Ages of American Capitalism (part 2)

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Jonathan Levy divides American economic history into four ages:

  1. The Age of Commerce (1660-1860)
  2. The Age of Capital (1860-1932)
  3. The Age of Control (1932-1980)
  4. The Age of Chaos (1980- )

Here I discuss the Age of Control, which is the era of the New Deal, World War II, and the postwar prosperity.

The Great Depression

“Rarely if ever before had an industrial economy been so poised on the brink of a great leap forward in wealth-generating enterprise. But it had stalled in mid-leap.” The run-up to the economic crash of 1929 is a prime example of one of Levy’s general observations, that major investment booms involve both long-term fixed investment that drives real economic growth and speculative bubbles that end badly. In this case, much of the new investment was in “Fordist” mass production of consumer goods like cars and home appliances. The electric assembly line represented the “largest surge in labor productivity ever recorded.” Unfortunately, high productivity does not translate directly into sustained economic expansion and lasting prosperity. The story of economic history must include the cyclical fluctuations in confidence and credit as well as the linear trend in technological innovation and rising productivity.

At the beginning of the 1920s, investor confidence was high. But one reason for the high confidence also contained the potential for a boom-and-bust cycle. During World War I, European governments had gone off the gold standard and expanded the money supply in order to finance the war effort. Now they returned to the gold standard and restricted the money supply to fight inflation. The U.S. Federal Reserve went along by raising interest rates. These policies contributed to a temporary situation of price stability, confidence in the currency, and a willingness of investors to lend, but at relatively high rates. The high rates set a high bar for business investments, which only made sense as long as the returns exceeded the costs of borrowing.

All was well as long as confidence in future profits remained high but also realistic. But once the boom got going, speculators could easily borrow too much in order to pay too much for assets whose real prospects couldn’t justify their cost. When these unrealistic expectations went unfulfilled and profits didn’t materialize, confidence was shaken, credit dried up, and investment collapsed. In 1931, the Federal Reserve made things worse by further tightening the money supply. By the time Franklin Roosevelt was elected in 1932, the economy had entered a “liquidity trap.” Precautionary liquidity had taken over, and businesses were afraid to invest in production even when they could borrow at lower rates. The Fed brought interest rates down, but it was too late. The economy hit bottom in 1933, with economic output only half of what it had been in 1929 and unemployment over 20%. The most productive factories the world had ever seen couldn’t sustain prosperity if they were idle.

New Deal capitalism

One of the first things the new administration had to do was counter the collapse of confidence that kept the economy in the liquidity trap. Much economic activity had simply come to a halt, as lenders were afraid to lend money they might not get back, businesses were afraid to produce goods that wouldn’t sell, and consumers were afraid to spend what little money they had as incomes fell. Roosevelt’s famous declaration that “we have nothing to fear but fear itself” was more than just rhetoric. The crisis of confidence went beyond the economy to challenge government as well. As some European countries turned to authoritarian leaders to address the crisis, many Americans questioned whether liberal democracy was up to the task.

Roosevelt believed that it was, and he welcomed the characterization of his policies as “liberal”. In its early days around the time of the Civil War, the Republican Party had been the liberal party, but now Democrats earned that label, leaving many Republicans to play the part of conservative doubters of the New Deal.

Democratic efforts to get the economic crisis under control initiated the “Age of Control.” One of the first things Roosevelt did was adopt a policy he called “definitely controlled inflation” by taking the country off the gold standard. Rather than be inhibited by the supply of gold, the money supply could expand along with economic activity. In fact, monetary expansion could encourage economic activity—at least in the short run—by putting more dollars in the hands of spenders, including the government itself.

Levy distinguishes two different kinds of economic liberalism, regulatory and developmental. While the New Deal was strong on economic regulation, it was weaker on directing the nation’s investment, a weakness that Levy sees as a problem to this day.

The two main objects of New Deal regulation were business practices and income security. The Security Exchange Act created the SEC to regulate publicly traded corporations and curb the worst abuses associated with financial speculation. It banned insider trading, required regular financial reports, and contained many provisions to prevent fraud. The Social Security Act created not only social insurance for retirees, but unemployment compensation and aid to poor women and children. The National Labor Relations Act guaranteed the right of workers to organize and collectively bargain. The Fair Labor Standards Act set maximum hours and minimum wages. New agricultural programs supported commodity prices to provide more stable farm incomes. If Americans were more secure in their incomes, they would feel more comfortable buying the goods that the emerging mass-production economy was capable of producing.

Developmental liberalism tried to stimulate investment in two ways. It lent capital to private investors, especially in banking, real estate and agriculture. It also made massive public investments in infrastructure through projects like the Tennessee Valley Authority.

