On the surface the idea behind the RFC sounds good. By 1932 the Great Depression had already been devastating. Banks were failing, railroads were going broke, workers had been laid off by the millions. Why not pump cash into some large struggling companies and keep them serving customers and hiring workers? Jobs would be saved, dollars would flow through the economy, and the Great Depression might be halted.

But there were two big problems. First, the $2 billion the RFC would dole out had to come from taxpayers. And they could have used that money instead to buy radios, shirts, gas, or a host of other products that would have put people to work making and selling these items. In other words, shifting capital from workers who earn it to central planners who spend it may not create or even save jobs.

Second, Hoover’s whole idea of an RFC assumed that a group of wise men could discern the U.S. economy clearly enough to pick the right banks, railroads, and corporations to resuscitate with the right amount of cash. What we find instead is that when an appointed committee like the RFC is matched with large amounts of money, the results quickly become politicized.

Thousands of large U.S. companies wanted capital, but only a fraction of them could get it. Rep. Louis McFadden (R, Pa.), himself a bank president, called the RFC “a scheme for taking $500,000,000 of the people’s money produced by labor at a cost of toil and suffering and giving it to a supercorporation for the sinister purpose of helping a gang of financial looters to cover up their tracks.”

Immediate Politicization

Hoover, a Republican, appointed former Republican Vice President Charles Dawes to head the new RFC. Dawes, however, resigned in June 1932 to care for his bank in Chicago, the Central Republic Bank and Trust Company. Three weeks after his resignation, Dawes won a $90 million loan for his failing bank (it went broke anyway). After that, Atlee Pomerene, the new RFC president, accepted a $12.3 million loan for his Cleveland bank. Joseph Nutt, treasurer of the Republican National Committee, won a $14 million loan for his bank in Cleveland. Republican Senator Phillips Goldsborough of Maryland received a $7.4 million loan for his Baltimore bank. Roy Chapin, Hoover’s secretary of commerce, won $13 million for his Detroit bank.

Some Democrats (Pomerene was a former Democratic senator) also finagled loans from the RFC, but the larger point is that choosing who got loans and who didn’t was a political process that gave capital to the winners and took more in taxes from everyone else. Funding federal programs was expensive. During 1932, for example, the top income earners saw their top tax rate hiked from 25 to 63 percent. Plus Congress that year passed a host of new excise taxes on gas, tires, telephone calls, and movie tickets.

The Other Side’s Turn

When Franklin Roosevelt was elected president, he installed a loyal Democrat, Texas banker Jesse Jones, as the new president of the RFC. Jones helped those Roosevelt sent his way—either through RFC loans or by using his influence with others. J. David Stern, for example, edited the Philadelphia Record, which backed Roosevelt and other Democrats enthusiastically in the election. Stern, however, almost went bankrupt in the 1930s, so Roosevelt asked Jones to help. Jones used his influence in the banking community to secure $1 million in loans to keep Stern publishing.

Some reporters were sensitive to the RFC money and influence offered by Jones. Walter Trohan, the Washington bureau chief for the Chicago Tribune, often interviewed Jones, who according to Trohan would often offer RFC loans and agency-controlled firms to him. “I turned these offers down, because I didn’t know anything about such businesses and because I didn’t think I would be honest in accepting,” Trohan revealed in his book Political Animals.

Others did not have Trohan’s scruples. Hall Roosevelt, the President’s brother-in-law, used White House telephones to request loans from the RFC. According to Jones, “Two or three loans were made in which it appeared Hall Roosevelt had some kind of interest.” At one point the President urged Jones to give Hall the loan he requested because, as Jones wrote in his book, Fifty Billion Dollars, “The president wanted to get Hall as far from the White House as possible.” Jones also helped FDR’s son Elliott escape a $200,000 debt from a failed radio business in Texas.

Defenders of the RFC are quick to cite its many loans and gifts during World War II to big corporations to make weapons and supplies that helped the U.S. government win the war. But even if we assume the right corporations got the right loans and gifts, that still leaves the RFC with no reason to exist after the war. The Great Depression had ended and unemployment had stabilized at under 4 percent in 1946 and 1947, yet the RFC was still aiding corporations.

The Closest Thing to Immortality

True, the RFC had lost its economic purpose, but with all those tax dollars on hand it never lost a political purpose. To repeat what FDR once said about Social Security, the RFC loans “were never a problem of economics. They are politics all the way through.” In other words, congressmen eagerly sought RFC money to bring back to corporations in their districts. President Truman noted that “a great many members of Congress had accepted fees for their influence in getting RFC loans for constituents.”

Not only were congressmen profiting, but RFC staffers were using these loans to get jobs with the lucky companies. John J. Hagerty, for example, head of the RFC in Boston, endorsed a loan to the Waltham Watch Company. Hagerty soon accepted a job with the company for three times his RFC salary.

In 1953 President Eisenhower ended the reign of the RFC, but not completely. Parts of it reemerged as the Small Business Administration—which began making loans to favored small businesses.

What do we learn from the RFC? First, that government programs are easier to start than stop; second, that those programs will cost more than the originators intended; and third, that federal money becomes politicized very quickly, helping politicians to win votes.

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.

What was true for an Englishman was true also for a citizen of the United States. There were unfortunately many in both countries who thought that freedom was not enough. They believed that in addition to liberty, people had also the right to a large measure of protection from the struggles and uncertainties of human existence. In America the crusade for a government large and powerful enough to offer such protection was led by the so-called Progressives. One of them, Walter Lippmann (1889–1974), later observed that the older faith was that human rulers’ limited moral and intellectual capacities could not safely be trusted with unlimited power. The Progressives believed, by contrast, that there were no limitations on man’s ability to rule others and therefore no need to limit the powers of government. They had renounced the wisdom of the ages, he said, in order to embrace errors that the ages had renounced.

