Time For a New “New Deal”

Marshall Auerback is a Denver, Colorado-based global portfolio strategist for RAB Capital plc and a Fellow with the Economists for Peace and Security (http://www.epsusa.org/). He is a frequent contributor to the blog, Credit Writedowns, and the Japan Policy Research Institute (www.jpri.org) and a new contributor to The Big Picture.


Time For a New “New Deal”

By Marshall Auerback

University of Texas Inequality Project
Lyndon B. Johnson School of Public Affairs
The University of Texas at Austin
Austin, Texas 78712

February 1, 2009


Historical revisionists have done much to dismiss the economic achievements of the New Deal, some even going so far as to suggest that FDR’s fiscal policies worsened the crisis.  Such arguments have been made popular during the past 25 years by economists and historians keen to debunk the effectiveness of Keynesian economics in favor of the neo-liberal Washington Consensus.  We suggest, on the contrary, that mainstream economics and policy have been unable to come to grips with our current socio-economic problems because of a lack of historical memory.

In particular, the key to evaluating Roosevelt’s performance in combating the Depression is the statistical treatment of many millions of unemployed engaged in his massive workfare programs. Including such ‘workfare’ recipients as employed presents a radically different picture for the New Deal, showing unemployment dropping by almost two-thirds from a high of 25%.  Treating these men and women as unemployed while soldiers in Germany and France were treated as having jobs has made the Roosevelt administration’s economic performance appear uncompetitive, but it is fairer to argue that the people employed in government public works and conservation programs were just as authentically (and much more usefully) employed as draftees in what became garrison states. Meanwhile Roosevelt was rebuilding America at a historic bargain cost.

As President Barack Obama confronts the most serious economic crisis since the Great Depression, it behooves him to embrace the legacy of Franklin Delano Roosevelt and introduce a new “New Deal”  as soon as possible.

Author Contact: MAuer1959-at-aol.com

Marshall Auerback is a global portfolio strategist for RAB Capital plc, a London-based fund management group.

As the current financial crisis has unfolded, Franklin Delano Roosevelt has been cited both for his talent at rallying the nation in crisis, and for the economic policies he used to lead the country through the Great Depression. In spite of recent attempts by diehard libertarian economists, particularly those of the Austrian school, to dismiss his achievements, we confess to sharing the enthusiasm recently expressed for the New Deal—as Professor Tom Ferguson characterized it, “that remarkable moment that gives the lie to all of today’s fashionable sneers about the impossibility of effective financial regulation and fiscal policy activism” (Ferguson  and Johnson 2008).  We feel that the new administration of Barack Obama would do well to embrace FDR’s economic legacy completely and introduce a new “New Deal” as the cornerstone of his economic policy as soon as possible. Is President Obama another Franklin Roosevelt, ready to embark on a radical remaking of the country’s political and social fabric?
We hope so. There is no shortage of projects and activities in which to invest:  extended unemployment insurance, state fiscal relief, increased food stamp programs, and large scale infrastructure. No question, there will be more debt, lots and lots of it.  But the alternative is far worse:  years of double digit unemployment, increased financial fragility, massive bankruptcy and epidemic foreclosures.  The question to be posed, surely, is: Ask not what it will cost to fund a new “New Deal”, ask rather what it will cost not to fund it?

President Obama now faces an economy in a severe and prolonged recession. Households will continue to face unaffordable mortgage and other debt, declining value of their homes, risk of debt default or foreclosure, tight access to credit with stringent borrowing conditions, erosion of their retirement savings amid a crashing stock market, lay-offs which may well take the unemployment rate to the double digit levels of the late 1970s – not to mention critical foreign policy challenges. In particular, consumer spending, long the driver of American economic growth, has contracted at rate matched in only one other quarter since records were first kept in 1947.

There appears to be little doubt today that Federal Reserve Chairman Ben Bernanke has internalized the lessons of the Great Depression and taken a large number of measures on the monetary front.  In the words of his famous November 2002 speech, “Deflation: Making Sure ‘It’ Doesn’t Happen Here:” “ to prevent significant deflation in the United States and, moreover, that the U.S. central bank, in cooperation with other parts of the government as needed, has sufficient policy instruments to ensure that any deflation that might occur would be both mild and brief”. (Bernanke, 2002)  Consequently, focus must now revert to fiscal policy.

