Another look at the Great Depression and today

Joe Stiglitz has a provocative new article out in Vanity Fair (obviously written for the layperson) — “The Book of Jobs”. In it he takes a new look at the Great Depression and its parallel to the economic transformation we are going through today:

At the beginning of the Depression, more than a fifth of all Americans worked on farms. Between 1929 and 1932, these people saw their incomes cut by somewhere between one-third and two-thirds, compounding problems that farmers had faced for years. Agriculture had been a victim of its own success. In 1900, it took a large portion of the U.S. population to produce enough food for the country as a whole. Then came a revolution in agriculture that would gain pace throughout the century–better seeds, better fertilizer, better farming practices, along with widespread mechanization. Today, 2 percent of Americans produce more food than we can consume.

What this transition meant, however, is that jobs and livelihoods on the farm were being destroyed. Because of accelerating productivity, output was increasing faster than demand, and prices fell sharply. It was this, more than anything else, that led to rapidly declining incomes. Farmers then (like workers now) borrowed heavily to sustain living standards and production. Because neither the farmers nor their bankers anticipated the steepness of the price declines, a credit crunch quickly ensued. Farmers simply couldn’t pay back what they owed. The financial sector was swept into the vortex of declining farm incomes.

The cities weren’t spared–far from it. As rural incomes fell, farmers had less and less money to buy goods produced in factories. Manufacturers had to lay off workers, which further diminished demand for agricultural produce, driving down prices even more. Before long, this vicious circle affected the entire national economy.

The value of assets (such as homes) often declines when incomes do. Farmers got trapped in their declining sector and in their depressed locales. Diminished income and wealth made migration to the cities more difficult; high urban unemployment made migration less attractive. Throughout the 1930s, in spite of the massive drop in farm income, there was little overall out-migration. Meanwhile, the farmers continued to produce, sometimes working even harder to make up for lower prices. Individually, that made sense; collectively, it didn’t, as any increased output kept forcing prices down.

He compares this to today’s situation of a transformation from manufacturing to services. While the diagnosis of a structural transformation of the US economy is correct, the description of today that he uses is unfortunately incorrect. We are not shifting to services just like we did not shift production out of agriculture. Agriculture became so productive that it needed fewer inputs and production in other areas grew so that the percentage of the total production contributed by food production declines while total food production grew. At a superficial level, it appears that we shifted out of agriculture. A deeper look reveals that we industrialized food production. It was transformed – not simply reduced.

Likewise, we are in the process of transforming the production of goods (including food) by infusing knowledge. Manufacturing is being transformed, not necessarily reduced. And during that transformation, we are seeing the types (but not the scale) of economic displacements and income shifts that Stiglitz describes.

Stiglitz’s argument that the Great Depression was caused by structural changes should hold important lessons for today. Unfortunately, most of the policy prescription that we hear tend to be more of the same. Simply trying to re-inflate previously existing sectors is a non-solution. So, while a robust housing sector is important for a sustainable economy, attempting to return to the go-go years of the past decade is folly. The same can be said of the financial sector. Or the manufacturing sector (thinking back more to the 1960s).

Rather, as Stiglitz notes, “The only way it [recovery] will happen is through a government stimulus designed not to preserve the old economy but to focus instead on creating a new one.” I would note, however, that his solutions don’t give that much guidance. For example, at one point he calls for moving workers out of manufacturing and into services; then he calls for more workers (including technicians) in clear energy industries. His call for more investment in education, basic R&D and infrastructure is fine as far as it goes. As I noted in an earlier posting, government investments in R&D, education and infrastructure should be a no-brainer. They were keys to the post-WWII industrial-era economic growth in the United States.

As currently carried out, these generic investments won’t, I’m afraid, help that much in making the transformation. Done right, these investment can fuel information age growth. But not if they follow the same old path and are not augmented by other policy changes. What we need now is bolder thinking on how the transformation is affecting the economy and what can be done to foster the positive trends and mitigate the negative. However, we seem to be stuck fighting the last battle over and over again.

Read more at The Intangible economy