That’s what Lippmann believed in 1937, when he was America’s most popular journalist. His “Today and Tomorrow” column was in 155 daily papers and would soon be in 200. At the height of his popularity he would have over 10 million readers, many of whom, it has been said, did not know how they should think about the issues of the day until they had read his comments. A lady in a New Yorker cartoon told a friend, “A cup of coffee and Walter Lippmann are all I need.”

His credentials as a libertarian were less than impeccable. As a student at Harvard he developed a fondness for the British Fabians, who believed they could overcome the prejudices and inefficiencies of popular democracy with a small core of selfless leaders. In 1914 he published Drift and Mastery, in which Frederick W. Taylor’s principles of scientific management were used to draw up a blueprint for the rational arrangement of society. (Editor’s note: See “Taylorism, Progressivism, and Rule by Experts,” by Kevin A. Carson, The Freeman, September 2011.)

Applying this blueprint, he said, would lead to an America in which the role of private entrepreneurs would be taken over by salaried bosses, government commissioners, and labor leaders. His Public Opinion appeared in 1922 and quickly became the subject of college courses, articles in scholarly journals, master’s theses, and even a few dissertations; it was described by John Dewey as “the most effective indictment of democracy as currently conceived ever penned.”

Lippmann spent most of his life, both before 1937 and afterward, writing things of which someone like Dewey would approve. His conversion to free-market principles was brief and fleeting. Still, it was sincere for as long as it lasted. It seems to have begun with his frustration over the blundering statism of Herbert Hoover. News of the stock market crash was still in the headlines when the President began a series of conferences in which he told industrial leaders that they must promise not to reduce wages. His Agricultural Marketing Act gave farmers a half-billion dollars in 1929 and another hundred million early in 1930. In 1931 he offered a nine-point program of government intervention, which broadened the range of those eligible for assistance of this kind.

As things grew worse Hoover justified himself with words remarkably similar to those of another troubled administration 80 years later: “We might have done nothing. That would have been utter ruin.” Instead of allowing things to take their course, he said, his administration had devised American history’s greatest program of economic defense. He blamed the problem on investors, criticized their interest in profit, and was amazed to see stock market prices continuing to fall.

Lippmann’s patience with all of this sagged rapidly and finally snapped when Hoover put his name to the Tariff Act of 1930 (aka the Smoot-Hawley Tariff), which raised the rate on some 20,000 imported goods to record levels. Hoover signed this despite the more than one thousand economists who endorsed a petition urging a veto. He could not, he said, go back on party pledges: “Platform promises must not be empty gestures.” The words were for Lippmann simply Hoover’s confession that his policies, far from being intended for the general good, were actually an appeal to special-interest groups.

Although he would later become what someone has described as “one of the Roosevelt administration’s most important journalistic assets,” he had no initial enthusiasm for Hoover’s replacement. Franklin Roosevelt, he said, was “a pleasant man without any important qualifications for the office, who would very much like to be president.” The New Deal, he observed, was little more than an extension of policies begun under Hoover, and it was in every way as much of an appeal to special interests. The Agricultural Adjustment Act, for example, helped large landowners at the expense of sharecroppers and agricultural laborers. Lippmann later attacked Roosevelt’s plan to pack the Supreme Court and found himself assailed by the left-wing press as a reactionary.

For the first (and only) time in his life he was excluded from the inner circle of “the intellectual elite.” Upset and a little angry, he sat down to apply his wide reading and literary talents to a defense of ideas he had once opposed and a reconsideration of ideas he had once espoused. The result, The Good Society, was for the most part a brilliant examination of the intellectual, logical, and moral impossibilities of economic planning.

Social Planning: The Intellectual Impossibility

The intellectual problems with social planning are illustrated by Colbert’s troubles in managing the economy of Bourbon France. The regulations for the textile industry, to take one case, filled four volumes of 2,200 pages and three supplementary volumes. It was discovered in 1718 that planners had in spite of this neglected to include the number of threads appropriate for use in the cloth of Langogne, “a matter which must be attended to without fail.” The information for attending to it could be obtained only by means of reference to existing procedures, which was available only from established manufacturers, who were thus empowered to use the law for preventing innovative competitors from introducing new methods.

This points to the dark truth behind every “plan” for “improving society.” Governments, Lippmann said, are made up of people who meet to make speeches and write resolutions, of people who study papers, listen to complaints, and shuffle paperwork. These people suffer from indigestion, asthma, boredom, and headaches, and all of them would rather be making love than passing laws. They know whatever they have happened to learn, are aware of what they have happened to observe, and are interested in whatever has happened to catch their imagination. A power-holder may sometimes have high ideals, but he is in the end no more than a human being, “a little man in trousers, slightly jagged,” as William Vaughan Moody put it.

Such a person cannot possibly know enough to devise wide-ranging schemes for society as a whole. No matter what the source of their authority human rulers are human beings, and as such have only a severely limited understanding of the world in which they find themselves. The social planner sits down to a breakfast that is the final link in a chain stretching far beyond his comprehension. Society goes on as it does because of processes that are habitual and unconscious, and it is only because people can take so much for granted that they have the time to attend to anything. Anyone who attempts to plan everything is immediately trapped in a web of details. “The real, rather than the apparent, policy of any state will be determined by the limited competence of finite beings dealing with unlimited and infinite circumstances,” Lippmann wrote.

