The World’s rich and advanced economies today, including the US, Western Europe, Australia, Canada, and New Zealand were living with average living standards of per capita income just one hundred years back. However, their success was achieved by passing through hard times. We can see rapid long-run growth, despite fluctuations of the business cycle, after every three to five years.
History: We will discuss three significant periods, distributed in long eras of distinctive nature, although having a good start but ended up badly.
1. The Year 1921 to 1941: The first period was economically defined as the “Great Depression” era which transpired Keynes’s concept of aggregate demand i.e, a total amount of demand for / expenditure on the goods & services produced in the economy.
2. The Year 1948 to 1979: At the end of the 2nd World War, this was a period of economic stability & success which, however, was averted in the crisis of production and profitability in 1970, because the role of aggregate demand shifted towards the concept of the supply-side aggregate economy, means, how labor and capital are used to produce goods & services. It was a labor market model.
3. The Year 1979 to 2015: In this last of the economically transpired era, the World was astonishingly captured by the economic crisis, due to neglecting the opportunities of debt-based growths & successful managements, during past so many growing years.
Graph: Unemployment & Production growth: Income share of 1% rich people. In the United States.
Explanation: The periods at serial # 1 & 3 show unusual changes, which cannot be described as economic crises in their real sense. We can see that the 2nd era of the golden years also ended up in an abnormal way. However, the economically common factors of ups & downs looked worsened in all these 3 periods, due to even positive feedback.
Graph: Debt as a percentage of GDP.
The per-hour productivity growth in business is a big measuring scale for economic performance. We see that this factor remained lowest during the great depression period and also in 1979.
There was a rise in unemployment in the 1st period, contrary to the low unemployment ratio & higher production during the economically golden era. But the employment situation soon deteriorated between the mid-1970s and early 1980s. However, the last era showed successive lowering of the unemployment ratio, till the emergence of financial crises. In the USA, the income sharing ratio was 1/5th for the top 1% population, during the late 1920s gradually declined but then revived in the golden economic ages.
The entrepreneurs always incline to invest in projected net profits to compete in the market. The productivity growth helps in their decision for investing in technologically updated machinery & equipment. Investment is correlated with the expected post-tax profits and past profitability performance.
Graph: Upper, Capital stock growth and profit rates for S non-financial corporations (1927–2015). Lower panel: Effective tax rate on profits for US non-financial corporations (1929–2015).
The banking crisis of 1929-1931 & business markets collapse during 1929, ended up in higher profitability as well as investments & profits boomed in the golden era. The 2nd World War, Korean & Vietnam Wars brought high taxes, but these rates fell down to 2%, effective early 1950 for 30 years, which eventually helped the net profits of the business. During the financial crises, the capital stocks grew slowly as compared to the post 2nd World War era. The financial crisis was coupled with the highest private sector debts.
The economy of the USA showed diversified behavior in different periods. 1921 -1929, low unemployment, rising inequality, great depression; 1929-1941, unusual low growth of capital stock, falling inequality, golden age; 1948-1973, stagflation, low unemployment, unusually high production & growth of capital stock, falling inequality ;
973-1979, high inflation & unemployment, lower productivity & profit, moving to great moderation in 1980; 1979-2008, low inflation & unemployment, rising inequality & indebtedness of households, financial crisis; 2008-2015, rising inequality & unemployment, low inflation.
Graph: Capital stock growth and profit rates for US non-financial corporations (1927–2015).
The US Great Depression.
The aforesaid three epochs of capitalism were responded to by the countries quite differently from the USA. Undoubtedly, the USA was the world’s highest production leader for 10 years and the largest economy for 50 years. However, the economic crisis of the USA in 1929 & 2008 spread over the whole world.
In the capitalist system, booms and recessions are just like fluctuations in agricultural production/output due to normal weather changes. Booms and recessions are not always alike. No doubt, the era of the economic great depression was terrifying for the world, as it was full of worst over worst.
