(Yet another thread about) the causes of the Great Depression

[innonimatu]

It's becoming a popular subject, isn't it? As it should, we might as well put history to good use by learning from past mistakes. It's too late to avert another Depression, too late even to solve it only through public spending (and perhaps that is a good thing). But we do need to understand how this came about, so that whatever economic system is now built does not allow for another Depression. I'd like to recommend this piece:

As I argue in Part I, the Great Depression was the consequence of a massive shift of income shares to profits, away from wages and thus consumption, at the very moment--the 1920s--that expanded production of consumer durables became the crucial condition of economic growth as such. This shift produced a tidal wave of surplus capital that, in the absence of any need for increased investment in productive capacity (net investment declined steadily through the 1920s even as industrial productivity and output increased spectacularly), flowed inevitably into speculative channels, particularly the stock market bubble of the late 20s; when the bubble burst--that is, when non-financial firms pulled out of the call loan market in October--demand for securities listed on the stock exchange evaporated, and the banks were left holding billions of dollars in "distressed assets." The credit freeze and the extraordinary deflation of the 1930s followed; not even the Reconstruction Finance Corporation could restore investor confidence and reflate the larger economy.

So recovery between 1933 and 1937 was not the result of renewed confidence and increased net investment determined by newly enlightened monetary policy (the percentage of replacement and maintenance expenditures in the total of private investment grew in the 1930s). It was instead the result of net contributions to consumer expenditures out of federal budget deficits. In other words, fiscal policy validated the new growth pattern that first appeared in the 1920s--the consumer-led pattern that was eventually disrupted by the shift of income shares to profits, away from wages and consumption.

That consumer-led pattern of economic growth was the hallmark of the postwar boom--the heyday of "consumer culture." It lasted until 1973, when steady gains in median family income and nonfarm real wages slowed, and even ended. Since then, this stagnation has persisted, although increases in labor productivity should have allowed commensurable gains in wages. Thus a familiar shift of income shares away from wages and consumption, toward profits, has characterized the pattern of economic growth and development over the last twenty-five years.

We don't need Paul Krugman or Robert Reich to verify the result--that is, the widening gap between rich and poor, or rather between capital and labor. Two arch-defenders of free markets, Martin Wolf and Alan Greenspan, have repeatedly emphasized the same trend. For example, last September, Greenspan complained that "real compensation tends to parallel real productivity, and we have seen that for generations, but not now. It has veered off course for reasons I am not clear about." (FT 9/17/07, p. 8) A year earlier, Wolf similarly complained that "the normal link between productivity and real earnings is broken," and that the "distribution of US earnings has, as a result, become significantly more unequal." (FT 4/26/06, p. 13)

The offset to this massive shift of income shares came in the form of increasing transfer payments--government spending on social programs--since the 1960s; these payments were the fastest growing component of labor income (10 percent per annum) from 1959 to 1999. The moment of truth reached in 1929 was accordingly postponed. But then George Bush's tax cuts produced a new tidal wave of surplus capital with no place to go except into real estate, where the boom in lending against assets that kept appreciating allowed the "securitization" of mortgages--that is, the conversion of consumer debt into promising investment vehicles.

So, income inequality, and the shift from wages to rents and profits. Who accepts that this is at the root of the falling phases of the "business cycle", and that taken too far (usually with the complicity of the state in protecting rents and profits against wages) it is also the cause of the big falls we end up calling Depressions?

If this is the cause, then it must be prevented. It means that the whole idea of the enterprise's sole goal being the maximization of profit is wrong. It means that the power of profit- and rent-seekers (the ones who get a free hand there under free-market theories) must somehow (how?) be balanced within the management of enterprises by other interested parties - workers and consumers.

If it isn't the cause, then can someone refute this explanation, offering a better one?