In his efforts to manage this complexity every ruler must imitate Colbert in calling on the expertise of those whose industry he hopes to regulate. In attempting to plan the production of cloth in eighteenth-century France the government got its advice from existing manufacturers and passed decrees that would protect them from competition. This led to laws against the production of printed calicoes, which then were all the rage. Attempting to regulate health care in early twenty-first-century America, the Obama administration accepted the advice (and contributions) of the American Hospital Association and the Federation of American Hospitals. These represent the interests of large community hospitals, whose dominance is threatened by the emergence of smaller hospitals offering superior service in particular physician groups’ areas of expertise. With its provisions against the creation of any additional doctor-financed hospitals, the Patient Protection and Affordable Care Act might have been better named the Large Hospital and Inferior Service Protection Act.

Earlier in his life Lippmann had endorsed a policy of gradual collectivism. He had never admitted to being a socialist, but he had argued that the government should gradually assume control of the economy, if not through outright ownership, then at least by means of detailed regulations. There should be a survey of all the available resources, and then national authorities should put together a plan for developing them. By the time he wrote The Good Society he had come to realize that such a plan would be flawed from the outset. The planners’ limited information must necessarily put them under the influence of such organized interests. “In practice,” he wrote, “gradual collectivism is not an ordered scheme of social reconstruction. It is the polity of pressure groups.”

Though they demand different things, these pressure groups agree in asserting that their interest is identical to the national interest. Those who believe the national interest is best served by means of cheap steel for the automobile industry, however, and those who believe it is best served by fixed and protected prices for the sake of the steel manufacturers, cannot both be right. Every new regulation, Lippmann said, is a decision in favor of some interest and against others.

Those who believe they have been harmed will react by seeking to protect their interests as well as they can. New laws lead to new violations, and these in turn to more new laws. In early eighteenth-century France lawsuits over methods for the production of cloth were endless. Observing that smuggling and bootlegging had become standard business practices Colbert decided to put the power of the State behind his decrees. An estimated 16,000 people were killed in his war on printed calicoes. A much larger number were punished somewhat less severely, though still with great cruelty. On one occasion 77 were hanged, 58 were broken on the wheel, 631 were sentenced to the galleys, one was set free, and none were pardoned. One assumes the Obama administration’s attempts to regulate health care will be less violent.

Social Planning: The Logical Impossibility

During the twelfth century there were 19 stations at which merchants travelling along the Rhine had to stop and pay a toll. Twenty-five more stations sprang up during the thirteenth century and 20 more during the fourteenth, all backed by the firepower of fortresses built for the purpose. Many of these were in the Duchy of Cleves, where they were referred to as the “treasure.” They were a treasure, though, only to the people involved in collecting the tolls. They added nothing to the peace or prosperity of Europe. They were merely a means for the forcible transfer of wealth. That, Lippmann said, is the real meaning of “economic planning.” The government does not produce anything. All it does is take from one group and give to another.

Even as he wrote, the policy of handing out money to appease the farm lobby, first planted by Hoover, was blossoming under Roosevelt. At the beginning of the twenty-first century’s second decade it has spread even beyond our shores. The Department of Agriculture gives American cotton planters about $3 billion a year. These handouts encourage overproduction, lower world cotton prices, and ruin small farmers in many Third World countries. In 2005 the World Trade Organization upheld a Brazilian challenge to these subsidies, but the United States ignored the ruling. When Brazil was granted the right to impose punitive tariffs and lift patent protections on a wide range of U.S. nonfarm products, Congress responded with a proposal to offer over $147 million a year to Brazilian farmers. Rather than eliminate a ruinous and unjust policy, our representatives wanted to expand the list of those who could make claims on it. In terms of Lippmann’s illustration, they decided that instead of abolishing the toll stations and tearing down the castles, they would “turn every cottage into a castle with a toll station of its own.”

The problem with such policies lies in the fact that the owners of these toll stations are the beneficiaries of a government-backed guarantee that they will receive additional income in exchange for reduced effort. Each is promised that his share of the national wealth will increase even though his contribution to that wealth has declined and perhaps even if he makes no contribution at all. This works for each of the stations for as long as there are only a few of them. Unfortunately they multiply. The granting of special treatment in one case is soon followed by the demand for similar grants to others, as in the case of the Brazilian farmers. There cannot in the end be more for everyone if everyone has been granted the privilege of producing less. Soon everyone, perhaps even the average toll station owner, is poorer than he would otherwise have been.

Social Planning: The Moral Impossibility

Specific economic contradictions may be eliminated by changing specific policies. Deeper and more difficult to eliminate is the effect of such policies on the character of the people. It is evident in the case of the cotton subsidy that it is gigantically helpful to the fewer than 20,000 planters who benefit from it. Nonbeneficiaries see this and come to the conclusion that the government has a magical power to create wealth. They forget about the iron chain that binds prosperity to production. They forget that wealth is the result of thought, effort, innovation, and thrift, and are gradually convinced that the path to abundance lies in the power of the State. They once understood that they could advance themselves only by increasing their service. They now believe that they must do it by imposing their will on those around them.

The greater the extent to which this idea is accepted, the more intense the struggle for power becomes. It goes on and must go on because the members of contending factions have been tempted to ignore the logic of their own beliefs. If power allows them to disregard other people’s preferences, their own preferences may be similarly disregarded by some third faction that has more power than they do. If they think about it, they will begin to see that their own liberty is ultimately dependent on their willingness to allow others similar freedom. In Lippmann’s terms, each man’s right to freedom from arbitrary treatment at the hands of his neighbor has an “inescapable corollary . . . the duty of man not to deal arbitrarily with others.”

