In my conception regime uncertainty pertains above all to a pervasive uncertainty about the property-rights regime—about what private owners can reliably expect the government to do in its actions that affect private owners’ ability to control the use of their property, to reap the income it yields, and to transfer it to others on mutually acceptable terms. Will the government simply take over private property? Will it leave titles in private hands but strip the owners of real control and profitable use of their properties? In any event the security of private property rights rests not only on the letter of the law but also on the character of the government officials who enforce—or threaten—presumptive rights.

Between 1935 and 1940 this matter attained prime importance. So many businessmen and investors lost confidence in their ability to forecast the future property-rights regime that few were willing to venture their money in long-term investments. They constantly sought clarification of the government’s designs, as President Franklin D. Roosevelt raged against “economic royalists” and blamed a “strike of capital” for the economy’s ongoing troubles, including the depression of 1937–38, which undermined the general public’s confidence in the New Deal.

Treasury Secretary Henry Morgenthau tried repeatedly to persuade Roosevelt to make a public statement to reassure investors, but the President steadfastly rejected this entreaty. Morgenthau ultimately became so frustrated that in a 1937 cabinet meeting, he blurted out to his boss: “What business wants to know is: Are we headed toward Socialism or are we going to continue on a capitalist basis?” Strange to say, Jim Farley and even Henry Wallace backed Morgenthau’s insistence that the President spell out what kind of economic system the administration sought to foster.

In his plea Morgenthau encapsulated the wide-ranging uncertainty that Lammont du Pont expressed in the same year, when he said: “Uncertainty rules the tax situation, the labor situation, the monetary situation, and practically every legal condition under which industry must operate. Are taxes to go higher, lower or stay where they are? We don’t know. Is labor to be union or non-union? . . . Are we to have inflation or deflation, more government spending or less? . . . Are new restrictions to be placed on capital, new limits on profits? . . . It is impossible to even guess at the answers.”

I doubt the regime uncertainty that a growing number of commentators and analysts have perceived since 2008 is as great as that of the latter 1930s. However, the government’s frantic actions in the past few years have surely shaken investors’ confidence about future property rights in the United States. The takeovers of Fannie Mae, Freddie Mac, AIG, GM, and Chrysler; the massive interventions in financial markets; the huge bailouts of banks and other financial institutions, mixed with letting Lehman Brothers go down while salvaging Bear Stearns—all these actions and many others suggest that a rational investor might well attach a huge risk premium to any money he ventures even for the intermediate term, not to mention the long term.

Moreover, the upsurge of the federal government’s size, scope, and power since the middle of 2008 has scarcely calmed investors’ minds. New taxes and higher rates of old taxes; potentially large burdens of compliance with new financial and energy regulations; unpredictable new mandatory health care expenses; new, intrinsically arbitrary government oversight of so-called systemic risks associated with any type of business—all these unsettling prospects and others of substantial significance must give pause to anyone considering a long-term investment, because any one of them has the potential to turn a seemingly profitable investment into a big loss.

The Current Picture

In testing my hypothesis about regime uncertainty, I have marshaled three distinct types of evidence: historical documentation of government actions and public reactions; findings of public-opinion surveys, especially surveys of businessmen; and financial-market data.

My most striking financial evidence for the New Deal episode pertains to the yield curve for corporate bonds—that is, to the spreads between the effective yields on high-grade corporate bonds of various maturities. I found that this yield curve suddenly became much steeper between the first quarter of 1934 and the first quarter of 1935 (when the New Deal lurched from its first, or business-tolerant, phase to its second, or business-hostile, phase) and remained very steep until it flattened between the first quarter of 1941 and the first quarter of 1942 (when the New Deal handed the reins to the military and the big businessmen who, along with the President, ran the war-command economy). I interpreted these extreme spreads from 1935 to 1941 as risk premiums on longer-term investments caused by regime uncertainty.

Does the corporate-bond yield curve show the same kind of shift during the past few years that it displayed in the face of the regime uncertainty that prevailed from 1935 to 1941? To find out I examined a number of series of corporate-bond yields by term to maturity.

I found that in 2008, before the onset of the financial panic in September, the corporate-bond yield curve was quite flat—that is, the yields increased only slightly with term to maturity. When the panic hit, yields became extremely volatile, especially for the bonds with two years to maturity (the shortest term in the data), and remained volatile for almost a year. After mid-2009 the volatility diminished. Once the dust had settled, the yield curve for corporate bonds had become substantially steeper.

Thus just as the steeper yield curve of the latter 1930s corresponds precisely with the so-called Second New Deal, when Roosevelt and his leading advisers went on the warpath against investors as a class, the steeper yield curve since mid-2009 corresponds with the bigger government left in the wake of the financial-market volatility and frenetic government action between September 2008 and the middle of 2009 and with the subsequent rash of extraordinary government measures.

Given the current regime uncertainty, investors will probably continue to remain for the most part on the sideline, protecting their wealth in cash hoards and low-risk, low-return, short-term investments and consuming wealth that might otherwise have been invested. Slow economic recovery, at best, will be the result.

There have been huge advances in technology and substantial declines in trade barriers in recent years. While these developments have raised living standards they have been hard on people whose skills were rendered obsolete or uncompetitive. When changes evolve gradually, as when so many people left farming in the last century, the disruption is not so great. Changes are now coming faster and are extending to some high-paid professional jobs. Automated systems can now handle at least the routine aspects of some legal research and medical diagnosis.

Time and time again new doors have opened to workers as old doors closed. Machines replace workers, but they raise productivity and produce new employment opportunities. We can expect this pattern to continue for a long time to come. Still, it is within the realm of possibility that robots and computers could take over so much work that the demand for human workers would shrink drastically. But those very machines would mean higher productivity and thus higher living standards.

A great deal of work can be now be done remotely, providing an advantage to areas with low living costs. Substantial outsourcing of such jobs to foreign countries has occurred (though that trend may be reversing as low-cost areas of the United States become competitive and as customer dissatisfaction and problems with managing offshore workers come up). The benefits of outsourcing and other productivity enhancements are spread across all consumers, but the job losses are concentrated among small and sometimes vocal minorities.

Another theoretical point: Unemployment notwithstanding, it is an empirical fact of life that labor is scarce relative to natural resources, as Murray Rothbard explained. Over time, this gap tends to lessen and could theoretically disappear.

Education Is Key

Problems with education are legion, but two in particular bear on unemployment and underemployment. One is the emphasis on college education over vocational training. Everyone should attend college, says President Obama. Really? What about welders, truck drivers, repair people, retail sales people? These skills are in demand, and for many people the jobs may offer good pay and personal satisfaction. Why not attend a trade school or get an apprenticeship rather than a college degree? Compare four years in school leading to a bachelor of arts in business and a big student debt versus on-the-job learning.

The second problem is that college administrators and instructors lack incentives to prepare students for good jobs. Schools usually have little to say about the jobs their graduates have gotten or the debt burdens they carry.

Even with all the emphasis on college, by 2020 only about a third of the labor force will be equipped with bachelor’s degrees or higher, according to the McKinsey Global Institute. But the glut of dubious business and social “science” degree-holders will continue while STEM (science, technology, engineering, and math) degree holders will remain scarce.

Among employers surveyed by McKinsey, a majority expect to hire more part-time, temporary, or contract workers. One reason for this trend is mandated and generally very expensive health insurance for full-time employees. But more sophisticated resource-management systems also contribute to this trend, in addition to telecommuting opportunities.

Unemployment Figures Are Grim, and Yet . . .

As this is written, the widely followed U-3 measure of unemployment stands at 9.1 percent while the broader U-6 is a whopping 16.2 percent. People are also going longer without work. About 45 percent of those unemployed have been out of work for more than 27 weeks. The number of discouraged workers rose sharply during the recent recession. Speaking of the Great Recession, it officially ended in June 2009, and if we had gotten a recovery along the lines of past recoveries, GDP would be booming by now and unemployment, always the last aspect to recover, would be falling noticeably. Not only is unemployment high, but GDP growth for the first half of 2011 was close to zero. There was talk of a slide back into recession, though this diminished in the fall.