Immediate challenges for Obama will include cushioning consumers from the economic slowdown by means of a large fiscal stimulus package and acting on a government guaranteed mortgage modification program. He has also called for grants for state and local governments, infrastructure spending to create jobs, tax cuts for lower income-groups and small businesses and on unemployment insurance, tax credits for firms that create jobs and government aid for the ailing auto industry. Part of his campaign program would allow households to draw up to $10,000 from retirement funds during 2008-09 without any tax penalty. During the campaign Obama also called for a ninety-day moratorium on foreclosures, modification of bankruptcy laws, a $10 billion foreclosure-prevention fund and 10% mortgage tax credit for the middle-class. Equally, he has criticized the manner in which so much taxpayer money has been lavished on major money center banks, which in turn have persisted in paying exorbitant bonuses to their staff despite being recipients of significant taxpayer bailouts. Obama has strongly endorsed greater financial re-regulation, control and reporting, including the creation of a financial market oversight commission to oversee liquidity, capital and disclosure requirements and plans to streamlining regulatory agencies to reduce overlap and assign greater role to the Securities and Exchange Commission (SEC) to prevent market manipulation and to the Federal Reserve to carry out regulation.

One advantage we have over policy makers of the 1930s:  the historic experience of the Great Depression itself.  The gross policy errors made during that period — such as raising taxes, tightening monetary policy and trade barriers — are less likely today. And the landslide victory of Barack Obama and the corresponding gains of the Democrats in Congress ensure less visceral opposition to a major role for government going forward.  Fiscal policy has been virtually absent from the US government’s policy arsenal for almost a generation, in part inhibited by a perception that the state’s major role should be to protect property rights and ensure a very modest supply of public goods. More specifically, according to this view of economics widely known as the “Washington Consensus”, the state should create and sustain (a) efficient, rent-free markets, (b) an efficient, corruption-free public sector able to supervise the delivery of a narrow set of inherently public services, and (c) decentralized arrangements of participatory democracy. It should not, in this view, attempt to influence the rate of unemployment.
The reputation of fiscal activism has also been harmed by a historical revisionism aimed at the heart of FDR’s original New Deal, the essence of which is that he achieved little of lasting economic benefit and that it was only World War II that finally took America out of the Great Depression.  This is factually incorrect.  There is much evidence to support the contrary position, that the effects of the New Deal were in fact greater than even mainstream historians have been willing to allow.  This paper presents some of the relevant evidence.

In 1933, there was great disagreement about how to deal with an economic recession or depression, and Roosevelt’s administration, and he himself, had conflicting impulses. Herbert Hoover, in conjunction with the Federal Reserve and his “liquidationist” Treasury Secretary, Andrew Mellon, had made the worst possible selection of policy options: higher taxes and tariffs and a shrunken money supply. The unemployment rate was 25 per cent, about four times what it is now, and there was no direct relief for the unemployed.

On Inauguration Day, 1933 (then March 4), there were machine-gun nests at the corners of the great government buildings in Washington, for the only time since the Civil War. All banks in 32 states had been closed sine die. Six other states had closed almost all their banks. In the other 10 states and D.C., withdrawals were limited to 5 per cent of deposits, and in Texas to $10 a day. The New York Stock Exchange and Chicago commodity exchanges had also been closed indefinitely. The financial system had effectively collapsed, and was threatening to take the life savings of millions of people and what was left of the world’s financial system with it. Revolution beckoned.

