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What Ended the Great Depression?
What finally ended the Great Depression? That question may be the most important in economic history. If we can answer it, we can better grasp what perpetuates economic stagnation and what cures it.
The Great Depression was the worst economic crisis in U.S. history. From 1931 to 1940 unemployment was always in double digits. In April 1939, almost ten years after the crisis began, more than one in five Americans still could not find work.
On the surface World War II seems to mark the end of the Great Depression. During the war more than 12 million Americans were sent into the military, and a similar number toiled in defense-related jobs. Those war jobs seemingly took care of the 17 million unemployed in 1939. Most historians have therefore cited the massive spending during wartime as the event that ended the Great Depression.
Some economists—especially Robert Higgs—have wisely challenged that conclusion. Let’s be blunt. If the recipe for economic recovery is putting tens of millions of people in defense plants or military marches, then having them make or drop bombs on our enemies overseas, the value of world peace is called into question. In truth, building tanks and feeding soldiers—necessary as it was to winning the war—became a crushing financial burden. We merely traded debt for unemployment. The expense of funding World War II hiked the national debt from $49 billion in 1941 to almost $260 billion in 1945. In other words, the war had only postponed the issue of recovery.
Even President Roosevelt and his New Dealers sensed that war spending was not the ultimate solution; they feared that the Great Depression—with more unemployment than ever—would resume after Hitler and Hirohito surrendered. Yet FDR’s team was blindly wedded to the federal spending that (as I argue in New Deal or Raw Deal?) had perpetuated the Great Depression during the 1930s.
FDR had halted many of his New Deal programs during the war—and he allowed Congress to kill the WPA, the CCC, the NYA, and others—because winning the war came first. In 1944, however, as it became apparent that the Allies would prevail, he and his New Dealers prepared the country for his New Deal revival by promising a second bill of rights. Included in the President’s package of new entitlements was the right to “adequate medical care,” a “decent home,” and a “useful and remunerative job.” These rights (unlike free speech and freedom of religion) imposed obligations on other Americans to pay taxes for eyeglasses, “decent” houses, and “useful” jobs, but FDR believed his second bill of rights was an advance in thinking from what the Founders had conceived.
Roosevelt’s death in the last year of the war prevented him from unveiling his New Deal revival. But President Harry Truman was on board for most of the new reforms. In the months after the end of the war Truman gave major speeches showcasing a full employment bill—with jobs and spending to be triggered if people failed to find work in the private sector. He also endorsed a national health care program and a federal housing program.
But 1946 was very different from 1933. In 1933 large Democratic majorities in Congress and public support gave FDR his New Deal, but stagnation and unemployment persisted. By contrast, Truman had only a small Democratic majority—and no majority at all if you subtract the more conservative southern Democrats. Plus, the failure of FDR’s New Deal left fewer Americans cheering for an encore.
In short the Republicans and southern Democrats refused to give Truman his New Deal revival. Sometimes they emasculated his bills; other times they just killed them.
Senator Robert Taft of Ohio, one of the leaders of the Republican-southern Democrat coalition, explained why he voted against much of the program: “The problem now is to get production and employment. If we can get production, prices will come down by themselves to the lowest point justified by increased costs. If we hold prices at a point where no one can make a profit, there will be no expansion of existing industry and no new industry in that field.”
Robert Wason, president of the National Association of Manufacturers, simply said, “The problem of our domestic economy is the recovery of our freedom.”
Alfred Sloan, the chairman of General Motors, framed the question this way: “Is American business in the future as in the past to be conducted as a competitive system? He answered: “General Motors . . . will not participate voluntarily in what stands out crystal clear at the end of the road—a regimented economy.”
Taft, Wason, and Sloan reflected the views of most congressmen, who proceeded to squelch the New Deal revival. Instead they cut tax rates to encourage entrepreneurs to create jobs for the returning veterans.
After many years of confiscatory taxes, businessmen desperately needed incentives to expand. By 1945 the top marginal income tax rate was 94 percent on all income over $200,000. We also had a high excess-profits tax that had absorbed more than one-third of all corporate profits since 1943—and another corporate tax that reached as high as 40 percent on other profits.
In 1945 and 1946 Congress repealed the excess-profits tax, cut the corporate tax to a maximum 38 percent, and cut the top income tax rate to 86 percent. In 1948 Congress sliced the top marginal rate further, to 82 percent.
Those rates were still high, but they were the first cuts since the 1920s and sent the message that businesses could keep much of what they earned. The year 1946 was not without ups and downs in employment, occasional strikes, and rising prices. But the “regime certainty” of the 1920s had largely returned, and entrepreneurs believed they could invest again and be allowed to make money.
As Sears, Roebuck and Company Chairman Robert E. Wood observed, after the war “we were warned by private sources that a serious recession was impending. . . . I have never believed that any depression was in store for us.”