Job losses since the start of the Great Recession number about 7.5 million; three million more people have become discouraged. Total payrolls amount to about 130 million, fewer than in 2000, when the population was about 11 percent lower. Seven people compete for each job opening.

Unemployment varies widely from place to place. The U-3 version varies from 3.2 percent in North Dakota to 12.4 percent in Nevada. Among cities the numbers range from 3.2 percent in Bismarck, North Dakota, to 27.9 percent in Yuma, Arizona. There is also wide variation among job classifications. Nutritionists, welders, and nurses’ aides are in short supply, along with computer specialists and engineers.

Aggregate figures always mask important differences. Many employers still find it hard to locate good people. The McKinsey study reports that 40 percent of companies surveyed have had openings for six months, while 64 percent reported positions for which they cannot find qualified applicants, with managers, scientists, and computer engineers topping the list.

Anecdotally, “Now Hiring” signs are not hard to spot. Friends who own businesses tell me they have difficulty filling even a receptionist’s job with someone who is reliable, can write a passable letter, or create a simple Excel spreadsheet. Alas these days one cannot assume that a holder of a bachelor’s degree in business, for example, has these basic skills.

Recent Government Policy

The Fed has been unable to do anything about unemployment in recent years. The massive doses of money inflation, which tripled the monetary base (currency plus bank reserves) from about 2008 until the present, have not produced any significant price inflation, and unemployment remains stubbornly high. Money inflation has not produced price inflation largely because banks are not lending but instead have accumulated massive amounts of excess reserves—above and beyond the levels mandated by the Fed to back deposit liabilities. (The Fed pays interest on reserves held in the banks’ Fed accounts.)

As we have seen, the distinction between U-3 and U-6 hinges on the rather arbitrary classification of some unemployed workers as “discouraged.” Alternately, one could simply count the number of work-age people who do not hold jobs. For example, one-fifth of all men of prime working age are not getting up in the morning and heading for a job either because they’re officially unemployed or excluded from the labor force.

Labor productivity is way up and with it, corporate profits. This is typical of the early stages of a recovery. Employers realize that they may have gone overboard with hiring during the boom and need to pull back. When they need additional help they usually turn first to temporary workers. Employees work harder with the specter of unemployment looming large. Only later does employers’ confidence pick up enough that they’re willing to take the risky step of adding permanent hires.

Productivity increases are a good thing in the long run, but by this stage of the recovery employment should be picking up. Why isn’t it?

What’s to Be Done?

Businesspeople have to predict the future, so they hate uncertainty, especially the kind that comes from government—and there’s plenty of that around right now. What will Obamacare do to them? Will the Bush tax cuts be allowed to expire next year? Will there be another debt crisis? What will happen to the not-so-almighty dollar? Who will win next year’s election? The best way to get the economy on track again is to lessen these vexing uncertainties. Given the performance of the President and Congress in the recent debt ceiling debacle, this seems unlikely to happen before the next election.

Rhetoric matters. By 1937 unemployment had recovered somewhat from its Great Depression peak of 25 percent. But with the failure of the New Deal becoming evident, FDR, needing a scapegoat, turned against businesspeople with new regulations, antitrust action, new taxes, and hostile rhetoric—he called them “economic royalists” at one point. The recovery stalled, unemployment rose, and only the war brought an end to unemployment—good news if you got a job, bad news if it was a job that got you shot at. (But what was being made? Not consumer goods.) President Obama has referred to “fat-cat bankers” but has backed away from inflammatory rhetoric, perhaps because of adult supervision.

Can stimulus programs mitigate unemployment? Sure, they can put people to work, but the projects are politically motivated and do not represent the best use of scarce resources, as market-based projects must try to do. The projects end, the workers disperse, and there has often been little or no lasting benefit. About all we have to show for those programs are massive new debt levels, a weakening dollar, and a feeble economy—and yes, a frightened and angry populace.

The economics profession must lessen its fascination with dubious macroeconomic aggregates. Production of needed and wanted goods and services is what really matters, not just production of any old thing that gets added to GDP. Economists should focus on conditions that generate real jobs, jobs that produce things people really want, not just any activity that draws a subsidized paycheck.

Congress must make serious spending cuts, and proponents should not pretend these won’t hurt short-term. Cuts should be immediate, because promises about cuts ten years from now are all but meaningless. Today’s Congress has little influence over future officeholders.

The Federal Reserve should be relieved of its unemployment mandate (and the new Consumer Financial Protection Bureau). Its money-creation powers should be reined in, and ultimately it should be abolished.

As the signs of the faltering economy become ever more manifest, some prominent businessmen and others are seeking solutions in the recent past. Believing that the present crisis is comparable to that of the Great Depression, they are showing interest in discarded economic strategies.

The bygone getting the most attention is the Reconstruction Finance Corporation (RFC). Created in January 1932, the RFC extended loans and guarantees to industries, banks, railroads, mortgage companies, farmers, and state and local governments in the name of economic recovery.

Prominent Businessmen

Two bill introduced in Congress this year [1980] would resurrect the RFC. Three prominent businessmen have recently advocated the creation of a similar agency. Henry Kaufman, an economist with the Wall Street brokerage firm of Salomon Brothers, has proposed a National Commission for the Revitalization of America. Frank A. Weil, a former Wall Street investment banker (now a Washington, D.C., attorney) proposes a government agency to anticipate problems rather than apply ad hoc remedies, as was done in the Chrysler case. And since 1974 Felix Rohatyn has openly called for recreation of the RFC. Rohatyn, perhaps the most prominent of these men, is a partner in the investment-banking firm of Lazard Freres and chairman of the Municipal Assistance Corporation, which overseas and floats bonds for the New York City bailout.

Rohatyn, an adviser to independent presidential candidate John B.Anderson before endorsing President Carter has bemoaned the American people’s loss of confidence in their government:

No matter how much technical jargon we hear from economists and monetarists, we have to begin with the notion that people must believe their leaders know what they are doing and where they are going. In the United States today, this is clearly not the case. Alone among the leaders of the West, the United States seems unable to govern itself, and a visit to Paris or Bonn or Tokyo brings home the most startling difference; there, governments do seem to govern. There are direct links between the identification of a problem, a recommendation for action, and public debate, which are followed by a decision and implementation.

His recommendations for restoring the lost confidence, in addition to a temporary wage-price freeze, a 50-cent-a-gallon gasoline-tax hike, and limits on free trade, include a new RFC “to provide a safety net for certain industries, financial institutions, and municipalities in serious difficulties.” Like all such nets, Rohatyn writes, “it should be initiated before, not after, further disasters.”

Other corporate leaders and financiers have joined the chorus for a new RFC, including Henry Ford; William McChesney Martin, former chairman of the Federal Reserve Board; and Gustave Levy, senior partner of Goldman Sachs.

In September President Carter showed signs of adopting Rohatyn’s suggestion. In his fifth (some say seventh) economic renewal program, Carter announced that he intended to create an agency that sounded similar to the RFC: the Economic Revitalization Board, which would set up an “industrial development authority” to channel tax revenues and private capital into economically troubled areas. Before that, when Carter announced an aid program for the auto industry, White House domestic affairs adviser Stuart E. Eizenstat said, “We consider this the first step of a national industrial policy.”

Despite this enthusiasm for a new RFC, however, few have looked back at the original to assess its intentions, activities, and record. Such a retrospective survey may provide a clue to what to expect from a new RFC.

