Why did the New Deal fail?

This is an essay from my undergraduate years at the London School of Economics. I thought maybe someone could use it, in whatever way. Beware academic language.

Historians frequently place Roosevelt among the top three presidents and most historians believe that the New Deal did not fail. If their assumption holds true, then this leads to the following conclusion: the benefits of the New Deal outweigh its cost. This essay tries to challenge that premise and questions whether benefits really outweighed the costs or vice versa. First, I will outline the four main reasons why most historians believe that the New Deal did not fail. This is important to consider in order to determine whether the benefits outweigh the costs or vice versa. Then, I will focus on the causes of the Great Depression and argue that Roosevelt did not understand what caused the Depression.

This, in turn, led Roosevelt to wrong decision-making and explains why the New Deal did not succeed. Finally I will argue, contrary to conventional wisdom, that the benefits of the New Deal did not outweigh the cost and demonstrate why the New Deal failed by analyzing the NRA, AAA, FERA, WPA and TVA in detail and further evaluate other policies of the Roosevelt administration which will illuminate why the New Deal failed.

According to Roosevelt?s defenders, the New Deal did not fail because of four major reasons. First, the New Deal did not fail because the 1920s were an economic disaster. Leuchtenberg argues that the havoc that had been done before Roosevelt took office was so great that even the unprecedented measures of the New Deal did not suffice to repair the damage. [1] Roosevelt provided useful tools to partially relief, recover and reform the U.S. economy. Thus, the New Deal could not fail because of the damage that was done to the economy before Roosevelt took office. Second, the New Deal did not fail because it led to positive results. For example, while unemployment in 1933 was at 25%, it decreased to 15% by 1937. McJimsey notes that one of Roosevelt?s achievements was to create an institutional structure for the modern welfare state. [2]

Conlin concludes that the greatest positive accomplishment of the New Deal was to ease the economic hardships suffered by millions of Americans? [3] Third, the New Deal did not fail because Roosevelt was popular. He was reelected three times after all. He mobilized America with his fireside chats and dominated Congress. Schlesinger notes that he came through to people because they felt that he liked them and cared about them. [4] Fourth, the New Deal did not fail because Roosevelt was an admirable executive and a good leader. Leuchtenberg defends FDR by noting that he essentially was a moralist who wanted to achieve certain humane reforms and instruct the nation in the principles of government. [5]

Other benefits of the New Deal include the Banking Holiday, the Glass-Steagall Act, which established confidence for savers and prevented bank failures to some extent, and the SEC, which increased safety requirements for stock trading companies, which, in turn, helped investors. Further, Roosevelt?s minimum wage and social security laws were also long-lasting parts of the New Deal.

In order to determine whether the New Deal failed or not, one needs to understand the causes of the Great Depression. The New Deal failed because Roosevelt misunderstood what caused the Great Depression. A doctor who recognizes the wrong symptoms cannot prescribe the right medicine to cure the disease of a patient. Similarly, Roosevelt prescribed the New Deal to cure the U.S. economy from the Great Depression.

However Roosevelt?s medicine did not work because his administration failed to recognize what really caused the Great Depression and therefore prescribed the wrong medicine. Roosevelt assumed that the free market not the government caused the Great Depression. Roosevelt believed the Great Depression was partly caused by poor investments and stock manipulations by rich people. [6] Further, he blamed the Great Depression on bankers, speculators and journalists.

Although the causes of the Great Depression are vast and complex, they can be boiled down to three major causes which explain why there was a banking crisis, why the stock market declined, why exports vanished, why trading partners were upset, why major industries collapsed, and why there was uncertainty on the administration?s policies. These three explanations of the causes contrast with Roosevelt?s assumption that the private, not the public sector caused the problem.

First, the negative consequences of World War I. Throughout the 1920s U.S. debt increased from less than $2 billion to over $20 billion, while at the same time, U.S. loans to Europe amounted to over $10 billion. When interest rates and tariffs increased, the U.S. was unable to make new loans to Europe, and Europe, in turn, could not repay earlier loans. Second, the Smoot-Hawley Tariff Act, which was the highest tariff in U.S. history. It affected over 3,000 imported items and even increased taxes on some items. As a result of those high tariffs, foreign goods became less competitive and similar domestic goods more competitive.

However, European markets retaliated by putting an import quota on American goods. As a result of retaliatory tariffs, U.S. exports from 1929 to 1932 more than halved. For example, American automobile companies sold less cars because of those retaliatory tariffs and also had to pay higher prices on imported goods necessary to build the car. What happened between 1929 and 1932 is that car sales declined by almost seventy percent. The high volatility of the stock market shows what uncertainty the Smoot-Hawley Tariff Act created.

Third, the Federal Reserve did not prevent a banking crisis but helped cause one. Friedman and Schwartz argued that the economic contraction was exacerbated because of the bank failures and the massive withdrawals of currency from the financial system while the Federal Reserve did not provide the necessary liquidity that the system required. [7] So, the three causes can be summarized as war debts, high tariffs and failed regulation which were not created by the private sector but the public sector. Thus, the New Deal failed because Roosevelt did not recognize that the Great Depression was mostly caused by the government itself.

The New Deal failed because the NRA, by fixing prices, damaged American business. Folsom explains that the traditional free market system, where businesses compete and innovate to sell products of varying price and quality to choosy customers was overthrown.[8] Competition is good for an economy because it allows an industry to innovate and keep prices low for customers. Without competition, there will be no new and cheaper products in the marketplace. For example, Andrew Carnegie and Charles Schwab innovated the steel market and kept prices low.