With freer markets, balanced budgets, and lower taxes, Wood was right. Unemployment was only 3.9 percent in 1946, and it remained at roughly that level during most of the next decade. The Great Depression was over.
Pingback by The Mandated Health Insurance Outrage | The Freeman | Ideas On Liberty on 24 February 2010:
[...] Obama about the role of government. Thomas Szasz returns to the horrific case of Alan Turing. Burton Folsom looks at what ended the Great Depression. John Stossel warns of the hazards of government mortgage [...]
Comment by fred lapides on 25 February 2010:
The usual tirade that a “free market” and small govt work always. In fact, What FDR began the war concluded. Massive govt spending–Keynes–for the war did the job. And the G.I. Bill–ah, more govt–created a new America.
There were regulations put into lace but over time both parties saw to it that they were removed! and now, a recession.
We need a balence between govt and the markets, but time has shown that unfettered free wheeling private enterprise leads to price fixing and rampant financial manipulation.
Comment by GunnyG on 26 February 2010:
Actually Fred, as you say, MASSIVE gov’t spending did the job.
What job? The redistribution of wealth? Creating a huge deficit?
Contrary to liberal beliefs, you CANNOT spend your way out of debt but you are free to try it with your own household budget.
Indeed, FDR also prolonged the Depression, thus adding to everyone’s misery, as proved in this study,
http://newsroom.ucla.edu/portal/ucla/FDR-s-Policies-Prolonged-Depression-5409.aspx
When you give someone money they did not earn, that means you took it from someone who DID! It doesn’t fall from the sky like manna.
Comment by Jonathan Finegold Catalán on 26 February 2010:
Professor Folsom,
What do you make of the idea that U.S. soldiers saved most of their incomes during the war, thus allowing for a lengthening of the structure of production after the war?
Comment by Robert on 26 February 2010:
When the U.S. got sucked into World War II, FDR was forced to abandon his policies that strangled industrial production in order to produce all that was needed to win the war. Fortunately, Congress did not re-implement the policies that strangled the economy before the war after the war was over. Another thing that happened was social mood turned up, as reflected in the stock market (it’s not called the mood meter for nothing), and perhaps influencing the choice of policies implemented (there’s more than one reason why a time of low social mood is called a depression). Favorable economic policies on top of a waxing positive social mood helped power recovery and expansion.
Massive government spending simply diverted production from things valued most highly by members of society to things chosen by government, with inherently lower value to members of society. The ending of massive government spending freed up production to go back to producing the stuff with the greatest value, making everyone better off in the process. And Fred, if there were price fixing and rampant financial manipulation, a truly unfettered free market would allow new competitors to enter the markets and break the price fixing and manipulation. It takes the force of government to stifle competition in order to allow monopolies and cartels to form in the first place.
Comment by Steve Farrell on 27 February 2010:
Thank you Professor Folsom, excellent article with vital information. I hope it spreads far and wide.
Comment by Tom G. Palmer on 27 February 2010:
Jonathan, If they were saving their incomes in the form of government bonds, as many were, how would that have added to the capital structure? I find that an unlikely explanation of the post-war recovery.
Comment by Craig on 28 February 2010:
“If they were saving their incomes in the form of government bonds, as many were, how would that have added to the capital structure?”
I had believed as Jonathan did, but your point is very well taken. I knew (from family stories and what I’ve read) that everyone had saved his money during the War — there was nothing to spend it on after all — but had not taken the time to think through the ramifications of its being saved in the form of government bonds.
I suppose that the large manufacturers made enough profit through their war production to fund the initial return to civilian goods, but it certainly does point to the return to a less-regulated economy as the primary source of the post-war boom.
Comment by Jonathan Finegold Catalán on 2 March 2010:
Dr. Palmer,
Do you know where I could find information on the wages of U.S. soldiers during the Second World War?
Comment by J Robert Kinnett on 12 March 2010:
Magnificent article, except it left off one key factor: Skills.
The political mood of the 1930′s was inflamed by one of the greatest advances in history: Henry Ford’s tractor. Introduced in the 1920′s, the tractor lowered the cost of production on farms across the U.S. enormously. It had one tragic side effect, though. It left ten million unskilled farm workers unemployed. Moving to the city to find work, wages for unskilled labor were pressured down and down with this influx of hungry people – hungry voters – trying to survive.
Astute politicians harnessed this angst to launch the Smoot-Hawley tariffs and FDR’s “feel good” programs, disregarding what made economic sense, for they were sure-fire vote-getters from what had previously been a largely illiterate public.
World War II provided eight million men with a job where they could see how Leadership, Management and Social Skills paid off in getting work done together with others in a modern organizational setting. Farm work teaches many great lessons, but not necessarily Social Skills. Granted, the cost of the War was staggering in human misery and just the increase in debt of 200 billion 1940-dollars (equal to 6 trillion 2010-dollars) left the nation with an enormous burden that could not be ignored.