Hoover’s Creation

The RFC was signed into law by President Herbert Hoover on 22 January 1932. The standard (and erroneous) view of the depression era is that government activism began after Hoover’s term. Popular myth has it that Hoover, the last defender of laissez-faire capitalism, refused to act when the stock market crashed and plunged the nation into poverty. It took Franklin Roosevelt’s election in 1932, this version has it, to get the government to end the economic debacle caused by free market.

As are so many “facts” about American history taught in government schools, this one too is apocryphal. Major corporate leaders had been prointervention since before the Progressive Era, and they found Herbert Hoover sympathetic. The New Deal, far from being revolutionary, was instead a continuation and expansion of Hoover’s interventionist programs.

Both contemporary liberal and conservative analyses are too feeble to grasp what happened during the Great Depression. Liberals tend to believe that the business class was displaced by “the people” under FDR’s leadership, conservatives that Roosevelt’s “anti-business” regime brought socialism to America. Neither view is correct, which Rohatyn seems to understand. He writes, “The economic road that I would travel is more interventionist than the conservative dogma but also more business-oriented than liberals would like.” He is a true descendant of the businessmen who helped erect the corporate state.

The RFC fits neatly into a chain of events that stretches back to the government industrial-planning agencies of World War I. The first RFC chairman, and the person who suggested to Hoover the idea of the RFC, was Eugene Meyer Jr., former managing director of the War Finance Corporation. Hoover’s first choice for chairman was Bernard Baruch, the financier who headed the War Industries Board, and the influence of such businessmen and financial moguls dominated the RFC, as we shall see.

In late 1931 when Hoover called on Congress to create the RFC, he recommended that it should operate for only two years, but, like so many other government programs, it led a prolonged life. The RFC operated until 1953, when its authority was transferred to the new Small Business Administration. On signing the bill Hoover promised, “It is not created for the aid of big businesses or big banks. Such institutions can take care of themselves. It is created for the support of the smaller banks and financial institutions. . . .” We’ll shortly see whether or not this pledge was fulfilled.

In the words of the RFC’s second chairman, Jesse H. Jones, a Texas Democrat, banker, and businessman, the agency “loaned and spent, invested and gave away a total of more then $35 billion and authorized many billions more that were not finally used.” The RFC thereby became America’s largest corporation and the world’s biggest and most varied banking organization, with almost unlimited authority to spend money. Jones boasted that the RFC used about $10.5 billion “without loss to the taxpayers” Indeed, he writes, a $500 million profit was returned to the Treasury.

During World War II the RFC became an agent of the military effort, disbursing some $22.4 billion. Jones writes that $9.3 billion of this was “unrecoverable” because after the war Congress authorized the Treasury to cancel some RFC notes.

Jones proudly recounts that although 5,000 banks failed during the depression, 7,000 were saved by the $4 billion RFC investment. With the market for mortgages frozen, the RFC jumped in and created the RFC Mortgage Co. and the Federal National Mortgage Association [Fannie Mae], which disbursed some $500 million from the RFC.

A billion dollars’ worth of RFC help couldn’t save one-third of the nation’s railway mileage from going into receivership or bankruptcy, Jones writes, but another one-third would have gone under without help. To push up plummeting agricultural prices, the RFC lent $1.5 billion to farmers, most of which was repaid. To fulfill its public-works mandate, in 1932 alone the RFC authorized $147 million in cash and loan guarantees.

In mid-1932, Congress enabled the RFC to expand its services to include business and industry. Four years later, it had made 9,000 loans totaling $500 million. At its peak in 1934, RFC personnel numbered 12,000. As late as June 1949 it had 4,600 employees.

Secrecy and Big Business

The first several months of the RFC’s operations were shrouded in secrecy. Neither Congress nor the public was permitted to know who was borrowing the money. The rationalization was that its customers’ confidence in a particular bank would collapse if they knew that the bank was getting help. In July 1932 Congress amended the law and required the RFC to make public reports. In its months of secret operation, the RFC had lent of $1 billion, 80 percent of which went to banks and railroads. By the end of the year, the percentage had declined only slightly.

In a January 1933 investigative article, journalist John T. Flynn demonstrated that much of the RFC’s largess was going to big banks and railroads, despite Hoover’s promise. According to Flynn, the RFC lent the Bank of America $65 million, and of the $264 million lent to railroads, $156 million went to lines controlled by the Morgans, Van Swerigens, and the Pennsylvania Railroad. Murray N. Rothbard notes that of $187 million in 1932 loans that had been traced, $150 million went to repay debts held by a few banking firms, notably J. P. Morgan and Co. and Kuhn, Loeb and Co. Interestingly, Meyer’s brother-in-law, George Blumenthal, was a member of the House of Morgan, and Meyer himself had served as liaison between Morgan and French government.

Flynn was mindful of the ironic connection between big bankers and the agency supposedly devoted to recovery: “Is it not worth a passing thought that almost all of the banks which had to seek help were under the domination of these political financiers who clustered round the throne and who coyly admit that they are the architects of the prosperity?”

The connection was fully acknowledged by Jesse Jones. In his book about the RFC he notes that in 1934 humorist Will Rogers attended a U.S. Chamber of Commerce dinner along with many major corporate leaders. Rogers noted in his newspaper column that the chamber’s ostensible purpose was to keep government out of business. Yet, “as each [big businessman] stood up, Jesse [Jones] would write on the back of the menu card just what he had loaned him from the RFC. . . .”

Secrecy and big-business connections were not the only controversies surrounding the RFC. Charges of favoritism were also leveled against the agency. In June 1932, three weeks after resignation of RFC president Charles G. Dawes (who had been vice-president to Calvin Coolidge), the Central Republic Bank in Chicago, of which he was “honorary chairman,” got a $90 million loan. (Its total deposits were only $95 million.) Union Trust Co. of Cleveland, whose board chairman was treasurer of the Republican National Committee, got a $14 million loan. The Guardian Trust Co. of Cleveland, a director of which was Dawes’s successor, Atlee Pomerene, got $12.3 million. The Baltimore
Trust Co., whose vice-chairman was a Republican senator, got $7.4 million. The Union Guardian Trust Co. of Detroit, a director of which was Commerce Secretary Roy D. Chapin, got $13 million. In July 1932 Congress amended the law to forbid loans to any bank that had a director or officer on the RFC board.

Immense Power

Jones boasted that as RFC chairman he had immense power, but not everyone was as pleased by his power as he was. In fact, there was concern that the RFC had achieved an immunity from popular sovereignty that was inappropriate in a republic. For example, in 1943 Congress learned that the Board of Economic Welfare, set up in 1941 to enable Vice President Henry A. Wallace to stockpile strategic materials, had spent $1.5 billion, although Congress had appropriated only $12 million for administrative expenses. Jones, who by then was commerce secretary and federal loan administrator, told Congress that the money had been appropriated by the RFC, which had borrowed it from the Treasury at 1 percent. As it turned out, the RFC had appropriated some $34 billion to various bureaus in the same way.

The RFC lasted about twenty years longer than Hoover envisioned, and some of its offspring live on to this day. Aside from the Federal National Mortgage Association, the RFC also created the Export-Import Bank, initially to induce trade with the Soviet Union (a failure) and later to assist the Allies in the war.

Did the RFC contribute to ending the depression? Jones asserts that by the fall of 1939 the county was out of the depression and that recovery would have been delayed “but for the billions pumped into the bloodstream of our economy by the RFC.” Yet unemployment stood at 9 million in 1939 and returned to its 1932 level until the United States entered the war.

Jones conspicuously neglects the question of where the billions came from. He assumes that had the RFC not used the money, it would have gone to waste. Clearly, the money came from the taxpayers. In 1932 Hoover signed one of the largest peacetime tax increases ever. All kinds of taxes were raised, including both personal and corporate income taxes and the estate tax. When capital is unusually short, a tax hike is especially inopportune.