In a fever of activity, Roosevelt guaranteed bank deposits, made the federal government a temporary non-voting preferred shareholder in thousands of suddenly under-capitalized banks – more than half the banks in the country – refinanced millions of residential and farm mortgages, tolerated cartels and collective bargaining to raise prices and wages, increased the money supply, effectively departed the gold standard, repealed Prohibition of alcoholic beverages (wrenching one of America’s largest industries out of the hands of the underworld), and legislated reduced working hours and improved working conditions for the whole work force. In the next two years, in what became known as the Second New Deal, he set up the Securities and Exchange Commission, created the Social Security system, and broadened the powers of the Federal Reserve to equal those of other national central banks.  The Hoover agricultural policy had been to dump surpluses abroad, lend foreign governments the money to buy them, and then pursue them aggressively when the debtor countries defaulted. Roosevelt had farmers vote, by category of what they produced, on agreed production cutbacks, assuring sustainable agricultural prices, and compensated farmers for the production they had curtailed.
The key to evaluating Roosevelt’s performance in combating the Depression is the statistical treatment of many millions of unemployed engaged in his massive workfare programs. The government hired about 60 per cent of the unemployed in public works and conservation projects that planted a billion trees, saved the whooping crane, modernized rural America, and built such diverse projects as the Cathedral of Learning in Pittsburgh, the Montana state capitol, much of the Chicago lakefront, New York’s Lincoln Tunnel and Triborough Bridge complex, the Tennessee Valley Authority and the aircraft carriers Enterprise and Yorktown.

It also built or renovated 2,500 hospitals, 45,000 schools, 13,000 parks and playgrounds, 7,800 bridges, 700,000 miles of roads, and a thousand airfields. And it employed 50,000 teachers, rebuilt the country’s entire rural school system, and hired 3,000 writers, musicians, sculptors and painters, including Willem de Kooning and Jackson Pollock.

Even pro-Roosevelt historians such as William Leuchtenburg and Doris Kearns Goodwin have meekly accepted that the millions of people in the New Deal workfare programs were unemployed, while comparable millions of Germans and Japanese, and eventually French and British, who were dragooned into the armed forces and defense production industries in the mid-and late 1930s, were considered to be employed.

This made the Roosevelt administration’s economic performance appear uncompetitive, but it is fairer to argue that the people employed in government public works and conservation programs were just as authentically (and much more usefully) employed as draftees in what became garrison states, while Roosevelt was rebuilding America at a historic bargain cost.

If these workfare Americans are considered to be unemployed, the Roosevelt administration reduced unemployment from 25 per cent in 1933 to 9 per cent in 1936, up to 13 per cent in 1938 (due largely to a reversal of the fiscal activism which had characterized FDR’s first term in office), back to less than 10 per cent at the end of 1940, to less than 1 per cent a year later when the U.S. was plunged into the Second World War at the end of 1941.  The reasons for the discrepancies in the unemployment data that have historically arisen out of the New Deal are that the current sampling method of estimation for unemployment by the BLS was not developed until 1940, thus unemployment rates prior to this time have to be estimated and this leads to some judgment calls.

The primary judgment call is what do about people on work relief.  The official series counts these people as unemployed, with the result that historians of a conservative bent are given ammunition with which to shoot at the entire New Deal.  Christopher Wrestley, for example,  argued:  “By the midpoint of FDR’s second term, the failure of the New Deal policies was evident to all but the truly delusional. The unemployment rate again reached levels associated with the hated Hoover, while the public’s tolerance of the pretentious New Dealers and their endless attempts to control the economy waned.”   (Wrestley,  2001).

However, this is an instance of an ideology fundamentally hostile to the role of government in our society using history to discredit activist economic policy. If one uses the unemployment series for the 1930s excluding workfare constituents, the figures appear as follows:

This is from a series constructed by the economist, Stanley Lebergott in 1964.2
Here, the recession of 1937-38 almost completely wipes out any gains of the previous few years. It is almost as if the New Deal didn’t do anything for anyone, much.

Many people looked at these numbers without reading the notes on how they were constructed and concluded just that.

Then in 1976, an economist named Michael R. Darby wrote an article with the delightfully self-explanatory title, “Three-and-a-Half Million U.S. Employees Have Been Mislaid.”3 What Darby did was read the notes. Here is what Lebergott had to say about counting unemployment in the 1930s:
These estimates for the years prior to 1940 are intended to measure the number of persons who are totally unemployed, having no work at all. For the 1930’s this concept, however, does include one large group of persons who had both work and income from work—those on emergency work. In the United States we are concerned with measuring lack of regular work and do not minimize the total by excluding persons with made work or emergency jobs. This contrasts sharply, for example, with the German practice during the 1930’s when persons in the labor-force camps were classed as employed, and Soviet practice which includes employment in labor camps, if it includes it at all, as employment. (Darby, 1976).
We would normally not consider people who painted murals for the WPA to be deemed worse off than those who “worked” in Mauthausen or the Soviet gulag.  And yet, until we adjust the “workfare” discrepancy, incredibly we count such individuals as unemployed, even though their position was considerably better than that of someone generating no income, or working in abysmal conditions in a slave labor camp.
A number of points may be made here:

