farm produce. Roosevelt and his advisers were very keen on reviving growth in rural America, believing this was key to ending the depression. Agencies were established to work with private companies to construct dams that curbed flooding and generate electricity-these initiatives brought electricity to many parts of the South for the first time.
Banking Reform: The Government closed all banks while writing new legislation, the Emergency Bank Act. Only 70% of banks adjudged as healthy were allowed to open after three days while over 4,000 banks were closed and merged with larger banks by the end of 1933. Customers of the failed banks were paid $0.75 for every $1 deposit. This restored confidence in American banks-billions of dollars and gold kept at home rapidly flowed back into the banking system. President’s Roosevelt’s broadcast to the nation which explained the need to separate healthy banks from insolvent ones was key to the success of the reform. The Roosevelt Government also enacted the Glass–Steagall Act which barred banks from investing in shares, thus safeguarding customer deposits from a stock market crash and also stimulating lending. The Act separating commercial banking from investment activities was repealed in 1999, an action which many hold responsible for the 2008 financial crisis.
The Greatest Stimulus in History
As a result of the coronavirus pandemic, the IMF forecasts that global GDP will decline by 3% in 2020. It could get worse if economies have to be kept fully or significantly closed if the rate of infection rises. The U.S. economy shrank by 4.8% in the first quarter. Unemployment in the USA, already at 33 million, is forecast to rise to 25% i.e. the Great Depression levels. In Germany, 470,000 firms have applied for state subsidies for over 2 million laid-off workers, 50 percent more than after the 2008 crash. In France, four million laid-off workers are to receive state subsidies. In Spain, 900,000 workers have been fired outright and 1.84 million are receiving subsidies after layoffs – more in two weeks than in the first 20 weeks after the 2008 crash.
Clearly, the world is thus set for the deepest recession since the Great Repression. But we will not see anything near the suffering and dislocation of the 1930s. Policymakers have long discovered the wisdom of fighting economic contractions with fiscal stimulus. Government credit to the private sector to support them to retain staff, pay rent, pay for supplies etc. will amount to the greatest stimulus in history. Everyone is now a Roosevelt New Dealer-The Great Lockdown will meet its match in The Great Stimulus. The question is how well will the intervention funds be used and how the global economy will look after it emerges from Covid-19 and encounters the mountain of government debt.