The argument that the depression would have been worse if the billions had not been diverted from other uses is reminiscent of the story about the dog owner whose veterinarian accidentally gave the dog a stimulant instead of a tranquilizer. After the dog’s violent rampage, the owner called the vet to thank him. “Think how much worse it would have been had you not given my dog the tranquilizer,” the owner said.

Restored Confidence

One of the arguments for the RFC is that it maintained or restored confidence in banks and other institutions. But this [raises] the question: Should confidence in a failed banking system have been restored? Realizing that the depression was a period of readjustment after a period of malinvestment, Flynn wrote of the failing railroads, “The quicker the correction comes, the quicker the regeneration . . . will come. . . . Any attempt . . . to save weaker debtors necessarily prolongs the depression.”

This observation gets at the crux of economic case against any affirmative government action in a depression. Such action necessarily impedes the readjustment to economic reality required by the artificial boom caused by monetary expansion. The RFC epitomizes the backward policies of Hoover and Roosevelt’s New Deal, policies that deliberately set up obstacles to the market process.

Thus the historical case for a new RFC is not persuasive. Favoritism, political jockeying, and all the unintended consequences of power are inescapable features of government solutions. There is no reason to believe that a new RFC would be any different. The behavior of a political agency is not accidental. It is a result of its nature. An agency with billions to lend (and no profit-loss test) must select its borrowers some way; it must rely one someone’s judgment. It will tend to rely on prominent bankers and brokers whose professional expertise is in finance.

Political Standards

Such an agency cannot lend money to everyone. What will be its standard of selectivity? In all probability, it will be prohibited from using the standard that private investors use. They look for actual or potential profit, which is a sign that consumers are being (or will be) satisfied. But a new RFC won’t be able to do that. Its purpose will be to lend to those who cannot find private funds. A pending House bill that would create an RFC-type agency mandates that it lend only to borrowers who “have presented evidence that they are unable to obtain funds on reasonable terms from any other source. . . .”

There are only two reasons why a borrower can’t get funds in the market: Either he is deemed unworthy of credit or his project is deemed unprofitable. Thus, a new RFC will be required by law to divert capital from those who can serve consumers well to those who can’t. Rohatyn’s belief that such an agency can be put on a sound banking basis has no validity because, by definition, the agency will exist to make unsound investments.

Since government agencies cannot use market criteria, they will use political criteria instead. Note that in the last twelve months, only Chrysler was bailed out, although as many people as Chrysler employs have their jobs threatened each year by business failures. What, but politics, explains that selectivity?

The whole of economic theory condemns the RFC’s rationale, revealing it as a package of myths. First, there is the “no cost” myth, according to which if government loans or loan guarantees are repaid, the taxpayers have suffered no loss. This is the classic fallacy of accounting for only the visible effects of a policy. If $1 billion is lent to a firm from the Treasury or if $1 billion is lent privately because government guaranteed the loan, that is $1 billion less that is available for consumer-oriented investment. The lost goods, jobs, etc., are real, yet unmeasurable, costs. That the loan is repaid later, even with interest, does not make up the loss. The government must get the money from somewhere; that is the starting point of a loss that ripples throughout the economy.

The goods produced by the politically connected borrower don’t represent gains to consumers. They had other preferences; otherwise the borrower would have been able to get capital without government intervention.

This illuminates the next objection to government “reindustrialization.” It will necessarily transform the economic system from demand economy to a command economy.  A business fails because consumers reject it. When the government props up failures, it overrules consumers. What they refused to do voluntarily, they will be forced to do as captive taxpayers. The result is a skewing of the economy away from consumers’ purposes toward the objectives of bureaucrats and spokesmen for business and labor.

Capital Shortage

The most fallacious argument for an RFC is that it can provide capital when there is a shortage of capital. Obviously, the government has no capital of its own. The most it can do is redirect private capital and in the process take a handsome cut. So although the government is no solution, it can be the problem: Government policies absorb capital and bring on the very shortage it complains about. These policies include monetary expansion, taxes on income and capital gains, and cost-raising regulations. Relieving the capital shortage requires the removal of obstacles to capital accumulation, not the rearrangement of existing capital.

The most compelling argument against reindustrialization, however, is ethical. Its purpose is to be forcibly interfere with people’s peaceful pursuit of their well-being, and its purpose is what indicts it. Private goals will be subordinated to “national objectives” chosen by distant rulers. Entrepreneurs whose plans don’t conform to the policies would be prohibited from “wasting” scarce resources. In the national interest, all will be ordered to get in line and march.

America doesn’t need an RFC or industrial policy. It needs more of what was responsible for its initial economic progress; individual liberty, respect for private property, and recognition of the rights of all.

Be that as it may, advocates of peace and freedom can’t be comforted by the war explanation. No Keynesian I know of wishes for war to stimulate the economy, but some have lamented that it’s too bad it takes a war to win mass support for government spending large enough to end a big downturn. There’s something to this, of course. John T. Flynn, the Old Right opponent of the New Deal and foreign intervention, pointed out in As We Go Marching that military spending is the one variety of government spending that will unfailingly win conservative support. Hence the tendency toward militarism.

For the sake of peace, then, we peace-and-freedom-mongers must refute the World-War-II-got-us-out-of-the-Great-Depression argument.

It’s not hard to do when you break things down to their elements.

I begin by asking anyone who makes this argument: What do you mean by “end the Depression”? Since depressions and recessions are marked by a general loss of economic well-being, a commonsense definition of “end the Depression” should be: “a general rise in economic well-being,” with well-being indicating growing opportunities for consumption and leisure.

GDP and Unemployment

But that’s not what Keynesians  mean. The one I debated talked not about prosperity but rather changes in GDP and unemployment, as if those were indicators of well-being. I guess they might be, but not necessarily. A rise in well-being will probably be reflected in GDP and employment statistics, but the reverse is not necessarily so. A rise in those indicators may not signify an increase in well-being.

To see this, we need only look at what was going on during the war. Robert Higgs has done the heavy lifting on this subject, so my debt is to him. GDP supposedly measures national output, but it includes government spending. During the war of course the government spent a huge amount of money, making any rise in GDP is misleading. (Murray Rothbard once suggested that government spending be subtracted from GDP.)

Higgs writes:

Yes, national output as conventionally measured did grow hugely during the war.  . . . [G]ross domestic product (in constant 1987 prices) increased by 84 percent between 1940 and 1944. What the orthodox account neglects, however, is that this “miracle of production” consisted entirely (and then some) of increased government spending, nearly all of it for war materials and equipment and military personnel. The private component of GDP (consumption plus investment) actually fell after 1941, and while the war lasted, private output never recovered to its pre-Pearl Harbor level. In 1943, real private GDP was 14 percent lower than it had been in 1941. If a nation produces an abundance of guns and ammunition, it does not thereby achieve genuine prosperity. [Emphasis added.]

With the government diverting resources from butter to guns, it does not seem that the average person would have been better off economically in the 1940s than in the 1930s.

Higgs goes on:

Those who lived through the war . . . forget the scarcity of decent housing, the hassles in commuting to work, and the severe rationing or complete absence of basic consumer goods. . . .

. . . Because of the many other ways that the well-being of consumers deteriorated during the war, which the official data fail to capture, actual wartime conditions were even worse than [the] figures suggest.

Well, what about unemployment? It fell from 14.6 percent in 1940 to 1.2 percent in 1944. “There you go! Case proved,” a Keynesian might say.

Hang on, Higgs replies:

What the orthodox account neglects, however, is that during that same period the government, mostly by conscription, increased the active-duty personnel of the armed forces by 11 million persons, equivalent to almost 20 percent of the total labor force (employed plus unemployed) in 1940. If a nation shoves 11 million persons into military service and, as a result, reduces the number of unemployed persons by eight million, that performance scarcely signifies the achievement of true prosperity. [Emphasis added.]