These men came home after the War elated with the energy that hard-fought victory brings, and trained to do real work in sizable organizations.
Add to that all the factors Professor Folsom listed above, and the stage was truly set for an economic revival.
Comment by British Whig on 18 March 2010:
Jonathan – you will need to think about sailors and marines too. ‘Soldiers’ and ‘armed forces’ are not synonyms!
Great article on a topic I’d just been pondering. Thanks.
Comment by Paul in Chicago on 23 March 2010:
Disabusing “fred lapides” of economic fallacies is a great idea. His ilk never tires of cheering for FDR and often relies on very loose reasoning, e.g. post hoc ergo propter hoc, to reinforce their prejudice.
Still, there are a few comments in the essay that don’t pass the smell test.
(1) “‘General Motors . . . will not participate voluntarily in what stands out crystal clear at the end of the road—a regimented economy’”, said Sloan.
How ironic. Now, was GM a corporation the owners of which enjoyed regimented sponsorship of the state, as by limited liability? Well, yes. Probably its financiers, suppliers, etc., too. Such limitation helps to allay fears among investors that they’ll get burned by one of their fellow investors, and you’ll not soon get the approximate of ltd. liability by contract. Another form of sponorship is roadbuilding, esp. the vastly expanded roadbuilding of the past 100 years. Without government to subsidize automakers this way, the full cost of car ownership would not be masked, and the purchase decision of car would have to factor this in.
In fact, GM participated in a regimented economy througout the jouney, Sloan was involved personally for decades, and GM stayed in business (which suggests positive cash flow over a long period of time). In Sloan’s defense, maybe he was suffering from the principle of salesmanship. Too bad he didn’t live to see what became of his Governmennt Motors.
(2) “With freer markets…”?
Aren’t all markets either free or not free? Whatever happened to the principle of negation and the law of noncontradiction??
Think of commerce as you would a person, who is either a slave or not a slave, either not free or free. If the person is unfree and then the unfreedom is diminished, s/he remains unfree nonetheless. S/he’s not freer, just less unfree, like an Oberkapo in a concentration camp upon promotion from mere Kapo.
The idea, again, is that there are degrees of enslavement but not of freedom. If you suppose otherwise, you must either accept (a) degress of freedom BUT NOT of slavery, which would be ludicrous (think: Oberkapo), or (b) use ‘free’ and ‘unfree’ as contraries, not contradictories. But (b) vastly complicates the issue, for what terms contradict both ‘free’ and ‘unfree’ and yet are not synonymous with either, as most use ‘unenslaved’ and ‘enslaved’ now? Perhaps two terms themselves contraries with respect to each other.
Anyhow, the conclusion becomes, “with less rigged, less unfree markets,…”. Of course, this will make some whine and complain about negativity. Let them pound sand.
Comment by cj on 29 March 2010:
It would be very interesting to see a contrast and comparison of FDR’s handling of the 30′s depression with the depression of the early 1920s.
http://www.cato.org/pub_display.php?pub_id=9880
Comment by Illibertarian on 3 April 2010:
Shorter The Freeman: “In 1946, the U.S. had a 120% debt-to-GDP ratio, a top marginal tax rate of 86%, and a very strong economy. This proves that the country’s current 80% debt-to-GDP ratio and top marginal tax rate of 35% is the road to ruin.”
Comment by Gonzalo on 5 April 2010:
Would it be too cynical to point out that it’s very likely ANY mildly sensible economic policy allowing international trade would have been successful after WWII for the US, considering the destruction of most production facilities in England, France, Japan and Germany? (not considering the rest of Europe, Africa and the Pacific) I mean, many US industries had virtually no large-scale competition in the world for quite a bit of time after the war.
Comment by Tallulah on 16 April 2010:
“The usual tirade that a “free market” and small govt work always. In fact, What FDR began the war concluded. Massive govt spending–Keynes–for the war did the job. And the G.I. Bill–ah, more govt–created a new America.There were regulations put into lace but over time both parties saw to it that they were removed! and now, a recession.
“We need a balence between govt and the markets, but time has shown that unfettered free wheeling private enterprise leads to price fixing and rampant financial manipulation.” ~ Fred Lapides
Fred, where have you seen “free-wheeling private enterprise” in your lifetime?
Was that what you’d call the economic shenanigans that led to the recent economic crisis? “Free-wheeling private enterprise?”
Did lenders just decide, on their own, to start lending to people who couldn’t ordinarily qualify for loans under sensible free-market standards? Those normal lending standards had been established by years of market experience, and on an unhampered market where a lender won’t get special help from government if he lends foolishly, do you think there would be many lenders who would have risked their businesses and livelihoods in careless lending practices?