(1) if one is using the data to answer the question, “did the New Deal help people?” then this data absent the workfare numbers set is going to give you the wrong answer, because they imply that workfare people were suffering from unemployment who in real life had a job;

(2) but what if people in emergency work acted like the unemployed—that is, what if they were looking for a “real” job,  and

(3) what about the “real” economy—the private industrial economy—how did it do?

Now, as it happens it looks like the answer to (2) is, mainly they did not—people who had an emergency job acted as if they had a job, and did not look for another one.  The reason, perhaps, is that they did in fact have a job, and should therefore probably not count as unemployed.4
If one includes the workfare employees, one gets a very different picture of unemployment in the 1930s. Below, a graph showing the same series as the above, then a new series—from Weir’s table D3, which also appears in Historical Statistics of the United States—which counts only people without jobs as unemployed.

Again, this illustrates the severity of the Great Depression, but it also illustrates the crucial role played by the New Deal in mitigating its worst excesses.
Indeed, rather than “distorting” the private market, the improvement in aggregate demand brought about by the provision of workfare programs created positive feedback loops in the private sector.  One can illustrate this by isolating the government employees within the data and showing a third line which features the private sector alone:

So again, here, we see significant improvement under the New Deal.  In the purely private sector, unemployment rates reached 33 percent in 1932;  by 1937 they were less than half of that, not counting those on government payrolls.

If anything, even the relapse of 1938 validates the efficacy of fiscal policy activism.  During Roosevelt’s first administration lots of things were tried– and the budget debt continued to “explode” until it got to 5.5% of GNP as employment (and profits) significantly improved over three and a half years — but unemployment rates were still very high.

But by 1936 many economists and financial experts feared the country would go bankrupt if the government kept deficit-spending.  And after all, it was argued,   the government deficits had “pump-primed” the economy. The private sector could now take off on its own and get back to close to the full employment level of 1928-early 1929.

Consequently, Roosevelt ran (in 1936) on a platform  that he would try to reduce significantly, if not completely eliminate, the deficit in the 1937 fiscal budget — and he sent to Congress a budget that did just that.  Roosevelt won by a landslide – understandably, as the U.S. was out of depression by 1937.  It only reverted when the fiscal activism of the previous 4 years was completely reversed within 9 months, based on balanced budget and a nonsensically tight monetary policy, brought on by the Fed as deflationary pressures abated and moderate inflation began to appear by the middle of that year.  FDR had caved in to the conservatives in Congress (and his treasury secretary) and presented a balanced budget, cutting stimulus spending . The Fed also began to tighten at this stage, as inflation had risen to 4%.

The result was that the economy contracted by 6% to 86.1 billion in 1938, and the recovery slipped. After FDR reversed his conservative budget mistake and reverted again to fiscal activism by 1939 (during which the budget deficit rose to 3.1% of GDP), the GDP rose again to $89.1 billion. It rose further $8.5billion to $96.8bn billion in 1940, which is almost where it had been at the start of the Great Depression. Around 1940, Congress and FDR lost any inhibition and ramped up the GDP by spending massively.  By 1943, the US was running a budget deficit equivalent to 30.3% of GDP.  By 1944, GDP was $210.9 billion, more than double what it was when the Great Depression began in 1929..

There had NEVER before been anything even close to the severe downturns that occurred just prior to the administration of FDR.  Not until now. And today’s crisis, unsurprisingly, has come at a time when much of the legislative framework put in place by Roosevelt has been largely eviscerated.  FDR’s long-term stabilizers in fact worked very well, but were gutted during an unprecedented period of corporate predation, which found its apotheosis in the recent credit boom and growth of the so-called “shadow banking system.” Before this market fundamentalist philosophy took root during the Reagan era, the financial sector accounted for only 2 per cent of U.S. corporate profits. In recent years, the figure has approached 40 per cent.