Lippmann said he had been brought up to believe there was no such thing as a self-evident truth, but this seems to be one. It is also the most ancient axiom of morality. “What you do not want done to yourself,” Confucius told his followers, “do not do unto others.” Mohammed said, “Not one of you truly believes until you wish for others what you wish for yourself.” A Buddhist text says, “Treat not others in ways that you yourself would find hurtful.” The same truth appears even more tellingly in the Upanishads, in the teaching of Hillel, and of course in the words of Jesus: “Therefore all things whatsoever ye would that men should do for you, do ye even so unto them.”

Adam Smith’s notoriously self-interested butcher and baker understood this. They understood that they would have to close their shops if they did not succeed in delivering something their customers would like. The Golden Rule of morality is the golden rule of economics, and it works because it respects the free choices of everyone involved. Every economic plan that depends on the coercive power of the State, on the other hand, tends toward disaster because it is in the final analysis immoral. “Though it is momentarily triumphant,” Lippmann concluded, “it is a failure, and it must fail, because it rests upon a radically false conception of the economy, of law, of government, and of human nature.”

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.

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.

In his State of the Union address earlier this year, President Obama spoke of the need for the federal government to help boost the economy by making “investments” in a wide variety of areas, including construction jobs, high-speed rail, education, biomedical research, “clean energy” technology, and even high-speed wireless Internet access. But this “investment” is just a code word for more spending on pet programs. This will only lead to more economic stagnation, not economic recovery, because the wealth-consuming nature of public investment is fundamentally different from the wealth-creating nature of private investment. Taxpayers ignore this difference at their peril.

President Obama’s form of investment promises to “create countless new jobs for our people,” but he does not stop to ask from where the money to pay for all these new jobs will come. It must be taken from others “of our people,” either today, through tax increases, or tomorrow, through borrowing (which will harm the economy in the future and delay the ultimate recovery). Of course, taking money from taxpayers to fund these new jobs means there is less money left in the private sector to invest in new jobs and business growth.

The crucial difference between the public sector and the private sector is that the public sector cannot create wealth; it can only shift resources from one group of people to another (after skimming some off the top to placate special-interest campaign donors and support bureaucratic inefficiency, of course). In the private sector, job growth—and economic growth generally—occurs when firms create something that consumers value. In the public sector, government growth occurs whenever government can appropriate more money from the people, and these funds are directed to whatever politicians desire.

The government’s “investment” in green energy startup Solyndra Inc. is a case in point. Last May, President Obama visited the Fremont, California-based solar panel maker in a highly publicized photo-op to hail it as the kind of business in which he thinks the country should invest. And that’s just what the government did. In September 2009 the administration announced that it was awarding Solyndra $535 million in taxpayer-funded loans to finance the construction of a new solar-equipment factory. The following June, just one month after the President’s visit, the company cancelled its initial public offering, and its CEO quit the following month. In November 2010 the company announced it was abandoning its plans to expand its Fremont facility (and the planned hiring of a thousand workers) and would even have to close another factory in the East Bay, eliminating nearly 200 additional workers. That’s some investment.

Throwing Good Money after Bad

This episode did not prevent Obama from visiting another green-energy company two days after delivering his State of the Union address to tout the benefits that surely would come from investing in such technology. During his trip to renewable-energy firm Orion Energy Systems in Manitowoc, Wisconsin, Obama lamented that the United States was falling behind the investment of even more centrally planned economies: “China’s making these investments and they have already captured a big chunk of the solar market, partly because we fell down on the job. We weren’t moving as fast as we should have. Those are jobs that could be created right here that are getting shipped overseas.” While China has made great strides toward a more open economy in the past couple decades, the communist country is hardly a model for economic policy. China’s growth is due to its economic liberalization, not the arbitrary decisions of the ruling elite, yet these command-and-control elements of economic planning that remain in China seem to be Obama’s model of the ideal. This does not bode well for economic liberty and growth here in the United States.

Government has never been particularly good at picking economic winners. Consider, for example, the government “investments” in Amtrak, which has never turned a profit since it began service in 1971 and has lost about $35 billion in its 40 years of operation—or the U.S. Postal Service, which lost a record $8.5 billion last year alone and has projected an additional $6.4 billion loss this year.

The reason for this failure of government investment is not simply poor leadership (although this is certainly endemic and does not help matters) but rather an inability to determine value in the public sector. There is no market price system in government, so there is no measure of profit and loss. As Mises noted in Human Action, “There is no such thing as prices outside the market. Prices cannot be constructed synthetically, as it were.” In Bureaucracy he added, “Bureaucratic management is management of affairs which cannot be checked by economic calculation.”

Value

In a free market prices are determined by supply and demand, by changing consumer preferences, differing knowledge and evaluations of market information, and the risk-taking of entrepreneurs. A greater desire for a good or service will be reflected in consumers’ willingness to pay more for it and bid up the price.

In the political sphere “value”—such as how much to spend on a particular government program—is determined by the force and influence politicians, bureaucrats, and special interests can exert to extract money from taxpayers and divide it up as these elites please. There is rarely even any semblance of competition for the provision of these services and thus little incentive to maximize productivity and service quality or minimize costs. Since there are no price signals to reveal people’s preferences for one thing or another, there is no good mechanism to determine if programs are useful or satisfying constituent demands.

In the absence of a true market price mechanism, how do you tell if an investment is profitable? And where is the incentive to avoid unprofitable investments? If a government program is deemed successful, there are calls to provide more funding. If it is a failure, we are told we must double down on the spending in order to turn it into a successful program.