Prosperity did not become a feature of life until after war. Do we really need technical economics to understand this? Except for government contractors and politicians with privileged access to stashes of goods, who else can prosper during a war in which government commandeers the entire economy and devotes virtually all resources to that effort? You can’t eat bullets, tanks, or planes. What good is a job if there is nothing to buy?

Keynesians find comfort in the rising macroeconomic aggregates while ignoring how flesh-and-blood people actually lived. How else can they blithely declare that war spending ended the Great Depression?

In no sense did the war end the Depression. It delayed recovery — just as government spending delays recovery today.

There are several responses to that criticism, the first being that the growth in government expenditures might have been part of the cause of the fall in GDP (by reducing investment more than government grew), which would bolster the point that government was growing in a harmful way.  However, the deeper and related response is that measures of the impact of government that focus only on the scale of government are an incomplete way of understanding the full effect that government can have on an economy.

Scale and Scope

To see that larger impact, we need to adopt a distinction that Robert Higgs effectively uses in his book Crisis and Leviathan.  Higgs differentiates between the scale of government and the scope of government.  Scale simply refers to the kinds of measures noted above. Higgs points out that we would expect there to be a strong correlation between, say, population and the size of government.  Even in a world of very limited government and economies of scale, a larger population will require more police and a larger legal apparatus.  A larger, more complex economy might also require a somewhat larger scale of government, even if it is strictly limited in its powers.  The scale of government is indicated by the size of total expenditures and other traditional measures.

By contrast scope refers to the range of government powers.  The important point is that giving government more power need not mean a significant increase in expenditures.  For example, the Federal Reserve System is not even on the map in terms of the expensive things the federal government does, yet giving the Fed the various powers, especially the monopoly powers, it possesses has had a significant — and damaging — effect on the economy.  One might say the same thing about laws like the minimum wage or occupational licensure.  They don’t necessarily cost much to implement or enforce, but they can have highly significant consequences.

Thus the ability of government to inflict economic harm by being “big” is a matter of both scale and scope, and we often forget to recognize the latter.

Great Depression

This point is nicely illustrated by the Great Depression.  In arguing that Hoover was no friend of laissez faire last week, I used quantitative measures to emphasize questions of scale, but my list of interventions contains both scale and scope items.  Public works and government loan programs certainly expand government budgets and thus scale, as well as increasing the scope of its powers.

Other items, however, are not very costly but still very damaging.  The big three here would be Hoover’s attempt to keep wages from falling, the Smoot-Hawley Tariff, and his stricter enforcement of antitrust laws.  None of these involved significant increases in government expenditures, yet all three were damaging to employment and the business environment, especially the first two, and thereby substantially worsened the Great Depression.

The same could be said of many policies of the Roosevelt administration, as well as its antibusiness rhetoric, which is one major source of the regime uncertainty that Higgs argues extended the depression.

Obamacare

The scale versus scope distinction is relevant in our own time as well.  The recently passed health care “reform” will certainly increase the scale of government, but it will also increase its scope, as government will have more power over individual decision-making.  Business leaders are already reporting that uncertainty about its effects, and not its impact on the federal budget, is a major reason they are not hiring.

The Dodd-Frank financial “reform” law probably won’t add that much to the federal budget, but the increased scope of intervention it creates is already making life miserable for the financial sector, and the damage it causes will be well out of proportion to its cost.  And in a repeat of the 1930s, the Obama administration’s frequent antibusiness, or at least anticorporate, rhetoric has been a cheap but effective cause of reduced private-sector investment.

The scale of government matters, but we cannot get so tangled up in debates about the size of federal government expenditures that we overlook the effects of changes in the scope of government power.  Changes in scope are often more damaging to economic growth — and individual freedom — than are changes in scale.  We forget about them at our peril.

Franklin Roosevelt recognized that the war only provided a short-term fix for the economy—and a very costly one at that. What would happen after the war—when 12 million troops came home and the strong demand for guns, bullets, tanks, and ships ceased?

Roosevelt envisioned a New Deal revival. He had created the National Resources Planning Board (NRPB) in 1939 and urged it during the war to plan for peacetime. The NRPB leaders believed that government planning was necessary to promote economic development. They consciously (and sometimes unconsciously) followed ideas popularized in 1936 by John Maynard Keynes in his bestselling book, The General Theory of Employment, Interest and Money.

Capitalism was inherently unstable, Keynes argued, and would rarely provide full employment. Therefore government intervention was needed, especially in recessions, to spend massive amounts of money on public works, which would create new jobs, expand demand, and rebuild consumer confidence. Yes, government would need to run large deficits, but economic stability was society’s reward. If government planners could manage aggregate demand through public works, the boom-bust business cycle could be flattened and economic development could be managed in the national interest. No more Great Depressions. Man could indeed be master of his economic future.

Before and during the war Keynes’s ideas swept through the United States and first transformed the universities, then the political culture of the day. With statistics in hand and a near reverence for government, the Keynesians were the new generation of planners. They wanted to remake society. Not entrepreneurs, but economists were needed to gather data, plan government programs, and regulate economic development. Paul Samuelson, for example, a 21-year-old economics student, was cautious at first, but then euphoric after Keynes’s book was published. “Bliss was it in that dawn to be alive, but to be young was very heaven,” Samuelson wrote. Other economists soon accepted Keynes, and by the 1940s his ideas dominated the economics profession. In 1948, Samuelson would defend Keynes by writing the best-selling economics textbook of all time.

Planning for Peace

Those on the NRPB were among the excited disciples of Keynes and economic planning. The war itself seemed to be evidence that government jobs had pulled the U.S. economy out of the Depression. Now the economists and planners needed to take the nation’s helm to plan for peace.

According to Charles Merriam, vice president of the NRPB, “[I]t should be the declared policy of the United States government, supplementing the work of private agencies as a final guarantor if all else failed, to underwrite full employment for employables. . . .” That idea launched what Merriam and the NRPB dubbed “A New Bill of Rights.” FDR would call it his Economic Bill of Rights. Included was a right to a job “with fair pay and working conditions,” “equal access to education for all, equal access to health and nutrition for all, and wholesome housing conditions for all.”

New Bill of Rights

FDR viewed this Economic Bill of Rights as his tool for guaranteeing employment for veterans (and others) after World War II. But it was more than a mere jobs ploy; it had the potential to transform American society. The first Bill of Rights, which became part of the Constitution, emphasized free speech, freedom of the press, and freedom of religion and assembly. They were freedoms from government interference. The right to speak freely imposes no obligation on anyone else to provide the means of communication. Moreover, others can listen or leave as they see fit.

But a right to a job, a house, or medical care imposes an obligation on others to pay for those things. The NRPB implied that the taxpayers as a group had a duty to provide the revenue to pay for the medical care, the houses, the education, and the jobs that millions of Americans would be demanding if the new bill of rights became law. In practical terms this meant that, say, a polio victim’s right to a wheelchair properly diminished all taxpayers’ rights to keep the income they had earned. In other words, the rights announced in the Economic Bill of Rights contradicted the property rights promised to Americans in their Declaration of Independence and in the Constitution.

FDR promoted his Economic Bill of Rights in his State of the Union message in 1944, but he died before the war ended. Shortly before his death, Senator James Murray (D-Mont.) introduced a full-employment bill into the Senate for discussion. The bill committed the government in a general way to provide jobs if unemployment became too high. Many leading Democrats and economists supported Murray’s bill. “In this session of Congress,” The New Republic reported, “one of the first bills to be introduced will no doubt be the full employment bill of 1945, designed to carry out item number one in the Economic Bill of Rights.” The Nation joined The New Republic in endorsing the full-employment bill. “Mr. Roosevelt’s program,” it concluded, “is squarely based on the best economic authority available. It is entirely consistent with the economic doctrines of the distinguished British economist Lord Keynes.”

