FDR's Folly: How Roosevelt and His New Deal Prolonged the Great Depression

Book by Powell Jim

The Great Depression has had an immense influence on our thinking, particularly about ways to handle an economic crisis, yet we know surprisingly little about it. Most historians have focused on chronicling Franklin D. Roosevelt’s charismatic personality, his brilliance as a strategist and communicator, the dramatic One Hundred Days, the First New Deal, Second New Deal, the “court-packing” plan, and other political aspects of the story. Comparatively little attention has been paid to the effects of the New Deal.

In recent decades, however, many economists have tried to determine whether New Deal policies contributed to recovery or prolonged the depression. The most troubling issue has been the persistence of high unemployment throughout the New Deal period. From 1934 to 1940, the median annual unemployment rate was 17.2 percent.1 At no point during the 1930s did unemployment go below 14 percent. Even in 1941, amidst the military buildup for World War II, 9.9 percent of American workers were unemployed. Living standards remained depressed until after the war.2

While there was episodic recovery between 1933 and 1937, the 1937 peak was lower than the previous peak (1929), a highly unusual occurrence. Progress has been the norm. In addition, the 1937 peak was followed by a crash. As Nobel laureate Milton Friedman observed, this was “the only occasion in our record when one deep depression followed immediately on the heels of another.”3

Scholarly investigators have raised some provocative questions. For instance, why did New Dealers make it more expensive for employers to hire people? Why did FDR’s Justice Department file some 150 lawsuits threatening big employers? Why did New Deal policies discourage private investment without which private employment was unlikely to revive? Why so many policies to push up the cost of living? Why did New Dealers destroy food while people went hungry? To what extent did New Deal labor laws penalize blacks? Why did New Dealers break up the strongest banks? Why were Americans made more vulnerable to disastrous human error at the Federal Reserve? Why didn’t New Deal securities laws help investors do better? Why didn’t New Deal public works projects bring about a recovery? Why was so much New Deal relief spending channeled away from the poorest people? Why did the Tennessee Valley Authority become a drag on the Tennessee Valley?

Curiously, although the Great Depression was probably the most important economic event in twentieth-century American history, Stanford University’s David M. Kennedy seems to be the only major political historian who has mentioned any of the recent findings. “Whatever it was,” he wrote in his Pulitzer Prize–winning Freedom from Fear (1999), the New Deal “was not a recovery program, or at any rate not an effective one.”4

It’s true the Great Depression was an international phenomenon—depression in Germany, for instance, made increasing numbers of desperate people search for scapegoats and support Adolf Hitler, a lunatic who couldn’t get anywhere politically just a few years earlier when the country was still prosperous. But compared to the United States, as economic historian Lester V. Chandler observed, “in most countries the depression was less deep and prolonged.”5 Regardless whether the depression originated in the United States or Europe, there is considerable evidence that New Deal policies prolonged high unemployment.

FDR didn’t do anything about a major cause of 90 percent of the bank failures, namely, state and federal unit banking laws. These limited banks to a single office, preventing them from diversifying their loan portfolios and their source of funds. Unit banks were highly vulnerable to failure when local business conditions were bad, because all their loans were to local people, many of whom were in default, and all their deposits came from local people who were withdrawing their money. Canada, which permitted nationwide branch banking, didn’t have a single bank failure during the Great Depression.

FDR’s major banking “reform,” the second Glass-Steagall Act, actually weakened the banking system by breaking up the strongest banks to separate commercial banking from investment banking. Universal banks (which served depositors and did securities underwriting) were much stronger than banks pursuing only one of these activities, very few universal banks failed, and securities underwritten by universal banks were less risky. Almost every historian has praised FDR’s other major financial “reform,” establishing the Securities and Exchange Commission to supervise the registration of new securities and the operation of securities markets, but in terms of rate of return, investors were no better off than they were in the 1920s, before the Securities and Exchange Commission came along.

FDR didn’t do much about a contributing factor in the Great Depression, the Smoot-Hawley tariff which throttled trade. Indeed, he raised some tariffs, while Secretary of State Cordell Hull negotiated reciprocal trade agreements which cut tariffs only about 4 percent. FDR approved the dumping of agricultural commodities below cost overseas, which surely aggravated our trading partners.

