What we can learn from 1920s America

By Doctor Michael Herron

There has been some recovery from the 2008 Crash but there are still some inherent problems with the US economy. One such problem is that of inequality. Although many would argue that inequality is just a fact of life in the American free market economy, others might argue that it poses a threat to the stability of the system itself. Indeed, some argue that the great inequality that existed in 1920s America contributed to the Wall Street Crash of 1929.

John Kenneth Galbraith identified five weaknesses of the US economy in the 1920s that led to the Crash, “the bad distribution of income”, “the bad corporate structure”, “the bad banking structure”, “the dubious state of the foreign balance” and “the poor state of economic intelligence”. “The bad distribution of income” was particularly serious since this meant as Galbraith put it “the economy was dependent on a high level of investment or a high level of luxury consumer spending or both.” This posed a problem because, according to Galbraith “both investment and luxury spending are subject, inevitably, to more erratic influences and to wider fluctuations than the bread and rent outlays of the $25-weekworkman.” The economy was thus vulnerable to a shock such as the Wall Street Crash. Furthermore, according to Richard Hofstadter, the 631,000 richest families were wealthier than the 16,000,000 poorest families, who could not meet their basic needs. In the midst of the boom of the 1920s there were simply not enough customers to buy the products supplied by American factories.

The responses of Presidents Herbert Hoover and Franklin Delano Roosevelt to the Crash contrasted sharply. While Hoover refused to intervene to help the ailing American economy, FDR developed the New Deal when the Federal Government supported the American economy through deficit financing. Conservatives are probably correct in their argument that the US only finally emerged from the Great Depression with the onset of the Second World War as Western European powers bought armaments and supplies from the United States thereby fuelling the American economic recovery.

Despite this fact, arguably, FDR laid the foundations for post war economic prosperity by regulating the financial system and by reducing inequality through the imposition of a wealth tax. However, widespread prosperity only really took off in the United States when returning American servicemen received grants to go to college under the GI bill and received federal assistance to buy homes, thus relieving them of potentially heavy debt burdens. These measures greatly reduced inequality in the United States and underpinned the prosperity of the next thirty years.

In 2016 two of the weaknesses identified by Galbraith of the US economy in the 1920s are still with us today “the poor distribution of income” and “the bad banking structure” since the Glass-Steagall law of 1933, which separated investment and commercial banking, as part of the 1933 Banking Act was repealed during the Clinton presidency in 1999. Indeed, Thomas Piketty has argued that the “poor distribution of income” contributed to the Financial Crisis of 2008. The main reason for this was that since the working and middle classes did not have enough money to buy the goods and services they wanted and needed they took on more debt which was supplied on credit by unregulated banks using savings built up by the elite.
The elite 1% has, indeed, according to Piketty built up massive savings, having gained 60% of the increase of US income from 1977 to 2007. However, the nature of this wealth owned by the 1% has changed where today’s elite’s wealth largely derives from earned income through managerial salaries rather than mainly from capital such as share dividends as was the case in the 1920s. Nevertheless, this distinction is not completely clear as many of the management class that comprise the 1% have stock options that are included as part of their salaries. As in the 1920s, arguably, the elite cannot use their savings to consume enough of the goods and services produced by the US economy to comfortably sustain it compared to the 1950s when there was a much more equitable distribution of income, the result of the GI bill and similar measures.

Are Hillary Clinton’s or Donald Trump’s economic programmes likely to replicate these post World War II outcomes? Taking into account the fact that after the Second World War, the United States was pretty much uniquely placed to prosper, this growth of prosperity is unlikely to be replicated. Trump’s plan of tax cuts may produce a short boost but is unlikely to solve the underlying problems of the American economy. Clinton’s proposal to subsidise American students’ college education comes closer to solving the problem. This is because, as Piketty has argued, the best way out of poverty is through the acquisition of skills and knowledge, as long as students are not saddled with heavy debts after graduation.

John Kenneth Galbraith The Great Crash 1929 (London: Penguin Books, 2009)
Richard Hofstadter The American Political Tradition & theMen Who Made It (New York: Vintage Books, 1973)
Thomas Piketty Capital in the Twenty-First Century (Cambridge, Massachusetts: The Belknap Press of Harvard University Press, 2014)

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