I’ve had several emails regarding unemployment rates during the Roosevelt administration. These readers were confused by some Keynesian sites asserting that the unemployment figures were inflated. One reader wrote that “the unemployment figures must have been greatly exaggerated because they excluded people on relief. If these people had been included then unemployment in 1938 would have been 12.5 percent and not be 19 percent.” I immediately recognised the figures as coming from Michael R. Darby’s 1975 paper1.
There is a sound reason why it is Keynesian votaries that tend to use Darby’s figures while the vast majority of economists and historians stick with the conventional figures. Putting the unemployed on relief and giving them a pay check is called working for the dole. It is an attempt to hide unemployment, not eliminate it. The old statisticians and economists understood that and were scrupulously honest in their estimates. It was called relief because it was understood that this ‘employment’ was a government-funded substitute for real employment. Better to be paid for doing something rather than be paid for doing nothing. Therefore, if these had been real jobs they would not, by definition, have been called relief. Taken to its logical conclusion all a government would have to do to eliminate unemployment is assign the jobless to various activities, no matter how pointless, and classify their dole payments as wages.
It should be equally clear that America’s hidden unemployment had to be paid for out of taxes and borrowing. Let’s look at this process from street level. Through no fault of his own poor Fred is priced out of his $800 a week job. Let us now assume that the powers that be impose a job tax on every household in Fred’s street. Fred is now considered employed by his neighbours at his old wage rate as the street’s caretaker. This means helping to maintain properties, repairing fences, mowing the lawns and nature strips while keeping the street clean. Presto! The street has now returned to full employment.
The first thing to note is that though everyone is now working the street’s aggregate income has not changed. What has changed is the composition of its income. Fred’s neighbours have had their total weekly purchasing power reduced by $800 in order to compensate Fred for the loss of his job. Those on whom that money was spent must now do without. You don’t need a doctorate in economics to see that there has been no increase in aggregate demand, just a redirection of purchasing power.
This is what happened with Roosevelt’s make-work schemes, the most well-known of which was the WPA2 (Works Progress Administration). Although billions of dollars went into these schemes the economy remained mired in depression while vast amounts of fixed capital remained in forced idleness. Now where did these dollars come from? Virtually every one came from the public either through taxes or borrowing. These schemes did not increase purchasing power, they absorbed it. The investments that would have been made and the goods and services that would have been bought with those dollars were permanently lost. The economists call this opportunity cost. John Stuart Milled expressed the classical wisdom on this nonsense about 184 years ago when he observed that
[t]he utility of a large government expenditure, for the purpose of encouraging industry, is no longer maintained. Taxes are not now esteemed to be ‘like the dews of heaven, which return in prolific showers’. It is no longer supposed that you benefit the producer by taking his money, provided that you give it to him again in exchange for his goods. There is nothing which impresses a person of reflection with a stronger sense of the shallowness of the political reasoning of the last two centuries, than the general reception so long given to a doctrine which, if it proves anything, proves that the more you take from the pockets of the people to spend on your own pleasures, the richer they grow; that the man who steals money out of a shop, provided that he expends it all again at the same shop, is a public benefactor to the tradesman whom he robs, and that the same operation, repeated sufficiently often, would make the tradesman a fortune3
It should be blindingly obvious to even the densest voter that increasing B’s purchasing power by reducing A’s purchasing power by the same amount does nothing for total purchasing power. Of course the really vulgar Keynesian would argue that this is not so if A is a big saver and B spends everything on consumption because B’s newly expanded buying power will promote growth by increasing the demand for consumer goods, whereas A’s saving retarded growth. This is where a classical economist would start tearing his hair out because he knew that it is savings that fuels economic growth and not consumption.
With respect to consumption versus saving Mill observed that
I apprehend, that if by demand for labour be meant the demand by which wages are raised, or the number of labourers in employment increased, demand for commodities [consumer goods] does not constitute demand for labour. I conceive that a person who buys commodities and consumes them himself, does no good to the labouring classes; and that it is only by what he abstains from consuming, and expends in direct payments to labourers in exchange for labour, that he benefits the labouring classes…4
From this it follows that demanding consumption goods directly, whether they be in the form of holidays, entertainments, medicine or education, does nothing to raise real wage rates and hence the standard of living because it does nothing to raise the marginal value of the labourer’s product. Mill was stressing the fact that demanding consumption goods directly does not, as the Austrian school of economics would put it, extend the capital structure. On the contrary, promoting consumption at the expense of savings reduces the level of investment5. In plain English, it’s savings that fuel investment and it is investment that raises real wage rates, not tax-funded boondoggles.
While Roosevelt’s disciples hail his make-work schemes as a roaring success they deliberately ignore the huge mass of capital goods that had been forced into idleness by his policy of maintaining wage rates above their market clearing levels. The massive extent of the economic slack that these policies created can be gauged by the fact that from 1939 to 1944 America was able to increase industrial production by 145 per cent6. By contrast, from 1914 to 1917 she was only able to expand industrial production by about 24.57, despite the economy being on a total war footing. Therefore the massive WWII increase in production revealed the existence of tremendous amount of industrial slack in the economy that Roosevelt’s policies had prevented from being eliminated.
