The Chicken Littles Of The '30s Are Back

A consensus of economists thinks little can be done about the current era of slow growth. We ate our seed corn during the 1980s, and we must pay with a period of prolonged adjustment. Fiscal policy is said to be useless because of the already exorbitant deficit. The Federal Reserve Board keeps lowering interest rates, but 3% short-term money has merely kept the recession from worsening.

Those who would commend belt-tightening should read some economic history. In the late 1930s, after a decade of zero growth, economists were in a similarly gloomy mood. Many of them made the mistake of extrapolating a depression decade into a permanent trend. In academic meetings and in the pages of prestigious journals, economists propounded the inevitability of slow growth in a mature industrial economy. The mature-economy thesis was the hot topic of the American Economic Assn.'s meetings in 1938 and 1939.

Reflecting on the slowing of growth in the 1930s, especially in mature industries such as railroads, steel, coal, shipbuilding, meatpacking, mining, and manufacturing, as well as slower population growth, economists Glenn E. McLaughlin and Ralph J. Watkins wrote gravely of the diminishing ability of an advanced industrial economy to absorb new investment capital. They concluded: "Under these circumstances investors become increasingly cautious.... These tendencies further aggravate the problem of industrial growth since they tend to deprive the economy of both capital funds and aggressive enterprisers ...Industrial maturity is likely to be especially devastating in its effects on real estate values...cutting off the flow of investment into construction, with a consequent further depressing influence on industrial trends."

CLOUDED VISION. Alvin H. Hansen, perhaps the leading American Keynesian at the time, wrote in the March, 1939, American Economic Review: "The problem of our generation is, above all, the problem of inadequate investment outlets....A full-fledged recovery...requires a large outlay on new investment, and this awaits the development of great new industries and new techniques."

The leading economists of the day had good reason to be pessimistic. A full decade after the crash, national income in 1939 had just barely recovered to its level of 1929. Private investment was depressed--and would likely stay that way as long as unemployment was stuck around 17% (its rate in 1939), personal income was stagnant, and customers were lacking. Even public investment had faltered: Federal spending was up, but state outlays on basic infrastructure had plummeted during the Depression. Some of the more conservative economic commentators saw in the mature-industry controversy a stalking horse for more federal deficit-spending. After all, in the wake of New Deal deficits, the national debt held by the public was an alarming $41 billion in 1939, or 47% of a year's gross national product.

If only those stagnationists had possessed a crystal ball! Within three years, World War II produced the most remarkable recovery program in economic history--most of it powered by public borrowing and public investment. The industrial-maturity hypothesis turned out to be nonsense. The human capacity to invent new technologies and thus to use capital to increase productivity is, of course, infinite. What was not nonsense, however, was the economic deadlock of the 1930s. As Hansen, among others, grasped, private investors were not investing and would not invest as long as output and wages were depressed.

CRUCIAL LEAP. What the war did, as the New Deal had not quite done, was to break this vicious circle by bridging the private sector's temporary unwillingness to invest. The federal deficit, during the war years, was astronomical. In 1943, more than two-thirds of all federal outlays were borrowed. The deficit that year was 70% of the budget and fully 31% of GNP. (Many economists are aghast that today's deficit is about 6% of GNP.) By the end of the war, the accumulated debt was over 119% of GNP--but that increased debt had restored personal income, recapitalized U.S. industry, revived corporate profits, and increased growth to better than 10% a year for four years. The U.S. economy lived off that immense jolt for more than a generation.

Today's stagnationist economy is like that of the late 1930s--not because there are no opportunities to invest, but because personal income has faltered, banks have been traumatized, real estate values have declined, and private investors are understandably gun-shy. Today's stagnationist debate is also like that of the late 1930s in that a lot of otherwise sensible people insist that nothing can be done. Today's "disabling" public debt, incidentally, at about 49% of GNP, is comparable to the debt of 1939--a debt that Roosevelt happily quintupled in order to win the war and recapitalize the economy.

Chronic economic paralysis is no more inevitable today than it was in 1939, and only public-investment can spare us another decade of stagnation. But can we foster the fiscal equivalent of war production without the war? Watch this space.