It is true that under FDR, we ended up with a national debt exceeded the national income by the end of the war —  as the government spent over $200 billion more than it took in taxes during the war years. But of course, the American people “saved” more than 200 billion” during the same period – the national debt was private financial wealth. And the end result was full employment prosperity.  A final point, which today’s deficit hawks should bear in mind:  if deficits are so economically ruinous, then why run them during wartime, when in theory the optimal functioning of the economy is most crucial?

So what form should a new ‘New Deal’ take today?  As any university economics student promptly learns, a dollar’s worth of expenditures on goods and services yields a larger multiplier than tax cuts. This suggests that supporting already planned investment in infrastructure — by states and municipalities that are currently liquidity constrained, and squeezed by declining tax revenues — would be a more effective way of supporting aggregate demand than “trickle down” economics.
But infrastructure is not everything:  in fact, the most disabling myth, which has been repeated many times during the debate on the Obama stimulus package, is that the government cannot competently spend large sums of money fast enough, and will end up building bridges to nowhere. “Infrastructure” in particular is being used as a straw man to discourage adequate outlay, particularly by the GOP opposition.
There is, however, ample stimulus that can take effect instantly. The only prerequisite is the necessity that the federal government start writing checks.  The Federal government can make sure that state and local governments do not lay off a single worker or cut back a single existing program, thus avoiding big losses to communities and enhancing the capacity of local government to fight recession.  Add emergency revenue sharing to states and cities by picking up increased shares of Medicaid, (which has suffered drastic cuts in eligibility and coverage), and enables states to restore Medicaid benefits to more people, thereby furnishing some general household budget relief. Have government temporarily pay most of the cost of COBRA coverage for laid off people who lose their health insurance, and allow people over age 55 to buy into Medicare. Expand Unemployment Insurance to cover part time workers, extend eligibility period, and increase benefit levels.  Roll back tuitions at state universities and community colleges, and increase Pell Grants–contingent on universities not increasing costs to students – which enables young people to spend the recession in college rather than clogging unemployment rolls or graduating with huge debt burdens. Similarly, colleges are spared the need to cut programs and lay off people in a recession. Professor James K. Galbraith sets out some useful criteria for good stimulus:
“– open-ended support for the current operations of state and local governments, for the
duration of the crisis, including open-ended support for public capital investment. Basically all
the resources being released from private residential and commercial construction should be
taken up in public building, to the extent physically and organizationally possible.
– comprehensive foreclosure relief, through a moratorium followed by restructuring
except in cases of demonstrable borrower fraud. There is no alternative to establishing a large
retail-level agency to evaluate and restructure mortgages on a case-by-case basis.
– increased Social Security benefits, say by thirty percent, and a cut in the eligibility age
of Medicare to (say) 55 years of age. The first of these measures would work to offset the
cataclysmic drop in equity wealth of the elderly population as a whole, while favoring the
poorer members of that population. The second would permit many older workers to retire,
while freeing firms from the burden of managing employee health plans for older workers.
Since the shift out of private wealth is likely to prove permanent, these increases in public
transfers to the elderly should be permanent as well.
– A payroll tax holiday to restore effectively the purchasing power of working families.
By setting the payroll tax rate at zero (and letting the government write a check to the Social
Security Trust Fund for the uncollected sums), tax relief can be delivered at large scale and with
immediate effect to the working population. Later, if growth resumes rapidly, this measure
could be scaled back.
– an energy program, under a long-term planning framework adequate to meet the
climate crisis, but also sufficient in the near term to reduce demand for oil as the economy
recovers and to quell speculation in the oil markets. This is necessary to prevent inflation of volatile commodity prices once the feedback loops start firing in an upward direction.