These facts make a mockery of claims that the real unemployment rate in 1938 was “12.5 percent”. Moreover, one would expect that forcing a mass of capital into idleness would lead to capital consumption, which is precisely what happened with one estimate putting the drop in net capital formation at minus 15.2 per cent8.
Compare Roosevelt’s sorry record with that of Australia. By 1938 Australian unemployment had fallen from its peak of 30 per cent in 1932 to 8.7 per cent while in the same year American unemployment stood at 20 per cent against its peak of 25 per cent in 1933.
In 1938 the average working week for US manufacturing was 35.5 hours against 44.82 hours in Australia. (In fact, during the depression hours of work in Australian manufacturing never fell below 44). Not only did short-time working in American manufacturing reveal a significant degree of hidden unemployment it also signalled the existence of a huge amount of idle capital. This is in stark contrast with Australia. During the recovery her manufacturing base expanded to the extent that manufacturing employment was 26 per cent greater in 1938 than in 1928. This clearly indicates that, unlike America, Australia experienced net capital formation. In addition, from 1930 to 1939 America’s gross debt increased by 150 per cent while from 1928 to 1939 Commonwealth debt rose by 4.4 per cent, with nearly all of it taking place from 1928 to 19319
Australia’s recovery from the depression saw unemployment steadily fall and manufacturing expand in absolute terms. Not only that but she cut spending and then ran surpluses right up to WWII. She in fact did what Keynesianism declares to be impossible.
It beggars belief that anyone can seriously assert, after examining these facts, that Roosevelt’s economic record is superior to Australia’s.
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Note: I am not the only one who finds it weird that Australia’s self-professed anti-Keynesians never really bothered to use the Australian experience in the Great Depression to effectively discredit Keynesianism. Professor Sinclair Davidson and Julie Novak’s essay Five and a half big things Kevin Rudd doesn’t understand about the Australian Economy failed completely to dent the Keynesian orthodoxy. Since then they and their colleagues have ceased to use the Australian experience in their attacks on Keynesian. By doing so they virtually snuffed out the possibility of genuine debate. One can only wonder at their reasoning.
1Three-and-a-Half Million U.S. Employees. Have Been Mislaid: Or, an Explanation of Unemployment, 1934-1941, Michael R. Darby, Working Paper No. 88, 1975, National Bureau of Economic Research, Inc.
2The degree of political corruption in Roosevelt’s New Deal policies was incredible. The historian Burton Folsom Jr. exposed some of the corruption in his book New Deal or Raw Deal? How FDR’s Legacy Has Damaged America, New York: Threshold Editions, 2008, pp. 86-92, 181-91, 200-2.
3Essays on Economics and Society, Collected Works of John Stuart Mill, University of Toronto Press 1967, pp. 262-63.
4Principles of Political Economy, Vol. I, University of Toronto Press, pp. 78-80. This is Mill’s fourth proposition on capital which, unfortunately, has been greatly misunderstood. Stanley Jevons and Edward Cannan were particularly hard on it.
What I found is that none of the critics appear to have been aware of John Rae’s pathbreaking work on capital theory. This is odd because Mill admitted in his Principles of Political Economy that his thinking on capital had been influenced by Rae. (Nassau Senior also admitted to being influenced by Rae’s work). Perhaps if Jevons and Cannan had read Rae their attitude to the fourth proposition would have been very different.
What Mill understood, perhaps not fully, and his critics failed to grasp is that it is a grave error to assume that because producer goods ultimately derive their value from the final products any increase in demand for consumer goods must therefore increase the demand for capital goods and hence expand the capital stock. This is the origin of the accelerator and I think it is a very dangerous fallacy.
I intend to eventually do a post on Mill’s proposition.
5Classical economists noted that increased government spending could promote consumption at the expense of capital accumulation.
6Historical Statistics of the United States 1789-1945, p. 330
7Frederick Cecil Mills, Economic tendencies in the United States: Aspects of Pre-war and Post-War Changes, National bureau of economic research, 1932, pp. 188-9. Incidentally, 1914 was also a recession year. If the American economy had been operating at its usual capacity the war-time increase in production would have been much lower.
8W. Arthur Lewis, Economic Survey 1919-1939, Unwin University Books, 1970, p. 205. It was also noted that by 1936 the real amount of capital per wage earner employed in terms of dollars was 18 per cent below the 1929 level (National Industrial Conference Board: Studies in Enterprise and Social Progress, National Industrial Conference Board Inc.,1939, pp. 224-25). I shall be returning to the question of capital consumption in another post.
9The debt actually fell in 1933 and continued to fall until 1937 after which it began to rise, Nevertheless, the debt in 1939 only exceeded the debt in 1928 by 4.4 per cent.