On September 6, 1945, President Harry Truman gave a major speech in which he supported the Economic Bill of Rights, especially a full-employment bill. Most congressmen, however, rejected both. Rep. Harold Knutson (R-Minn.) said, “Nobody knows what the President’s full employment bill will cost American taxpayers, but the aggregate will be enormous.”

Instead, Knutson and many other congressmen favored cutting tax rates and slashing the size of government as the best measure to restore economic growth. Senator Albert Hawkes (R-N.J.) even argued that “the repeal of the excess-profits tax, in my opinion, may raise more revenue for the United States than would be raised if it were retained.” Hawkes proved to be prophetic. After vigorous debate Congress scrapped the Economic Bill of Rights and cut tax rates instead. American business then expanded, revenues to the Treasury increased to balance the federal budget, and unemployment was only 3.9 percent in 1946 and 1947. The Great Depression was over.

The punditry is right about one thing: Hoover can be blamed for turning what would have likely been a severe but short market correction in the wake of the artificial boom of the 1920s into a deep and long Great Depression.  The reason, however, is not that Hoover did nothing, but that he did many things.  Hoover, much like FDR, was skeptical about free markets, as both his earlier work as secretary of commerce and his own description of his beliefs made clear. Faced with the worsening crisis in the fall of 1929, he expanded the federal government’s role in a whole variety of ways.

Long List of Interventions

Without going into detail about any one of them, the Hoover interventions include: expanded public works, greater government control over agriculture, the Smoot-Hawley tariff, a virtual end to immigration, government loans for construction and other businesses, and greater enforcement of antitrust laws.   Most important was Hoover’s pressuring businesses to not cut wages even as the prices of their output fell.  The result was higher real wages, which were responsible for the unemployment rate topping out at 25 percent, causing the greatest human toll of the Great Depression.  (I ignore here the very important mistakes made by the Federal Reserve System in allowing the major deflation to take place, not because it was unimportant – it was crucial to making matters worse – but because Hoover had no real control over the Fed.)

Hoover also proposed budgets that raised total federal expenditures by almost 50 percent in nominal dollars and over 60 percent when we adjust for the deflation.  He ran budget deficits in 1931 and 1932 that were 52.5 percent and 43.3 percent of total federal expenditures those two years.  No year under Roosevelt between 1933 and 1941 had a deficit that large.  Finally, in 1932 Hoover presided over the largest peacetime tax increase in U.S. history, which among other things increased the income-tax rate on top incomes from 25 to 63 percent. This is hardly the program of a man committed to laissez faire.

More interesting, though, is that people at the center of the action during the Great Depression knew that the differences between Hoover and FDR were small.  For example, consider the “Brains Trust,” the group of advisers who surrounded FDR in the campaign and after the election.  Two of its most prominent members were Rex Tugwell and Raymond Moley, professors of economics and law, respectively.  Tugwell and Moley recognized both at the time and subsequently that the policy initiatives of the New Deal owed much to ideas and programs that Hoover began.

New Deal Owed Much to Hoover

For example, Tugwell said of his time with FDR: “When it was all over, I once made a list of New Deal ventures begun during Hoover’s years as Secretary of Commerce and then as president…. The New Deal owed much to what he had begun.”  In 1948 Moley wrote of that period:

When we all burst into Washington … we found every essential idea [of the New Deal] enacted in the 100-day Congress in the Hoover administration itself. The essentials of the NRA, the PWA, the emergency relief setup were all there. Even the AAA was known to the Department of Agriculture. Only the TVA and the Securities Act was drawn from other sources. The RFC, probably the greatest recovery agency, was of course a Hoover measure, passed long before the inauguration.

In the 1960s Tugwell wrote to Moley and said of Hoover, “[W]e were too hard on a man who really invented most of the devices we used.”

They were correct in claiming that a great part of the New Deal was anticipated by things Hoover did as president.  Hoover dramatically worsened the depression, but not by sitting idly by while the economy crashed.  It was his expansion of government intervention that did the damage, just as the massive intervention of the Bush and Obama administrations has likewise turned a market correction into a major recession, and perhaps worse.

Intellectuals and pundits need to learn their history from somewhere other than Annie or a high school history textbook.  Reading what their own hero’s advisers said would be a start.  If they don’t get the story straight they will continue to be the enablers of the myth that promotes the very thing they are opposing:  a repeat of the disastrous Hoover presidency.

As described in William J. Bernstein’s book The Birth of Plenty: How the Prosperity of the Modern World Was Created, France’s minister of finances under Louis XIV from 1665 to 1683, Jean-Baptiste Colbert, worked tirelessly to expand commerce by improving his country’s roads and canals.  Unfortunately, trade was hindered by more than potholes — a complex system of internal tariffs was throttling commerce.  Colbert tried to dismantle the tariffs but was only partially successful.  After his death, “all fiscal restraint was lost.  By the end of Louis XIV’s reign three decades later, the State had doubled the tolls on the roads and rivers it controlled, and the nation that had once been Europe’s breadbasket … was bled white….”  Bad regulations trumped good roads.

Prometheus Bound (in Red Tape)

During the Great Depression, Franklin Roosevelt initiated massive public-works programs to improve the nation’s infrastructure in hopes of putting people back to work and jumpstarting the economy.  The construction efforts were staggering.  According to Conrad Black:

The government hired about 60 percent 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 City’s Lincoln Tunnel and Triborough Bridge, the Tennessee Valley Authority, and the heroic aircraft carriers Enterprise and Yorktown. They 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.

Yet these extraordinary accomplishments were not enough to pull the nation out of the Depression. Neither were the millions of jobs generated by this monumental work.

Not only did the work direct resources away from the private sector but, worse, Roosevelt unleashed a regulatory blizzard on the nation’s private sector, significantly increasing the risk of doing business in the country.  Higher personal, corporate, excise, and estate taxes; wage and price controls; production restrictions; antitrust lawsuits; and constant experimentation provided few incentives for companies to expand.  As in Louis XIV’s France, an improved infrastructure could not revive commerce in the face of stifling government regulations.

High-Speed Rail to Nowhere

Today, Barack Obama is touting high-speed rail and other infrastructure improvements as keys to economic renewal.  But if massive infrastructure investments were not enough to turn the economy around in the 1930s, they are far less likely to do so today.  Because Roosevelt was starting from a lower base, his improvements would have had a far greater impact on the economy of his day than would similar work done now.  Furthermore, the lighter regulatory burden in the 1930s meant that there were projects then that truly were “shovel ready.”  Today, environmental impact studies, possible archeological finds, and nuisance lawsuits may stall construction for years or halt it completely.

The real roadblock to economic growth is the burgeoning regulatory burden that President Obama, like Roosevelt before him, has placed on business.  According to a study by James Gattuso and Diane Katz, “[T]he Obama Administration imposed 75 new major regulations from January 2009 to mid-FY 2011, with annual costs of $38 billion.”  Hundreds of additional regulations will pour forth from Obamacare, Dodd-Frank, and proposed EPA greenhouse gas restrictions.  All this is on top of an already monumental regulatory burden imposed by government.  According to a Small Business Administration report (pdf), the cost of regulatory compliance was over $1.75 trillion in 2008 alone.

Goods, people, and information will not flow freely across a nation, regardless of the quality and extent of its infrastructure, if taxes and regulations block their flow.  Trade perished in France as Colbert’s improved roads and canals were made all but useless by high internal tariffs.  Some 700,000 miles of new and rebuilt roads were not enough to move commerce past the regulatory roadblocks that Roosevelt erected.  President Obama’s proposed high-speed trains will not pull the country over the mountain of regulations that has been created in the decades since the Great Depression and that Obama has raised to new heights.  A bridge wrapped in red tape is truly a bridge to nowhere.

