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Fellows with Friedman

Milton Friedman Explains the Great Depression

Lee Ohanian

Lee Ohanian explains that the growth that followed the low point of the Great Depression was primarily due to productivity. Productivity is considered a supply-side factor by many economists. It is determined by the technology and regulatory structure of the economy and therefore is largely independent of spending policies.

“The growth rate of real per capita output is the sum of the growth rate of per capita labor input and productivity growth. Increasing aggregate demand is supposed to increase output growth by increasing labor input. But between 1932 and 1934, the period that Mr. Bernanke cited in his speech, per capita real gross domestic product (GDP) growth was entirely due to productivity growth, as per capita total hours worked—a standard measure of labor input—was actually, according to our research, lower in 1934 than it was in 1932.

“One reason that many believe higher aggregate demand brought about by government spending programs and monetary expansion created recovery is because unemployment did decline between 1933 and 1937. But declining unemployment reflected significant work-sharing in New Deal policies that began in 1933 with the President's Reemployment Agreement and continued with the National Industrial Recovery Act of 1933 and the Fair Labor Standards Act of 1938.

“Work-sharing increased employment by spreading jobs across more people. Spreading scarce jobs was probably desirable. But the key point is that higher aggregate demand didn't significantly expand the amount of work that was done.

“Productivity growth continued to be the major factor for the rest of the 1930s, accounting for about three-quarters of the growth in real per capita output that occurred between 1932 and 1939. But despite rapid productivity growth, the economy remained well below trend because labor input failed to recover. In 1939, labor input as measured by total hours worked per adult was more than 20% below the 1929 level.”

The economy began to recover following the New Deal because policy changed for the better. The policy changes in the late 1930s benefited the economy by increasing competition, by bringing wages more in line with productivity, and by improving the incentives for investing. 

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Michael Boskin

“The practical lesson on the damage done by excessive government is learned from comparing economic performance in the United States and Western Europe during the past three decades. Although worker compensation has been growing more slowly for the past twenty years than in the previous two decades, the American economy has been flexible and dynamic enough to provide employment to virtually all those who seek it. Compare that performance with the sorry state of Western Europe, where the unemployment rate is now 11 percent, more than double that of the United States. . . .

“In addition to their strong moral base in personal freedom, capitalism and competitive markets work to deliver substantial economic progress; communism, socialism, even large bureaucratic welfare state “third ways” do not work. They sap individual incentive, initiative, and creativity and ultimately cannot deliver sufficiently rising standards of living to meet the expectations of their citizens for better material lives for themselves and their progeny. Episodic economic downturns or other perceived market failures create great opportunity for misplaced permanent expansion of government’s role in the economy.”

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