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Wednesday, March 4, 2009
Commentary
New Deal replay will fail like original
Gary Wolfram
In 1927, an economist predicted: "Whoever does not deliberately close his eyes to the facts must recognize everywhere the signs of an approaching catastrophe in the world economy."
Ludwig von Mises foresaw the Great Depression not because of particular economic policies, but because he observed a movement away from the belief in market capitalism and limited government toward interventionism and expanded government. This was reflected in the progressive movement and found its great flowering in the Franklin Roosevelt administration.
Today, Americans have a similar trend, a belief that markets result in instability and big government is the solution to the country's problems. These include a sustained expansion of credit by the Federal Reserve and the decision to use government-sponsored entities, including the Roosevelt-created Fannie Mae, to buy subprime mortgages to expand home ownership beyond what could be sustained in the market. This is similar to the decisions of Herbert Hoover and Roosevelt to expand the role of government. And President Barack Obama's policies seem to be following in Roosevelt's footsteps.
The policies of the Roosevelt administration ended up prolonging the Depression, as Hillsdale College colleague Burton Folsom points out in his recent book, "New Deal or Raw Deal?" Roosevelt deployed a vast array of government programs, including the:
• Works Progress Administration, the bureaucratic program that built infrastructure in areas that were politically crucial for Roosevelt's re-election.
• Agricultural Adjustment Act, which inserted government deep into the agriculture sector of the American economy.
• National Recovery Act, which thrust government into wage-and-pricing decisions of the private sector.
The result: Unemployment that year was 17.2 percent. Roosevelt's Treasury secretary admitted that despite all the government spending and taxing, little had been accomplished. The reason for this is simple: Government spending had to be funded by taxing and borrowing, both of which discouraged private-sector activities that would have been more efficient and less political.
Obama is pursuing an updated version of Roosevelt's policy. His stimulus package and budget bills spend billions of dollars on roads, school buildings and the electric grid. His programs spend billions to establish medical protocols to allow further government intervention into the health industry.
The federal government is mimicking the National Recovery Act by taking major positions in the financial and auto industries, using them to inject more political considerations into how banks lend and what kinds of cars Americans should drive.
Roosevelt was fully committed to taxing "the rich" to support his expansion of government. In 1929, the top marginal tax rate was 24 percent. By 1935, Roosevelt had pushed it up to 75 percent and was proposing a 100 percent tax rate on top incomes. This, of course, dampened the economy and discouraged entrepreneurs and small business from risking their money to innovate.
While Obama's tax policy does not approach the level of FDR's, the president is committed to raising taxes on the wealthy. He supports the expiration of the Bush tax cuts, which would have the effect of substantial increases in the capital gains, dividend and estate taxes. He also plans to increase the top marginal rate from 35 percent to more than 39 percent. And his effort to reduce tax deductions for high earners would push the effective top marginal rate above 40 percent. The effect will be to reduce innovation and forestall new investment in the economy.
Pursuing such large government interventions in private decisions creates uncertainty among private investors about their income and projects and contributes to the economic malaise. Economic historian Herman Kroos argues that business leaders in Roosevelt's time were genuinely concerned that America was heading for socialism.
The Obama administration, following up on the Bush administration, has created a great deal of uncertainty about investment. Banks may be nationalized, mortgages may be subject to bankruptcy proceedings, federal borrowing will be far greater than any historical precedent, taxes will be rising, and massive spending programs are voted on within days of introduction.
One thing is certain: The economy will begin to recover when we re-establish rule of law and recognize that government intrusion into the economy will only cost us in the long run.