There is no question that the tax funding of public-sector unions creates important distinctions from those in the private sector. For one thing, private-sector unions negotiate in the context of limited money; if they demand too much the company cannot compete against rivals and union members could find themselves unemployed. By contrast public-sector unions have no similarly clear limit on available money and government has no competitor. Thus public-sector unions are among the loudest voices for increased taxation and big government to sustain their wages and benefits.

Reducing those wages and benefits has become a popular cause largely because private-sector workers (even within unions) make considerably less than the government employees whom they are heavily taxed to support. In December 2009 the U.S. Bureau of Labor Statistics reported that government employees at the state and local levels earned an average of $39.60 an hour (including benefits), while private workers earned $27.42—over 30 percent less. Moreover, according to the Bureau of Labor Statistics, private workers have a 20 percent chance of losing their jobs in any given year; public workers have a 6 percent chance.

Reducing the power of either form of union is far less popular than reducing public-sector costs for at least two reasons. First, all modern unions benefit from legal privileges such as collective bargaining and the government certification that bestows a virtual bargaining monopoly on specific unions. Second, such prerogatives are widely viewed as workers’ rights to be cherished in the same manner as constitutional rights. That’s why Jesse Jackson compares Wisconsin’s massive pro-union demonstrations to Martin Luther King’s 1965 march in Selma for the voting rights of blacks.

Is it accurate to equate collective bargaining with workers’ rights? Is it accurate to view public- and private-sector unions as distinct rather than fundamentally similar? The answers lie in history.

It is important to define unions precisely. In a free-market context a union is nothing more than a collective agency through which workers protect common interests and secure common advantages through negotiation or other forms of persuasion, such as boycotts or peaceful strikes. Individual workers assign their right to negotiate to the collective agency in much the same manner as they might assign power of attorney; no one is forced to join or to pay dues. Thus the union is a collective expression of the individual right to free association and to contract one’s own labor. Employers remain free to decline negotiation and hire replacement workers.

Many conservatives and libertarians would consider the foregoing definition of unions to be unrealistic. In his article “The Myth of the Voluntary Union,” economist Thomas DiLorenzo argues that those who believe unions can be voluntary fall into “an easy trap . . . detached from any reality and history.” He insists that “violence against competitors has always been an inherent feature of unionism, even apart from the ‘violence’ of State-imposed legislative privileges that unions enjoy” (emphasis added). DiLorenzo refers specifically to the legal power of collective bargaining and to a history of brutal strikes as proof of unionism’s inherent violence. Yet it is not clear that violence is inherent in unions.

Political Evolution

Could unions exist without legal privileges in a society in which employment relationships were not mandated, in which there were no restrictions on self-employment or home industry? Are free-market unions possible?

The current paradigm of a modern union is rooted in the presidency of Franklin Delano Roosevelt. It was created through New Deal legislation, especially the Wagner Act, which established the legal right of workers within an industry or company to unionize if a majority of them voted in favor of doing so. The result has been far from an expression of the free market. For example a modern union receives government certification in order to engage in collective bargaining. In other words, the government authorizes it as the sole representative of a set of workers and legally requires the employer to give the monopoly union a seat at the negotiating table. This monopoly shuts out other groups or dissenters from negotiating their own contracts on their own terms. In many cases individuals can choose not to join a specific union but nevertheless they remain bound by union contracts and are required to pay union “fees.” The modern union thus represents a forced transfer of authority from individual workers to a collective.

Government schools, which are operated by what is arguably America’s strongest union, teach that the New Deal transferred power from business to labor. And without question the modern form of union gained political clout. But the political transfer was far more complex than it is portrayed to be.

Wagner and Big Business

In his essay “Labor Struggle: A Free Market Model,” Kevin A. Carson argues that the Wagner Act was designed to centralize, bureaucratize, and tame the unions to the advantage of big business, which was already no stranger to privilege and subsidy. That is why some of the most vigorous advocates for modern unionism were leaders of industry, such as Gerard Swope, president of General Electric. By specifying who could negotiate terms and how strikes could occur, Wagner removed some of the most powerful tactics from the labor movement. Carson comments, “The primary purpose of Wagner, in making the conventional strike the normal method of settling labor disputes, was to create stability and predictability in the workplace in between strikes, and thereby secure management’s control of production” (emphasis in original).

Certification created labor monopolies that eliminated the need for business to negotiate contracts with multiple groups or individuals within the same company. Business also benefited from the unions’ acting as enforcement agents, policing their own memberships’ compliance with contracts. They prevented wildcat strikes and punished boycotts, work slowdowns, and other labor tactics that had proven both popular and effective in the past.

Leaders of modern unionism were aware of the benefits they offered to big business. In Ethics and American Unionism (1958), Sam Dolgoff wrote of John Lewis, president of the United Mine Workers of America (UMWA) from 1920 to 1960, “In 1937, Lewis assured the employers that ‘a CIO contract is adequate to protect against sit-downs, lie-downs, or any other kind of strike’. . . . [T]he corporations accepted . . . ‘industrial unionism’ because as a matter of policy, the mass-production industries prefer to bargain with a strong international union able to dominate its locals and keep them from disrupting production” (emphasis added).

Wagner and Grassroots Federations

Dolgoff outlined the impact of the Wagner Act on grassroots labor federations such as the UMWA. The National Federation of Mine Laborers had been the parent union of the UMWA, and by its constitution, “the Federation consisted of Lodges (Locals) and districts which vigilantly defended their independence from the domination of the National Office. Their insistence on autonomy and unity through federation (free agreement) was in keeping with the finest libertarian traditions of the American Labor Movement. . . . When Lewis became President in 1919 he did away with the federalist structure of the union, rooted out autonomy and self-determination of locals, centralized and took complete control of the union.” The Wagner Act completed the centralization.

Thus both Carson and Dolgoff argue convincingly that the modern union was an arrangement of shared advantage between big labor, big business, and big government. The relationship between business and unions was not necessarily cordial but it was often convenient.

Among those disadvantaged by the arrangement were smaller employers, the self-employed or non-unionized workers, and the broader grassroots labor movement itself.

Nineteenth-century America was the heyday of the grassroots labor movement. Fueled by a massive influx of immigrant workers and the rapid development of industry, a system of vigorous and varied labor organizations arose to address the specific needs of working people, which went far beyond a decent wage: Labor organizations often functioned as social and cultural support systems as well.

The most prominent nineteenth-century labor federation was the Knights of Labor. Established in 1869, membership reached 28,000 in 1880 and peaked at nearly 700,000 members in 1886. The primary demand of the Knights was an eight-hour day, but it also campaigned on such issues as ending convict and child labor. The Knights emphasized projects designed to empower its membership both economically and socially and to provide security for families. Through local chapters the Knights established worker-owned producer cooperatives; it launched public education campaigns to raise awareness of and sympathy for labor issues; and it organized social support networks to insure against the injury or ill health of members. Indeed many organizations or unions began as “benevolent associations” intended to care for the families of deceased or incapacitated members.

In “Revolutionary Tendencies in American Labor—Part 1,” Dolgoff explained that the labor movement “created a network of corporative institutions of all kinds: schools, summer camps for children and adults, homes for the aged, health and cultural centers, insurance plans, technical education, housing, credit associations, et cetera. All these and many other essential services were provided by the people themselves, long before the government monopolized social services wasting untold billions on a top-heavy bureaucratic parasitical apparatus; long before the labor movement was corrupted by ‘business’ unionism.”

Although the Knights of Labor used pressure tactics such as boycotts and the endorsement of friendly politicians, they did not generally emphasize strikes. Terence V. Powderly, who presided over the Knights during its ascendancy (1879–1893), openly opposed strikes, which he believed caused violence and increased conflict; he favored peaceful negotiation instead. Some local leaders within the Knights disagreed and flexed their autonomy by pursuing local strikes. Indeed, the internal conflict over strikes contributed to the Knights’ decline.