Private investment means putting your own money at risk in anticipation of realizing a gain later; public “investment” means taking and spending someone else’s money to support your idea of how you think they should live, or to satisfy the special interests that help get you reelected. Private investment requires putting off spending today so that you may (hopefully) earn more in the future; public “investment” is all about spending today.

Unfortunately, the federal government has not learned the lessons history has tried to teach us about subsidizing business and illusory job growth. This ignorance is especially on display when politicians react to the onset of a recession. The prescription made famous by economist John Maynard Keynes is to “stimulate” the economy through government spending and job creation (otherwise known as “make-work”). Never mind that this means fighting a problem of too much debt by incurring even more debt. As Freeman columnist Robert Higgs, senior fellow in political economy at the Independent Institute and author of Crisis and Leviathan, has said, “Every drunk understands this way of fighting depressions.”

Lost Decade

In the 1990s—and beyond, as it turned out—Japan faced a financial crisis as asset bubbles in the real estate and stock markets, stoked by the central bank’s expansionist monetary policy of the late 1980s, burst and prices came crashing down. The ensuing government response and policy errors paralyzed the economy and ultimately led to a series of economic recessions. Japan followed the Keynesian remedy—with disastrous results—and the country still has not recovered to this day. During the 1990s, Japan passed ten fiscal stimulus packages, focused largely on public works. When one construction plan did not work (meaning it did not return the economy to rapid growth), another was tried. Altogether the Japanese government spent about $6.3 trillion on construction-related projects between 1991 and 2008. Those plans did not revive the economy, but they did saddle the nation with a mountain of debt that postponed any recovery at all for many years, leading the period to be dubbed Japan’s “Lost Decade.”

The construction jobs for the government’s infrastructure projects were not sustainable and did not lead to systemic economic growth. Public debt skyrocketed, unemployment actually doubled, and the economy remained stagnant. (Does any of this sound familiar?) As Gavan McCormack, Pacific and Asian history professor at the Australian National University, noted in his book The Emptiness of Japanese Affluence, “The construction state is in some respects akin to the military-industrial complex in Cold War America (or the Soviet Union), sucking in the country’s wealth, consuming it inefficiently, growing like a cancer and bequeathing both fiscal crisis and environmental devastation.”

The Great Depression

Even during the Great Depression, often held up as a great example of government creating jobs to help get the nation out of an economic recession, President Roosevelt’s massive spending program, which actually had its roots in the Hoover administration, did not stimulate the economy. Despite all that spending and all those jobs programs, unemployment remained extremely high. Prior to the stock market crash in 1929, the unemployment rate stood at a little over 3 percent. By 1933, in the midst of massive spending and public-works projects, it had risen to 25 percent. Even after years of New Deal programs unemployment remained around 15 percent or higher through 1940. It was not until World War II that unemployment dropped back to the low single digits (and then only because millions were drafted into military service).

This led Henry Morgenthau, treasury secretary under Roosevelt, to make a startling admission in 1939:

We have tried spending money. We are spending more than we have ever spent before and it does not work. And I have just one interest, and if I am wrong . . . somebody else can have my job. I want to see this country prosperous. I want to see people get a job. I want to see people get enough to eat. We have never made good on our promises. . . . I say after eight years of this administration we have just as much unemployment as when we started. . . . And an enormous debt to boot! (Morgenthau Diary, Roosevelt Presidential Library)

The fact is that economic recessions—and even more serious depressions—need not be so severe or so long-lived. It is government policies that prevent the natural pressures and incentives of the market from purging bad investments and other economic decisions and returning to a path of stable growth. As Murray Rothbard wrote in the introduction to the third edition of his book, America’s Great Depression,

Before the massive government interventions of the 1930s, all recessions were short-lived. The severe depression of 1921 was over so rapidly, for example, that Secretary of Commerce [Herbert] Hoover, despite his interventionist inclinations, was not able to convince President Harding to intervene rapidly enough; by the time Harding was persuaded to intervene, the depression was already over, and prosperity had arrived. When the stock market crash arrived in October, 1929, Herbert Hoover, now the president, intervened so rapidly and so massively that the market-adjustment process was paralyzed, and the Hoover-Roosevelt New Deal policies managed to bring about a permanent and massive depression, from which we were only rescued by the advent of World War II. Laissez-faire—a strict policy of non-intervention by the government—is the only course that can assure a rapid recovery in any depression crisis.

After more than two and a half years and trillions of dollars worth of bank and auto industry bailouts, stimulus packages, and Federal Reserve interventions, the American economy remains sluggish and unemployment is still about 9 percent. According to Federal Reserve Chairman Ben Bernanke, it could take another four or five years for the labor market to “normalize fully.” Unless the government’s interventionist policies are abandoned and reversed, it appears that the United States is headed for its own Lost Decade.

The United States’ $14 trillion federal debt and annual deficits of over $1 trillion are reducing productivity and hindering economic growth. It is time we learned the repeated lessons of the past that government spending, particularly when used to try to stimulate an economy, is simply a bad investment.

Once I happened to criticize high tax rates to a friend, a “liberal” with decidedly egalitarian beliefs. His reply was that he didn’t mind high taxes because, he said, “The public receives needed government services in return.” That is the sentiment politicians and interest group leaders know how to exploit. All they have to do is to cloak their programs in rhetoric about “the public good” and most opposition to their schemes will evaporate.

In his latest book Manhattan Institute scholar Steven Malanga explores the venal game of separating people from their money through conspiracies between politicians and special-interest groups. Taxpayers are systematically robbed by those conspiracies—Malanga uses precisely the right word—to fund a plethora of high-cost, low-benefit (sometimes no-benefit) government boondoggles like public education, urban renewal, safety from terrorists, mass transit, and alternative energy. Naturally the people and organizations that receive the cash invest some of it in propaganda (excuse me, “public relations”) and political campaigns to ensure that their money never stops flowing.