– programs, in the spirit of the New Deal, to hire people to do what they do best, including art, letters, drama, dance, music, scientific research, university teaching and the nonprofit sector, including community organization.”  (Galbraith 2009)
As for infrastructure itself:  virtually everybody agrees that America’s national infrastructure is a mess and a large degree of public works expenditure should be focused on its renewal.  On a daily basis, we drive on paved roads over bridges, take a hot shower, turn the lights on and off, and take out the trash. Most of us take these experiences for granted, expecting that our needs will be satisfied in a safe and convenient way. The universal availability of these services differentiates a modern country from a developing nation.
In fact, a public-works strategy for national recovery has had broad ideological respectability from the days of Alexander Hamilton and Abraham Lincoln to those of Franklin D. Roosevelt and John F. Kennedy. If Democrats can brag about the proud heritage of the Works Progress Administration and the Public Works Administration from the era of the Great Depression, there are still a few Republicans who remember the Golden Age of interstate highway construction that commenced in the 1950s with President Dwight D. Eisenhower. Indeed since the national shame of Hurricane Katrina, Americans have become outspokenly nostalgic about competent federal governments and magnificent public investments.
This infrastructure did not come into existence overnight. It took planning, effort, and a great deal of money. When the U.S. was still a colony of Britain, most of the country was untouched wilderness. A few years before the adoption of the Constitution, George Washington had plans to connect the Hudson River to Lake Erie, settle Ohio, and build steamboats. The Erie Canal for example, was not finished until 1825, 26 years after his death. It cost $7 million to build, a fortune at that time, but it cut the cost of shipping items from Buffalo to Manhattan by 90%. It paid for itself in ten years over in tolls collected, not to mention the development and trade it engendered.
Repeatedly through history we see that building infrastructure not only improves the standard of living through greater conveniences, but leads to increased general prosperity. The transcontinental railroad connected the railhead at Omaha, Nebraska to Sacramento, California in 1869. It cut travel time from the east coast to the Pacific from about five months to six days in an instant. Within a decade of completion, $50 million worth of goods had been shipped cross-country. Asian products reached the cities of the Northeast, Western settlers had access to Eastern finished goods, and the vast mineral resources of the heartland were available for exploitation. It was the internet of its day; it allowed ideas to travel quickly from one end of the U.S. to the other.
The transcontinental railroad was echoed later by the Interstate Highway System, which was initiated in 1956 and which is still not complete today. This led to the dominance of the automobile, and the exodus from the inner cities to the suburbs. Jobs and residences shifted outward. Massive economic development sprang up along the highway corridors. Railroads were largely abandoned for the now-cheaper roadways.
Unfortunately, the last few decades have seen very little investment in infrastructure in the U.S. In response, the American Society of Civil Engineers (ASCE) began grading the state of the nation’s infrastructure in 2001 to raise awareness of the silent crisis. They determined that every area from aviation to roads to wastewater needed serious attention. The problems in the electric grid were not addressed, among other areas, leading to the major blackout in 2003. In ASCE’s latest report card issued in 2005, the society determined that the U.S. has made little progress, earning a collective “D.” To repair all the areas of infrastructure to good condition or a grade of “B” would cost $1.6 trillion over 5 years time. While the $1.6 trillion advocated by the ASCE to fix the problems is considerable, Joseph Stiglitz estimates it’s about half what the U.S. will spend on the wars in Iraq and Afghanistan.
Fifty years ago, the U.S. spent a much higher percentage of its budget on infrastructure. Now hundreds of billions of dollars are going to bail out banks, GSEs, insurance companies, and even the carmakers. Most of that deficit spending is unlikely to save jobs or stimulate the economy because it is going to unwind trillions in derivatives or strengthen the balance sheets of frail banks. Obama himself voted in favor of the $700 billion Troubled Asset Relief Program (aka “TARP”) which will enrich bankers but will not repair a single levee or bridge.