FDR tripled taxes during the Great Depression, from $1.6 billion in 1933 to $5.3 billion in 1940.6 Federal taxes as a percentage of the gross national product jumped from 3.5 percent in 1933 to 6.9 percent in 1940, and taxes skyrocketed during World War II.7 FDR increased the tax burden with higher personal income taxes, higher corporate income taxes, higher excise taxes, higher estate taxes, and higher gift taxes. He introduced the undistributed profits tax. Ordinary people were hit with higher liquor taxes and Social Security payroll taxes. All these taxes meant there was less capital for businesses to create jobs, and people had less money in their pockets.

In addition, FDR increased the cost and risk of employing people, and so there shouldn’t have been any surprise that the unemployment rate remained stubbornly high. Economists Richard K. Vedder and Lowell E. Gallaway, in their 1997 study Out of Work: Unemployment and Government in Twentieth-Century America, reported: “New Deal policies (and some Hoover-era policies predating the New Deal) systematically used the power of the state to intervene in labor markets in a manner to raise wages and labor costs, prolonging the misery of the Great Depression, and creating a situation where many people were living in rising prosperity at a time when millions of others were suffering severe deprivation. . . . Of the ten years of unemployment rates over 10 percent during the Depression, fully eight were during the Roosevelt administration (counting 1933 as a Roosevelt year).”8 Vedder and Gallaway estimated that by 1940 unemployment was eight points higher than it would have been in the absence of higher payroll costs imposed by New Deal policies.9

Economists Thomas E. Hall and J. David Ferguson reported, “It is difficult to ascertain just how much the New Deal programs had to do with keeping the unemployment rate high, but surely they were important. A combination of fixing farm prices, promoting labor unions, and passing a series of antibusiness tax laws would certainly have had a negative impact on employment. In addition, the uncertainty experienced by the business community as a result of the frequent tax law changes (1932, 1934, 1935, 1936) must have been enormous. Since firms’ investment decisions very much depend on being able to plan, an increase in uncertainty tends to reduce investment expenditures. It should not be a surprise that investment as a proportion of output was at low levels during the mid-1930s.”10

Black people were among the major victims of the New Deal. Large numbers of blacks were unskilled and held entry-level jobs, and when New Deal policies forced wage rates above market levels, hundreds of thousands of these jobs were destroyed. Above-market wage rates encouraged employers to mechanize and in other ways cut total labor costs. Many New Deal policies were framed to benefit northern industries and undermine the position of employers in the South, where so many blacks worked. “New Deal labor policies contributed to a persistent increase in African American unemployment,” reported economist David E. Bernstein.11

When millions of people had little money, New Deal era policies made practically everything more expensive (the National Industrial Recovery Act), specifically maintained above-market retail prices (the Robinson-Patman Act and the Retail Price Maintenance Act) and above-market airline tickets (Civil Aeronautics Act). Moreover, FDR signed into law the Agricultural Adjustment Act, which led to the destruction of millions of acres of crops and millions of farm animals, while many Americans were hungry.

New Deal agricultural policies provided subsidies based on a farmer’s acreage and output, which meant they mainly helped big farmers with the most acreage and output. The New Deal displaced poor sharecroppers and tenant farmers, a large number of whom were black. High farm foreclosure rates persisted during the New Deal, indicating that it did almost nothing for the poorest farmers. Historian Michael A. Bernstein went farther and made a case that New Deal agricultural policies “sacrificed the interests of the marginal and the unrecognized to the welfare of those with greater political and economic power.”12

The flagship of the New Deal was the National Industrial Recovery Act, which authorized cartel codes restricting output and fixing high prices for just about every conceivable business enterprise, much as medieval guild restrictions had restricted output and fixed prices. That FDR approved contraction was astounding, because the American people had suffered through three years of catastrophic contraction. With the National Industrial Recovery Act, it actually became a crime to increase output or cut prices—a forty-nine-year-old immigrant dry cleaner was jailed for charging 35 cents instead of 40 cents to press a pair of pants.