This plague is far worse in some states than others. Malanga devotes entire chapters to the fiscal wreckage done to California and New Jersey by public-sector unions. California has a prodigious budget deficit that is sure to increase due to the high salaries and lavish retirement benefits promised to government employees. Prison guards, for example, earn six-figure salaries owing to the political support their union gave to former governor Gray Davis and key legislators.

The union’s endorsement enabled them to posture as “tough on crime” when they really meant to be tough on taxpayers.

Teachers’ unions are virtuoso performers in the shakedown. They tirelessly promote the notion that more spending on education is a panacea that cures poverty, inequality, economic woes, environmental degradation, and so on. Anyone who dissents will be pilloried as “anti-education” in heavily funded attack ads. In New Jersey the government until recently was essentially a vassal of the New Jersey Education Association, squeezing more and more out of taxpayers. That rising tax burdens have long-term adverse economic effects apparently never occurs to the union leaders.

Or perhaps they simply don’t care. In any event New Jersey underscores just how steep a price we pay for having turned education, which should be a matter of choice and contract, into a coercive near-monopoly by government.

The most expensive shakedown ever has been our housing debacle, to which Malanga devotes an illuminating chapter. He begins with the forgotten history of governmental meddling in the housing market, which goes back to that early advocate of government economic intervention, Herbert Hoover. As Warren Harding’s secretary of commerce in 1922 Hoover launched the Own Your Own Home campaign, the beginning of a long series of futile, costly federal programs to encourage Americans to buy rather than rent their housing. Just as with education, housing is none of the government’s business, but the notion that rising ownership percentages show progress has become an article of faith with many politicians. From Hoover through Barack Obama, taxpayers have had to pick up the costs of mortgage defaults—mortgages that would never have been written but for the idiotic political mania. The huge tab for the lending binge by the two government mortgage giants, Fannie Mae and Freddie Mac, falls not on the politicians and advocacy groups that inflated the housing bubble, but on the suffering taxpayers.

What makes these and many other shakedowns possible (and arguably inevitable) is what Malanga calls “the culture of entitlement.” Rapidly eroding are the old virtues of thrift and self-reliance. They have been replaced by feelings that everyone is entitled to whatever he wants and the purpose of government is to ensure that it is provided. Thus there is nothing morally wrong in pushing the government to give you whatever you want. If others aren’t happy, they can play the political game, too. As long as the process of expropriation takes place under the cover of “democracy,” no one can complain.

Well, people should complain, and Shakedown will undoubtedly provide the fuel for the building rebellion against the conspiracy Malanga has ably exposed.

Since the last few months of 2008, the Great Depression has been thrust back into the national debate about economic policy. The deepest recession in more than six decades, including a credit meltdown and steep decline in production, has generated serious speculation about “another Great Depression.” If so, what is needed to avoid it? And who or what was to blame for this mess?

Let’s begin with questions about the causes of the Great Depression and how it eventually ended. The conventional idea is that unbridled capitalism in the 1920s crashed to earth, laissez-faire advocate Herbert Hoover failed to take needed action, and then Franklin Roosevelt and his New Deal rescued the nation. For many years that has been the accepted story.

Robert P. Murphy’s The Politically Incorrect Guide to the Great Depression and the New Deal joins a growing list of books based on sound economics and history that, in recent years, have questioned the accepted narrative. Murphy’s book—a quick, easy read—provides a valuable counter to wrongheaded conventional wisdom, while offering some points for debate among free-market economists.

As for the causes of the Great Depression, Murphy makes clear that it was not capitalism run amok but rather bad public policy. The debate within free-market circles is which policies were most responsible. Murphy favors the idea that it was monetary policy being far too easy in the 1920s, thus creating a bubble that inevitably had to burst. That puts him in the seemingly awkward spot of arguing that the 1920s were about both real prosperity (helped along by substantial tax relief during the Coolidge administration) and false prosperity. It also leads Murphy to declare that given “the unsustainable boom when Herbert Hoover took office, . . . a bust and the ensuing small ‘d’ depression were unavoidable, no matter what Hoover did in office.” That’s a debatable point within the free-market community.

Murphy notes that many free-market advocates have other ideas on the Great Depression’s causes. Unfortunately, he fails to give a full hearing to those who point to other poor policy choices, namely, the Smoot-Hawley Tariff, which acted as the trigger, followed by grossly misguided tax, regulatory, and spending policies.

Once beyond the debate over what sparked the Depression, Murphy does excellent work debunking many myths about the era. For example, he makes clear that Hoover was not a free-market stalwart but instead a big-government Republican. He criticizes Hoover’s labor and wage, trade, immigration, spending, and tax policies, which all worked to deepen the Depression. Murphy highlights Hoover’s farm-support programs, public-works spending, and Reconstruction Finance Corporation as examples of “Hoover’s New Deal Lite.”

Murphy also does yeoman’s work in explaining the many ills of Franklin Roosevelt’s policies, showing how they made things far worse, particularly highlighting two important points that often have gone unnoticed.

First, Murphy observes the dearth of private-sector investment during the Depression, and ties that to the uncertainty created and costs imposed by FDR. Second, he notes that most previous recessions or depressions in “U.S. history were over within two years, and all of them within five.” So the question is, “Why did the Depression last so long?” If one honestly looks at the history and the economic and policy facts, the clear answer is that Hoover-nomics and FDR’s New Deal created the longest and deepest economic downturn in U.S. history.