Labor organizations within the nineteenth-century libertarian movement adopted much the same approach as Powderly—namely the use of mutual support, persuasion, and education as tools of labor reform. Perhaps the most prominent of these organizations was the New England Labor Reform League (NELRL), established in Boston in 1869. Its membership boasted individualists Josiah Warren, William B. Greene, and Benjamin Tucker. Ezra Heywood’s The Word served as the NELRL’s publication. The foundational “Declaration of Sentiments” declared the League’s goals to be “Free contracts, free money, free markets, free transit, and free land—by discussion, petition, remonstrance, and the ballot, to establish these articles of faith as a common need, and a common right, we avail ourselves of the advantages of associate effort.”

One example of NELRL activity illustrates the broad manner in which the League defined labor activity. Along with his wife Angela, Heywood founded the Co-Operative Publishing Company from which pamphlets issued, including ones on birth control. The NELRL believed that women workers were victims of the poverty created by unplanned children; thus, birth control fell within the realm of labor reform. “Lady Agents” were sent out to tour the factories and other working-class haunts of New England. Once they had found an audience, the Lady Agents spoke on subjects that merged labor reform with family planning, all the while offering the Co-Operative pamphlets for sale.

With effective networks and diverse strategies, a broad grassroots labor movement grew in power; its threat to entrenched interests also grew. The threat came into glaring focus in 1877 and 1894 with two strikes that involved violence on both sides. The Great Railroad Strike of 1877 began in West Virginia over a cut in wages; lasting 45 days, it was finally put down by federal troops who went from city to city to quash sympathy strikes by industrial workers. The Pullman Strike of 1894 began in Pullman, Illinois, again over a cut in wages. Spreading nationwide, it also attracted wildcat sympathy strikes and ultimately involved about 250,000 workers in 27 states. Eventually President Grover Cleveland sent U.S. marshals and some 12,000 troops to break the strikes.

By the turn of the twentieth century the labor movement—notably, the Industrial Workers of the World (IWW, or Wobblies)—had also become a political threat to the status quo. Organized in 1905, the Wobblies had strong leaders but emphasized rank-and-file organization. Unlike the Knights of Labor, however, the IWW enthusiastically embraced strikes; indeed, it initially opposed the signing of all labor contracts specifically because they blunted the power to strike.

With a large immigrant membership and explicitly socialist principles, the IWW became a potent voice against America’s entry into World War I, which it viewed as a conflict in which the workers of one nation were fighting the workers of another for the profit of capitalists. Thus the IWW became a prime target of the Department of Justice. In September 1917, 48 IWW meeting halls were raided and 165 leaders were arrested under the new Espionage Act. The next year 101 of them went on trial. All were convicted and received prison sentences of up to 20 years. Government repression effectively destroyed the IWW.

Government and big business had learned a lesson: An uncontrolled labor movement was unpredictable, politically dangerous, and bad for commerce. This was particularly true in the early 1930s, when Roosevelt swept into power in the wake of the Great Depression.

In 1929 the stock market collapsed and people panicked, causing runs on banks and massive bank failures. Unemployment rose as high as 25 percent while the personal income of those still employed declined. Large cities were hard hit, especially those dependent on heavy industries. Rural areas were devastated as crop prices tumbled and a severe drought turned farmland into dust. Hundreds of thousands of people were driven from their homes in search of any work whatsoever. Still other people left because of bank foreclosures.

A massive and migrant army of unemployed is a formula for labor revolt. Thus Roosevelt offered a New Deal to American workers; it was a series of interlocking economic programs implemented between 1933 and 1936. Through them the federal government’s regulation of all aspects of commerce increased dramatically; its purpose was to create stability, especially in the area of labor.

This is the context into which the modern union, or big labor, was born—a governmental response to labor upheaval and a big-business desire for regulatory stability. The business elite may not have liked every aspect of New Deal labor policies, but it had long favored Roosevelt’s general approach to labor relations.

The clout of a voluntary union comes from the individual members who assign their rights of contract over to a representative of the collective. In modern unions the opposite happens. Some members may join freely but they cannot later negotiate for themselves if they disagree with the union. Other members may be required to join as a condition of working in a specific industry or at a unionized company. Thus the modern union is the opposite of a grassroots organization; it strips individual workers of the rights of free non-association and of contract. The modern union—whether of the public or private sector—is the antithesis of workers’ rights.

Unfortunately Farmer’s idea is as bad as it is big—and it’s very big. Central to his idea is his notion that investor “confidence” is an economic “fundamental”—along with factors such as tax rates, supplies of magnesium, and the prospect of war in the Middle East. If confidence is too high people try to live beyond their means, causing prices to rise. If confidence is too low people spend too little, causing aggregate demand and employment to fall. Being a fundamental, confidence can be at any level, regardless of the state of other fundamentals. So the economy needs some means of managing confidence lest it get stuck at a level that is economically destructive—and Farmer wants central banks to do this.

More specifically, Farmer believes investor confidence is most powerfully affected by equity prices: The higher equity prices are (as reflected in the price of a stock index) the higher confidence is. So a central bank can manage investor confidence by targeting the price of an all-inclusive index of the shares of the nation’s corporations. The immediate goal of active buying and selling by the central bank would be stabilizing average equity prices. By keeping investor confidence from sinking to dangerous lows or soaring to dangerous highs, the central bank would ensure stability.

Sounds simple, but Farmer accepts too much conventional wisdom about macroeconomic history in general and the Great Depression in particular to trust his analysis and prescription.

For example, he asserts that U.S. “banks were often subject to panics” because they “made illiquid loans [and therefore] typically had much less cash on hand than they needed to meet their liabilities in the form of deposits.” Farmer seems unaware that restrictions on branch banking in the United States prevented banks from adequately diversifying their portfolios, making them more subject to runs. So one historical illustration Farmer offers for why a loss of confidence can spread like a contagious disease is poorly grounded.

Farmer also ignores two other important streams of research that cast doubts on his analysis. The first is Robert Higgs’s work on “regime uncertainty.” Higgs marshals a great deal of evidence that during the 1930s Franklin Roosevelt and his New Dealers scared away private investors by creating economy-wide uncertainty. The length of the Great Depression was indeed the result of a loss of confidence, but it had nothing to do with animal spirits or market imperfections that prevent job seekers from matching up smoothly with employers; it had everything to do with unprecedented enterprise- and investment-killing government intrusions into the economy.

The second line of research I’ll describe broadly as “market-process macroeconomics.” This research includes the Austrian theory of the business cycle and the monetary-disequilibrium theory favored by my former teacher Leland Yeager, as well as what EconLog blogger Arnold Kling calls the “recalculation” theory. Although these three accounts of economy-wide fluctuations differ, they all look beyond conventional aggregates (such as aggregate demand) and focus instead on the incentives and constraints that confront individuals, households, and firms.

Had Farmer absorbed the lessons of this scholarship, he might have been less eager to propose such a radical expansion of central-bank power.

This brief review affords too little space even to list the many problems infecting Farmer’s proposal—a sampling must suffice. Why should the central bank focus on the value of corporate equity rather than, say, on the value of other assets, such as real estate? Also, given widespread daily reporting of stock indexes, such as the Dow Jones Industrials, it’s likely central banks would be pressured by politicians to manipulate such indexes for electoral purposes—even when those purposes run counter to the well-being of the economy.

Most importantly, if government enacts destructive legislation that changes real fundamentals in ways that drastically reduce the value of corporate equities, even a depoliticized central bank is unlikely to allow the target value of its stock index to fall by enough to reflect this unwise change in tax or regulatory policy.

While I hope Farmer’s proposal goes no further than the pages of his book, I nevertheless recommend it to readers seeking a clear overview of the development of mainstream macroeconomic thinking during the past century. In that, Farmer excels. As for policy, he fails—big time.