In the year 1930, three positive mechanisms happened to downfall the US economy. The declining investment and stock market crash of 1929 extensively spread fear among the household, who desperately ran to save more for even worse circumstances & squeezed their demands.
The declining income caused havoc on the non-payment of loans. Therefore, by the year 1933, half of the American Banks failed viz-a-viz the bank credits highly decreased. The Banks, with fear of failing/closure, raised interest rates to avert risks. Consequently, the interest factor demotivated the companies and firms to make higher investments and discouraged the household sector to purchase necessities like home appliances and durables. The stores were filled with unsold items and products, which caused the prices to drop down (deflation). The deflation factor affected the high debts, in a way that their real value cropped up & the high debt people were far more in number.
The household stopped buying cars and houses and so many debtors became insolvent, putting the banks in trouble. A major part of this community was the farmers because the prices of their product fell down, income decreased and the burden of their debt kept on rising.
Graph: Changes in the components of aggregate demand during upswings and downswings (1924 Q3–1941 Q4).
Only very few people understood the real situation and got to know the mechanisms at that time. The US Government’s attempts to reverse the downward spiral failed in the beginning due to adopting wrong economic assumptions and a very small Government share in the economy. The unemployment in the US remained above 10% by 1941.
On Thursday 24th October 1929 the US industrial average fell down to 11% and the 3 years decline of the stock market began. That’s why Black Thursday is known to memorate the Great American Depression. The long downswing from the third quarter of 1929 until the first quarter of 1933 was driven by big falls in household and business investment and in consumption of nondurables.
Fiscal Policy during Great Depression:
The United States fiscal policy put little impact on improvement in the economy. In the year 1931, the small budget surplus would have implied a large surplus, with the outcome of a decline in tax revenue during the depression period. In the period 1938-39, the economy was under recession & the deficit shrank to 3% in 1938. This was a mistake on the part of economic policies.
The impact of monetary policy during the depression caused an increase of interest rate to its peak of 13% in 1932 because the prices were also falling. Once the downturn of the depression period started in 1929, this policy could not offset but reinforced the declining trend of aggregate demand.
Graph: Policy choices in Gold standard.
The Gold Standard:
During the great depression, the fixed exchange rates i.e, the value of currency were defined in the terms of gold. The US Government was determined to exchange dollars for a specific quantity of gold. Under this agreement, the authorities had to pay off the gold at fixed rates. Therefore, if dollar demand falls, the country”s gold reserves would fall by exporting to other countries.
There were two ways to avoid this, one making tradable goods more competitive, two raise the capital inflows by gold. The policy
makers were not inclined to reduce the interest rates up to zero lower bound, to prevent gold outflow.
During the depression period, maintaining the gold standard was not right till declining in wages to compete with the international standards, lowering imports & enhancing the exports. In 1931, UK left the gold standard so a large gold outflow from the USA was seen. Uk did this on the assumption that the USA would devalue its currency and abandon the gold standard system.
Many countries showed a sharp decrease in outputs and employments during the 1930s. The countries, leaving the gold standard at the early stages of the 1930s, recovered soon. However, the US also recovered due to President Roosevelt’s new policies. These policies included emergency public works & relief packages for new employments, which successfully established basic structures of social welfare of a modern state.
In April 1933, the US dollar was devalued to $35 per ounce of gold, and the nominal interest rate was reduced to close to the zero lower bound. Moreover, due to Banking system reform policies in 1932 & 1933, the people’s beliefs were restored about the future.
It was true about investment fears in 1929, but early recovery signals plus the President’s new deal policies, the companies, and the household started believing about reduction of prices & expansion in employments. In late 1933, employment, as well as production, started growing.
Still apprehending future uncertainty, the households re-evaluated their expected wealth & earnings and reversed cutbacks in daily consumption, avoiding additional savings. The additional savings during the depression period would now make temptation for more consumption.
Recovery started slowly, however, the US economy would not be able to take pre- Great Depression levels of employment.
Graph: The Great Depression and recovery: Households cut consumption to restore target wealth in the depression; and increased consumption from 1933.