That brings us to the present. Murphy argues in his closing chapter that President Bush was Hoover-like in his big-spending ways and his complete abandonment of free-market principles when confronted by the credit mess at the end of his administration. And like FDR, President Obama has offered an unprecedented agenda of government expansion.

Murphy wonders if Obama’s New Deal “will finally sink the American economy.” At best the Obamanomics agenda of higher taxes, increased regulation, and a vast expansion in government spending seems destined to result in lackluster economic performance.

As Murphy notes about the New Deal and the wartime economy, “True prosperity did not return until demobilization, when the federal government relinquished its stranglehold on the American economy and once again allowed private investors and entrepreneurs to direct resources.” Currently, there is no sign that anyone in the White House understands the economics of FDR’s or Obama’s New Deal. So the stranglehold tightens.

Causation. The main causes of both crises lie in actions of the federal government. In the case of the Great Depression, the Federal Reserve, after keeping interest rates artificially low in the 1920s, raised interest rates in 1929 to halt the resulting boom. That helped choke off investment. Also, President Hoover signed into law the sky-high Smoot-Hawley Tariff, which stifled trade and damaged American exports throughout the 1930s. Finally, the President signed a large tax increase into law in 1932, which halted entrepreneurship.

The seeds of the Great Recession were planted when the government in the 1990s began pushing homeownership, even for uncreditworthy people, with a vengeance. Mortgage-backed securities built on dubious mortgage loans became “toxic” when the housing market took a downturn, and many American banks verged on collapse. The government’s urgent desire to bail out various banks and corporations created uncertainty and instability, and this may have widened the recession.

Massive federal spending. Presidents Roosevelt and Obama responded similarly to the crises. They talked about balancing the federal budget, but instead resorted to massive spending. Earlier presidents, like Cleveland and Harding, cut spending when the nation was threatened with economic hardship. Hoover was the transition president, running deficits with record spending on public works, the first federal welfare program, and the first large-scale federal farm program. The results were budget deficits and 25 percent unemployment.

President Roosevelt became Hoover on steroids. FDR and his advisers, despite some early moves to cut spending and control the deficit that Hoover left behind, decided that ever-larger federal spending would trigger economic expansion and pull the country out of its economic slump. Thus Roosevelt began the Agricultural Adjustment Act (AAA), which paid farmers not to produce, and then expanded Hoover’s Reconstruction Finance Corporation, which provided bailout money to large banks and corporations. He also expanded spending on public works and targeted large subsidies to various special interests.

President Obama, who often cites FDR, followed his example of targeting spending to interest groups. He signed into law a $787 billion stimulus package that sent tax dollars to various cities and voting groups across the nation. He later supported an expensive “jobs bill” that would send money into key congressional districts. The President also campaigned for a cap-and-trade bill and universal health coverage, both of which promised to increase the federal debt substantially. In fact, the increase in federal debt under Obama and Roosevelt is similar. The national debt more than doubled in Roosevelt’s first two terms, and it is projected to double again in eight to ten years.

Spending fails. After the large increases in federal spending under Roosevelt and Obama, unemployment remained high. In the 1930s unemployment fluctuated, but recovery never occurred. In April 1939, toward the end of Roosevelt’s second term, unemployment was almost 21 percent. Treasury Secretary Henry Morgenthau complained, “We are spending more than we have ever spent before and it does not work.” Nonetheless, almost all of FDR’s programs continued—usually with annual budget increases.

When Obama took office unemployment was at 8 percent, and in the next year it steadily increased to over 10 percent before falling back just under that mark. He and his advisers were puzzled that large spending increases did not slash unemployment, and he argued that his spending was saving jobs that would otherwise have been lost.

Critics of Roosevelt and Obama insisted that it was impossible to spend our way out of a recession. During the New Deal, economics writer Henry Hazlitt observed that public-works spending destroyed as many jobs as it created. “Every dollar of government spending must be raised through a dollar of taxation,” Hazlitt emphasized. If the Works Progress Administration builds a $10 million bridge, for example, “the bridge has to be paid for out of taxes. . . . Therefore for every public job created by the bridge project a private job has been destroyed somewhere else.”

Tax rates raised. During the Great Depression Roosevelt raised both income and excise taxes. In 1935, with FDR’s push, the top marginal tax rate hit 79 percent. Few paid that rate, but thousands of Americans were in the 50-percent bracket. Entrepreneurs had to hand over more than half of any income above a certain level. Facing disincentives to make capital investments, many entrepreneurs used their wealth cautiously—investing in tax-exempt bonds, art collections, and foreign banks. Little wealth went into creating jobs, so high unemployment persisted. During World War II FDR raised taxes further, to 94 percent on all income over $200,000.

Most of the tax hikes under Obama are planned for the future. Thus far we have seen proposed tax hikes on products such as cigarettes, liquor, plane tickets, and soft drinks. He wants the tax cuts enacted under President Bush to expire. That will mean a spike in the capital gains tax, the income tax, and the estate tax. As FDR showed, tax hikes eventually follow large spending increases.

Scapegoats. The sequence of massive federal spending followed by a lack of recovery plus tax hikes is poison for a politician. Therefore Roosevelt sought scapegoats to explain his failure. Wall Street bankers were his favorites. He called them “economic royalists” and blamed them for causing the Great Depression. He also blamed America’s top businessmen for instigating a “capital strike”—they were refusing to invest in order to make him look bad. FDR then launched IRS investigations of key Republicans and used the newspapers to encourage hostility toward these targets.

Obama has followed FDR’s playbook of attacking Wall Street bankers and various corporate leaders. He condemns the raises these bankers sometimes receive and the profits earned by some large oil companies and health insurance companies.