In a truly free-market economy,governments do not bail out businesses. Businesses follow prudent practices, and take risks based on sensible criteria, and sink or swim according to their own decisions.
In the recent lead-up to the crisis, too many sub-prime loans were made because government regulatory agencies, urged on by politicians, demanded that lenders obey quotas to see to it that a certain percentage of loans go to people who could not ordinarily qualify under sensible criteria. The Justice Department threatened prosecution against lenders who did not comply with these quotas.
This coecive threat, plus the belief that the government would financially cushion any damage that followed, played a huge role in the economic disaster that resulted.
Furthermore, the problem that the quotas were meant to fix was caused by previous government interventions.
For an elaboration of these and other non-free-market causes of the economic mess we’re in, please read “The Housing Boom and Bust” by Thomas Sowell. It’s only 148 pages, so it won’t take up much of your time, but it will give you another perspective to consider.
Comment by stubenpoop on 1 October 2010:
I recently discussed this same thing with a libertarian. The problem with you folk is that you are religious in your devotion to the free market. So, like the highly religious, you start with the conclusion and then find evidence to support it or create complex ad hoc arguments. This is one of them.
Comment by Brian on 2 October 2010:
Whoa! Big grins here Stubenpoop! Religion, generally described, involves belief(s) that are beyond challenge by data. I try to be data drive, so please, enlighten me. What data and history contradict the libertarian notions that people should have the freedom to enter into contracts without the government dictating any terms?
Comment by poopy on 1 November 2010:
heyyyyyyyyyyy
Comment by Joe Schmoe on 1 November 2010:
‘Shorter The Freeman: “In 1946, the U.S. had a 120% debt-to-GDP ratio, a top marginal tax rate of 86%, and a very strong economy. This proves that the country’s current 80% debt-to-GDP ratio and top marginal tax rate of 35% is the road to ruin.”’
I’m pretty sure the point is whether the figures were headed down or up. If you bothered to look up statistics, at the very least learn how to use statistics correctly.
Comment by Anonymous on 5 November 2010:
wow thanx for the great facts it really helped me with my great depression paper
Comment by Walter L Johnson on 11 December 2010:
I don’t think it is even possible to understand the Great Depression or what ended it without first understanding what caused it in the first place. In contrast to the 94% top marginal tax rate from 1944 to 1945, the top marginal tax rate before the Great Depression was only 25%. It may well be that the low top rate encouraged too much risk taking, while the 1944-1945 94% rate encouraged too little risk taking.
Because the first GI bill sent so many returning veterans to college, the end of the way might have simply delayed economic recovery some, while providing the foundation for the subsequent prolonged economic boom.
The Marshall Plan helped rebuild Europe and its economy, which had the gradual effect of enriching European populations. That was an essential condition to provide a means for Europeans to import American goods along with buying their own products. Sometimes it is easy to forget that business investment only happens when product demand exists. No rational businessman would build a manufacturing plant or refit an exiting one without confidence demand for the production will exist when the plant or change is finished. The destruction of World War II left everyone poorer until they could find employment. Without the Marshall Plan it would have taken far longer for U. S. manufacturing and dependent suppliers to recover. In 1938 the U. S. had $3.0 billion in exports, in 1948 that had increased to $13.5 billion per Table XXIII at http://unstats.un.org/unsd/trade/imts/Historical%20data%201900-1960.pdf on page 52. That increase could not have happended without other nations having acquired the means to produce goods of dollar value. While the 1938 trade gave the U. S. a $0.8 billion trade surplus, the 1948 trade gave the U. S. a $6.4 billion trade surplus and the means to expand the reach of U. S. businesses globally and the de factor American Empire was created.
Comment by struddle on 11 December 2010:
wow every time theres any kind of response window why does someone always have to bring up religion? dont you know thats one of main things that should never be brought up, especially on the internet? So yeah any way thanks to the guy who wrote this it helped me write my deppresion paper as well.
Comment by haya masood on 11 January 2011:
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Comment by wesley on 27 April 2011:
well i would say where and how did they get the information and if its accurate or not
Comment by Kon stall on 30 April 2011:
i am one of many people who would want to know when the great depression ended. in fact, all the information here including the comments always changes and im not also sure what to choose.
Comment by candixe goulds on 11 May 2011:
whats the point in commenting on this anyway?
Comment by david Jones on 22 September 2011:
I propose a slightly different Hypothesis. I suspect it was US paranoia during the war that ultimately forced American Companies to hire American workers first. It becomes harder to outsource offshore workers, or hire immigrant workers at lower rates when you are not sure where their loyalties for your country lie. Have a look at the immigration chart for the years in question
http://web.missouri.edu/~brente/immigr.htm
I believe it strengthens the hypothesis.
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