That TARP has been even allocated to the Treasury is perverse. Typically Federal Reserve ‘spending’ is considered monetary policy, as the Fed routinely buys securities/financial assets (such as the $31bn from Bear Stearns), while Treasury federal spending is ‘fiscal’ insofar as it encompasses things such as paying the soldiers and the postal workers.  TARP in most respects is a monetary operation, not fiscal.  If policy makers had placed TARP in the custody of the Federal Reserve (where it belonged), it would not have been part of the ‘budget’  and the spending not accounted for as part of the ‘deficit.’ This may well have mooted President Obama’s curious fixation with “entitlement reform.”  One is tempted to believe that the reason TARP was allocated by the Bush Administration to the Treasury was to allow it to show up as increased deficit spending and thereby put a cap on ‘social programs’ likely to be proposed by an activist Democratic Congress.
Even one accurately distinguishes fiscal and monetary operations, bureaucratic fumbling can prevent effective action. This was exemplified America’s inability to fix the areas devastated by Hurricane Katrina in 2005. In Louisiana, the state government has still delayed disbursing most of the $750 million in house elevation grants. Some families still live in government trailers as they have no money to repair their homes, and areas such as Terrebonne Parish are waiting for the Army Corps of Engineers to rebuild levees. In contrast, 18 months after the massive earthquake in Kobe, the Japanese government spent the equivalent of $113 billion to fix buildings, port facilities and other infrastructure.
Another obstacle to improving America’s infrastructure is the current credit crisis. Municipal bonds have been sold by hedge funds and others seeking liquidity, so yields are up substantially year-over-year. This sharply increases the cost of financing large public work projects. Banks are increasingly unwilling to lend despite the large influx of capital, so world trade in commodities needed to build infrastructure is freezing up. The Baltic Dry Index, a measure of shipping costs, has dropped 95% this year alone as few firms in the maritime sector can find funding.  Here again, as Federal government borrowing costs are close to zero, it is logical for the state to interpose itself as a credit intermediary, possibly via Obama’s proposed National Infrastructure Bank.
New infrastructure investment would at least build jobs and wealth, even though it would increase the deficit in the short term. Obama seems quite willing to borrow money and increase government spending, and the alternatives seem much worse than repairing infrastructure. In fact, in the absence of sufficient fiscal activism, President Obama may well find himself renewing another FDR innovation: Works Progress Administration in 2010 to combat an economy sliding back into recession.
Above all else,  the main focus must be on fiscal policy.  The Obama Administration must also be able to respond robustly to the question “what is it going to cost the U.S. taxpayer?,”  a question that reflects an unthinking bias against active government policies to prevent recession and depression. Asking how much an active government policy to prevent a financial market calamity is going to cost the taxpayer can only be based on an economic theory that assumes that the macroeconomic activity in the economy will be unchanged whether or not the government takes any positive action to remove distress in financial markets.
Consider the historic precedents.  In the words of Professor Paul Davidson:
Let us look at a historical example where if this type of “what will cost to the tax payer and/or the economy?” question were asked, one of the most desirable government policies would never have been undertaken. At the Bretton Woods conference it was recognized that the European nations would need significant aid to help rebuild their economies after the war. Keynes estimated that the need would be between $12 and $15 billion. U.S. representative Harry Dexter White indicated that Congress could not ask the taxpayers to provide more than $3 billion. Accordingly, the Keynes Plan was defeated at Bretton Woods, and the Dexter White proposals were adopted