These programs were liberal but not radical. They did not overturn the fundamental assumptions or power structures of capitalism; nor did they bring the Depression to an end, although the economy did improve from 1933 to 1936. Levy’s assessment:

New Deal capitalism was a variety of capitalism because the discretionary power of when and where to invest remained in the hands of the owners of capital. During the 1930s, whether the investment was private (incentivized or not) or public, its combined magnitude was simply insufficient to draw out sufficient economic activity to end the Great Depression. A general lack of initiative and spending remained.

In 1937, the government contributed to a “recession within the Depression” by prematurely trying to balance the budget and tighten monetary policy. Levy also suggests that a new kind of liquidity preference played a role, one that he calls “political liquidity.” Industrial capitalists who opposed the New Deal “threatened not to invest unless their political demands were met, especially for lower taxation on their incomes.”

In 1938, Roosevelt accepted deficit spending as a way to stimulate the economy. John Maynard Keynes had presented the rationale for this in The General Theory of Employment, Interest, and Money (1936). But he also warned, in 1940, “It is, it seems, politically impossible for a capitalistic democracy to organize expenditure on the scale necessary to make the grand experiment which would prove my case—except in war conditions.”

World War II

As Keynes expected, the massive government spending required by World War II was what brought the economy back to full production. It also provided a powerful psychological stimulus, generating popular support for an all-out political and economic effort to win the war. Economic preferences shifted dramatically toward fixed investment and away from any kind of liquidity—precautionary, speculative, or political. Why be shy about investing, when the government provided a willing buyer for all the armaments a factory could turn out? By 1942, the U.S. was winning the “war of the factories,” surpassing both Germany and Japan in the production of munitions.

Big Government liberalism thrived in both its regulatory and developmental aspects. On the regulatory side, government raised taxes, rationed consumer goods like gasoline, and implemented wage and price controls to curb inflation. On the development side, military planners told industry what to invest in.

World War II also encouraged a spirit of shared sacrifice and shared rewards. In addition to winning the war itself, Americans could expect a more equal distribution of economic benefits, through measures such as a more progressive income tax, support for organized labor, and the GI Bill of Rights.

The American military-industrial machine not only won the war, but unlike the economies of other combatants, remained undamaged by the war. Now that we had a fully-functional mass-production system up and running, we just had to convert it to peacetime uses.

Postwar prosperity

Levy uses the term “postwar hinge” to refer to the unique connection between domestic politics and international politics at the end of World War II. “At the war’s close, Americans owned three-quarters of all invested capital in the world, and the U.S. economy accounted for nearly 35 percent of world GDP….” Big Government combined with capitalist industry to make the U.S. the most powerful country in the world, the biggest exporter of products, capital, democratic ideas and consumer culture. The U.S. was the newest hegemonic power, although its hegemony was challenged by its next-strongest rival, the Soviet Union.

As a result of the Bretton Woods conference of 1944, the American dollar became the anchor of the global financial system. The dollar was agreed to have a fixed value in relation to gold. Other currencies would have a value in dollars, but could be revalued under certain circumstances. This arrangement institutionalized the dollar as the world’s strongest currency and helped secure the value of investments denominated in dollars.

Although wartime military spending declined, government contributed in a number of ways to the continuation of the private investment boom—not only maintaining the strength of dollar, but continuing support for income security, maintaining a military establishment during the Cold War, and engaging in Keynesian deficit spending to counter recessions.

At the same time, postwar politics placed definite limitations on government’s role in the economy, especially with respect to developmental liberalism. The owners of capital reassumed control over investment decisions, choosing, for example, to direct investments toward single-family homes and shopping malls in all-white suburbs, while inner cities were allowed to decay. Government cooperated by providing highway construction and racially discriminatory housing loans. Once the Cold War began, conservatives could exploit the fear of communism to defeat liberal proposals for greater government influence. Among the casualties were Harry Truman’s call for national health insurance in his “Fair Deal,” the Taft-Ellender-Wagner public housing bill, and a provision within the Full Employment Act of 1946 that called for supplementing private investment with public investment in order to maintain full employment.

The federal government might tax and redistribute incomes, and it might regulate specific industries, but it remained incapable of acting autonomously and creatively in furtherance of a recognized public interest beyond “national security.” Cold War military spending was the most legitimate form of government expenditure to sustain economic growth…. That the government enjoyed an autonomous arena of action only when targeting benefits toward white male breadwinners, or invoking national security, warped state action at home and abroad…. Surely government planning for long-term economic development on behalf of the public interest was off the table.

The political economy of the postwar era was strong enough to produce a postwar economic boom and raise incomes for millions of white working families. The era became known as a “golden age” of capitalism. Yet it was not sustainable enough to last more than a few decades before things started to go seriously wrong again.


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