Such emphasis on “class warfare” may be an inevitable part of redistributing wealth from one group to another. Perhaps Roosevelt and Obama believed that by increasing envy and resentment toward some Americans, they could capture the votes of larger groups of Americans and thereby win reelection (in FDR’s case there is evidence of this). True, this strategy guarantees that many wealthy Americans will attack any president who uses class warfare, but the campaign for redistribution will always supply large amounts of money to subsidize favored groups.

When Roosevelt was reelected in 1936 Senator Carter Glass, Virginia Democrat, admitted, “The 1936 elections would have been much closer had my party not had a 4 billion 800 million dollar relief bill as campaign fodder.”

Obama may be hoping his “stimulus” package and his health insurance bill will generate similarly large support among Americans receiving federal benefits and that these voters will go to the polls to overwhelm those who are paying the bills.

Another example is a 2004 article by two UCLA economists—Harold L. Cole and Lee E. Ohanian—in the important mainstream Journal of Political Economy. They observed that Franklin Roosevelt extended the Great Depression by seven long years. “The economy was poised for a beautiful recovery,” the authors show, “but that recovery was stalled by these misguided policies.”

In a commentary on Cole and Ohanian’s research, Loyola University economist Thomas DiLorenzo pointed out that six years after FDR took office, unemployment was almost six times the pre-Depression level. Per capita GDP, personal consumption expenditures, and net private investment were all lower in 1939 than they were in 1929.

“The fact that it has taken ‘mainstream’ neoclassical economists so long to recognize [that FDR’s policies exacerbated the disaster],” notes DiLorenzo, “is truly astounding,” but still “better late than never.”

Part of the Great FDR Myth is the notion that he won the presidency in 1932 with a mandate for central planning. My own essay on this period (“Great Myths of the Great Depression”) argued otherwise, based on the very platform and promises on which FDR ran. But until a few months ago I was unaware of a long-forgotten book that makes the case as well as any.

Hell Bent for Election was written by James P. Warburg, a banker who witnessed the 1932 election and the first two years of Roosevelt’s first term from the inside. Warburg, the son of prominent financier and Federal Reserve cofounder Paul Warburg, was no less than a high-level financial adviser to FDR himself.  Disillusioned with the President, he left the administration in 1934 and wrote his book a year later.

Warburg voted for the man who said this on March 2, 1930, as governor of New York:

The doctrine of regulation and legislation by “master minds,” in whose judgment and will all the people may gladly and quietly acquiesce, has been too glaringly apparent at Washington during these last ten years. Were it possible to find “master minds” so unselfish, so willing to decide unhesitatingly against their own personal interests or private prejudices, men almost godlike in their ability to hold the scales of justice with an even hand, such a government might be to the interests of the country; but there are none such on our political horizon, and we cannot expect a complete reversal of all the teachings of history.

What Warburg and the country actually elected in 1932 was a man whose subsequent performance looks little like the platform and promises on which he ran and a lot like those of that year’s Socialist Party candidate, Norman Thomas.

Who campaigned for a “drastic” reduction of 25 percent in federal spending, a balanced federal budget, a rollback of government intrusion into agriculture, and restoration of a sound gold currency? Roosevelt did. Who called the administration of incumbent Herbert Hoover “the greatest spending administration in peace time in all our history” and assailed it for raising taxes and tariffs? Roosevelt did. FDR’s running mate, John Nance Garner, even declared that Hoover “was leading the country down the road to socialism.”

Copying Hoover and the Socialists

It was socialist Norman Thomas, not Franklin Roosevelt, who proposed massive increases in federal spending and deficits and sweeping interventions into the private economy—and he barely mustered 2 percent of the vote. When the dust settled, Warburg shows, we got what Thomas promised, more of what Hoover had been lambasted for, and almost nothing that FDR himself had pledged. FDR employed more “master minds” to plan the economy than perhaps all previous presidents combined.

After detailing the promises and the duplicity, Warburg offered this assessment of the man who betrayed him and the country:

Much as I dislike to say so, it is my honest conviction that Mr. Roosevelt has utterly lost his sense of proportion. He sees himself as the one man who can save the country, as the one man who can “save capitalism from itself,” as the one man who knows what is good for us and what is not. He sees himself as indispensable. And when a man thinks of himself as being indispensable . . . that man is headed for trouble.

Was FDR an economic wizard? Warburg reveals nothing of the sort, observing that FDR was “undeniably and shockingly superficial about anything that relates to finance.” He was driven not by logic, facts, or humility but by “his emotional desires, predilections, and prejudices.”

“Mr. Roosevelt,” wrote Warburg, “gives me the impression that he can really believe what he wants to believe, really think what he wants to think, and really remember what he wants to remember, to a greater extent than anyone I have ever known.” Less charitable observers might diagnose the problem as “delusions of grandeur.”

“I believe that Mr. Roosevelt is so charmed with the fun of brandishing the band leader’s baton at the head of the parade, so pleased with the picture he sees of himself, that he is no longer capable of recognizing that the human power to lead is limited, that the ‘new ideas’ of leadership dished up to him by his bright young men in the Brain Trust are nothing but old ideas that have been tried before, and that one cannot uphold the social order defined in the Constitution and at the same time undermine it,” Warburg lamented.

So if Warburg was right (and I believe he was), Franklin Delano Roosevelt misled the country with his promises in 1932 and put personal ambition and power lust in charge—not a very uncommon thing as politicians go. In any event, the country got a nice little bait-and-switch deal, and the economy languished as a result.

In the world of economics and free exchange, the rule is that you get what you pay for. The 1932 election is perhaps the best example of the rule that prevails all too often in the political world: You get what you voted against.