Suppose that in 1946 it was recommended that U.S. give a gift of $13 billion dollars over four years to various European countries to help them rebuild their war-ravaged economies (in 1940s current dollars, this sum would be well over $150 billion in 2007 dollars). Obviously if Dexter White was correct, the Congress would never have approved the Marshall Plan. Since the Marshall Plan did not reveal in advance that it would provide foreign governments $13 billion over a period of four years, Congress approved the Marshall Pan. The Marshall Plan gave foreign nations approximately two percent of the United States’ GDP each year for four years. Was the Marshall Plan costly to U.S. taxpayers and the U.S. economy?

The statistics indicate that, during the Marshall Plan years, for the first time in history the U.S. did not experience a serious economic slowdown immediately after a war. And this despite the fact that federal government expenditures on goods and services declined by approximately 57 percent between 1945 and 1946. Furthermore, four years after World War II, federal government expenditure was still approximately half of what it had been in 1945.

When the U.S. emerged from World War II, the federal debt was more than 100 percent of the GDP. Accordingly, there was great political pressure to reign in federal government spending to make sure that the federal debt did not grow substantially. Clearly, then, it was not “Keynesian” deficit spending that kept the U.S. out of recession in the immediate post-World War II years.
What was the cost of the Marshall Plan to the U.S. economy and the U.S. taxpayer? In 1946, the GDP per capita was 25 percent higher than it had been in the last peace years before the War. GDP per capita continued to grow during the Marshall Plan years. Despite giving away two percent of U.S. GDP, American residents (and taxpayers) experienced a higher standard of living each year.  – (Davidson, 2008.)
It is this kind of thinking which should be foremost in the new Administration’s mind.  It has become politically fashionable to rant against government spending and demand fiscal responsibility. But right now, concerns about the budget deficit should be put on hold.  As our new President with a large Democratic majority in both houses of Congress, Barack Obama will clearly find less of the traditional knee-jerk opposition to spending. But he will face a chorus of conventional voices telling him that he has to be responsible, that the big deficits the government will run next year if it does the right thing are unacceptable. The larger population will also be wary:  Americans are always skeptical of ambitious government initiatives. This is a country, historian Louis Hartz once pointed out, founded on Lockean liberalism. But, as Roosevelt discovered when he was elected, a national crisis creates popular willingness to entertain dramatic initiatives. Moreover, Obama will not face the same formidable adversaries that Jimmy Carter and Bill Clinton had to confront. The Republican Party is divided and demoralized after the elections. And, just as the Great Depression took Prohibition and the other great social issues of the 1920s off the popular agenda, this downturn has pushed aside the culture war of the last decades. It simply was not a factor in the presidential election.
If, however, Obama and the Democrats take the advice of official Washington and go slow–adopting incremental reforms, appeasing adversaries — they could end up prolonging the downturn and discrediting themselves. What might have been a hard realignment could become not merely a soft realignment, but perhaps even an abortive one. That’s not the kind of change America needs–or wants. Like FDR, President Obama must ignore that chorus. The responsible thing, right now, is to give the economy the help it needs. Now is not the time to worry about the deficit.  It’s time for a new “New Deal”.



1   The more extreme supply-side revisionists now claim that Roosevelt should not have stabilized food prices and financed, through public works projects, flood and drought control and rural electrification, because it would have been better to starve these people off the land and to the cities, where, a generation or more later, they would have had higher standards of living.  This is the logic of the so-called Austrian School of Economics, taken to its perverse extreme. Had it been implemented, it this policy would have put Roosevelt in the same general category of agrarian reform as Stalin and Mao.

2 Stanley Lebergott, Manpower in Economic Growth: The American Record since 1800 (New York: McGraw-Hill, 1964), table A-3.

3 Michael R. Darby, “Three-and-a-Half Million U.S. Employees Have Been Mislaid: Or, an Explanation of Unemployment, 1934-1941,” Journal of Political Economy 84, no. 1 (February 1976): 1-16.
4 Cited in Darby, 3; Lebergott, 184-5.

5 Robert A. Margo, “The Microeconomics of Depression Unemployment,” NBER Working Paper no. 18, December 1990.


Bernanke, Ben “Deflation: Making sure ‘it’ doesn’t happen here” http://www.federalreserve.gov/BOARDDOCS/SPEECHES/2002/20021121/default.htm
Speech before the National Economists Club, Washington DC, Nov. 21, 2002

Darby, Michael R.,  “Three-and-a-Half Million U.S. Employees Have Been Mislaid: Or, an Explanation of Unemployment, 1934-1941,” Journal of Political Economy 84, no. 1 (February 1976): 1-16.

Davidson, Paul, “How to Solve the US Housing Problem and Avoid a Recession: A Revived HOLC and RTC” – Schwartz Center for Economic Policy Analysis: Policy Note, January 2008

Ferguson, Thomas and Robert Johnson,  “Bridge Loan to Nowhere?”, The Nation, Sept. 24, 2008
Goodwin, Doris Kearns, “No Ordinary Time: Franklin and Eleanor Roosevelt: The Home Front in World War II” (Simon and Schuster, Oct. 1995)

Galbraith, James K.,  The Predator State, Free Press, 2008.

Galbraith, James K.  “A Critique of the Geithner Program”, unpublished, Jan. 28, 2009

Lebergott, Stanley, Manpower in Economic Growth: The American Record since 1800 (New York: McGraw-Hill, 1964), table A-3.

Leuchtenburg, William, “Franklin D Roosevelt and the New Deal”, Harper Perennial, July 1963
Margo, Robert A. “The Microeconomics of Depression Unemployment,” NBER Working Paper no. 18, December 1990.

Wrestley, Christopher, “The Roosevelt Nobody Knows” http://mises.org/article.aspx?Id=813&FS=The+Roosevelt+Nobody+Knows, Oct. 29, 2001


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