This wasn’t full-scale government control as in the Soviet Union, but it came closer than anybody had thought possible. Although the NIRA was struck down by the Supreme Court in May 1935, the New Deal continued to multiply restrictions on business enterprise. “Perhaps the greatest defect in these limited planning measures,” wrote economic historian Ellis W. Hawley, “was their tendency toward restriction, their failure to provide any incentive for expansion when an expanding economy was the crying need of the time.”13

While FDR authorized the spending of billions for relief and public works projects, a disproportionate amount of this money went not to the poorest states such as the South, but to western states where people were better off, apparently because these were “swing” states which could yield FDR more votes in the next election. The South was already solidly Democratic, so there wasn’t much to be gained by buying votes there. It was observed at the time that relief and public works spending seemed to increase during election years. Politicking with relief and public works money got to be so bad that Congress passed the Hatch Act (1939).

The New Deal approached its climax in 1938 as Thurman Arnold, head of the Justice Department’s Antitrust Division, began to file about 150 lawsuits against companies employing millions of people. Hawley called this “the most intensive antitrust campaign in American history.”14 Whatever the merits of the government’s claims, these lawsuits made it politically more risky for businesses to pursue long-term investments, and private investment remained at an historically low level throughout the New Deal—prolonging the Great Depression.

All the highly publicized relief programs and public works projects couldn’t make up for the damage inflicted by New Deal taxes, restrictions, antitrust lawsuits, and the rest. Indeed, the more money the government spent on relief and public works, the more tax revenue it needed, and the more damage done to the economy.

As a cure for the Great Depression, government spending didn’t work. In 1933, federal government outlays were $4.5 billion; by 1940 they were $9.4 billion, so FDR more than doubled federal spending, and still unemployment remained stubbornly high. Changes in federal budget deficits didn’t correspond with changes in gross domestic product, and in any case the federal budget deficit at its peak (1936) was only 4.4 percent of the gross domestic product, much too small for a likely cure.15

The most that could be said in FDR’s defense was this, by Donald R. Richberg, former head of the National Recovery Administration: “Although the tremendous expenditures and supports for agriculture and industrial labor that were projected in the Roosevelt administration did not end a huge unemployment problem, they did raise new hopes and inspire new activities among the American people which turned them away for a time at least from even more radical political programs.”16

FDR had assumed unprecedented arbitrary power supposedly needed to get America out of the Great Depression. Although Democrats controlled Congress, FDR was impatient with American democracy, and he issued an extraordinary number of executive orders—3,728 altogether17—which is more than all the executive orders issued by his successors Harry Truman, Dwight D. Eisenhower, John F. Kennedy, Lyndon B. Johnson, Richard M. Nixon, Gerald R. Ford, Jimmy Carter, Ronald Reagan, George H. W. Bush, and Bill Clinton combined. In the name of fairness, FDR saw to it that some individuals were treated much more harshly than others under the federal tax code. NRA codes denied individuals the fundamental liberty to enter the business of their choosing. Compulsory unionism denied individuals the right to work without joining a union. Americans gave up these liberties and more without getting out of the Great Depression, as had been promised. Principal legacies of the New Deal have been a massive expansion of government power and loss of liberty.

FDR’s failure to end chronic high unemployment and his increasingly arbitrary tactics were reasons why, after 1936, his political support declined. Republicans gained seats in Congress during the 1938 elections, and they gained more seats in 1940. FDR’s own vote totals declined after 1936, and Republican presidential vote totals increased over both those of 1936 and 1932.

FDR didn’t make the recovery of private, productive employment his top priority. Along with advisers like Louis Brandeis, Felix Frankfurter, Rexford Tugwell, and Thomas Corcoran, FDR viewed business as the cause of the Great Depression, and he did everything he could to restrict business. His goal was “reform,” not recovery. Accordingly, the New Deal taxed money away from the private sector, and government officials, not private individuals, made the spending decisions. New Deal laws determined what kind of people businesses must hire, how much they must be paid, what prices businesses must charge, and it interfered with their ability to raise capital.

The British economist John Maynard Keynes recognized that FDR’s priorities were subverting the prospects for ending high unemployment. He wrote FDR a letter which was published in the December 31, 1933, issue of the New York Times. Keynes warned that “even wise and necessary Reform may, in some respects, impede and complicate Recovery. For it will upset the confidence of the business world and weaken their existing motives to action. . . . I am not clear, looking back over the last nine months, that the order of urgency between measures of Recovery and measures of Reform has been duly observed, or that the latter has not sometime...