As a result, customers had access to better products which were also cheaper at the same time. However the NRA assumed that an industry was stagnant and did not change, and therefore fixed prices. Letting the market set prices and wages is more sensible than letting the government fix prices. Further, the NRA wrote over 500 codes into law which increased bureaucracy. By fixing prices, smaller companies were not able to compete with bigger companies because those smaller companies had to raise their prices and lost competitiveness and market share.

For example, the Pharis Tire company could weather the Great Depression but not the NRA. [9] Yale economist Fisher analyzed the impact of the NRA and told Roosevelt that the NRA has retarded recovery and especially re-employment. [10] Thus, the NRA was eventually deemed unconstitutional and the New Deal failed because the NRA increased prices, wages and bureaucracy while decreasing working hours and competition which, in turn, reduced innovation.

The New Deal failed because the AAA, by interfering with supply and demand, damaged farming which had repercussions on the overall economy. The government ensured price floors on wheat and cotton. Thus, wheat and cotton farmers expanded their businesses and other farmers flocked to those ?guaranteed? crops.

As a result, there was an overproduction of wheat and cotton, which later had to be sold by the government at a loss. As a result of the shift to wheat and cotton production, the U.S. failed to produce other agricultural products and thus at some point during the 1930s became a major food-importing country. To ensure higher prices, the government reduced production by paying farmers not to produce on certain part of their land. However this was abused by farmers, who could set aside the least fertile land, and the government would pay the farmer anyway. From the subsidy received by the government, the farmer could buy fertilizer and use it to increase the yield on his used land.

Further, the government by stifling competition and efficiency, failed to recognize that price cuts are in the benefit of the consumer because price cuts lead to cheaper and better food. The government reduced competition by adjusting commodity prices for inflation and parity from a period when farm prices were high. As a result, prices of food increased in the 1930s. Therefore, less people were able to get food. Because clothing prices also increased, fewer clothing items were sold and textile companies had to lay off people. The decrease in demand for cloth led to decreased future cotton prices.

In addition, as an unintended consequence over 100,000 tenant farmers were thrown off the land into unemployment and the AAA became the largest employer in the federal government due to increased bureaucracy. Folsom notes how the government almost ruined one of the biggest apple producers by closing down that producer?s export markets due to high tariffs and competing while running losses with taxpayer?s money. [11] Thus, the AAA through overproduction, price setting, centralization, bureaucratization and wrong incentives, partly caused the New Deal to fail.

The New Deal failed on account of relief programs such as FERA and WPA by shifting incentives and politicizing relief. Those programs shifted money from the frugal states to the inefficient states. While FERA was aid from the government which did not require the recipient to give anything in return, WPA created government jobs by which people would work for relief. Before Roosevelt?s relief programs, states and cities had incentives to be frugal with charities and a tendency to take care of their own while requesting aid only in emergencies.

Afterwards, states were looking to the government to solve their problems and had no incentive to work hard to raise local funds. The less work a state did in raising money, the more it received from the government. Folsom describes this historical shift to using federal dollars for local relief profoundly changed the American work ethic. [12] The WPA almost cost $5 billion and its utility is rather questionable if one takes into consideration both direct and indirect consequences. The direct consequence being the jobs created as well as the schools, bridges and hospitals built. However, the indirect consequence should not be forgotten by which many projects never came into existence because of that money transfer from the private to the public sector. Shlaes indicates that New Deal laws themselves contributed to the sense of lost opportunity and Roosevelt offered rhetorical optimism, but pessimism underlay his policies. [13]

Further, Roosevelt by having discretion on how to allocate funds often used the relief program as a tool of political manipulation. For example, a state in the South, which was likely to vote for Democrats, received less relief money than a state in the North, which was less likely to vote for Democrats, although wages in the South were substantially lower than in the North. Thus, the cost of the FERA and WPA probably do not outweigh the benefits and therefore contributed to the failure of the New Deal.

The New Deal failed because subsidized projects such as the TVA did not bring lasting results. First, the project created benefit for 2% at the cost of 98% of the population. Second, the state of Tennessee did not even outperform other states economically given the advantage it had in terms of electricity subsidies. Chandler concludes that subsidized power gave many people in Tennessee incentives to stay on small farms, not to change their way of life. [14] In the non-TVA states, people moved to the city, which accelerated the process of industrialization in those states and increased incomes and the market for electricity. Powell notes that the result is that the 2% started lagging behind and did not perform as well as the 98% who gave them the tax dollars.[15] Thus, government subsidies also caused the New Deal to fail.

The New Deal failed because Roosevelt created uncertainty by experimentation, protectionism, regulation and raising taxes. For example, by raising taxes he did not encourage businesses to expand. Best indicates that Roosevelt saw himself in political struggle in which he wanted to tax businessmen as much as they wanted to oust him from the White House. [16] The business community feared Roosevelt. In a Fortune poll in September 1940, over 77% of the executives surveyed opposed Roosevelt?s policies designed to achieve recovery.[17] By the end of the New Deal, the top income tax rate was 79%, national debt was doubled, the budged was unbalanced, and tariffs only slowly reformed.

The New Deal failed because it prolonged the Great Depression by creating uncertainty. Businessman DuPont explained the problem rather well by claiming that uncertainty ruled the tax situation, the labor situation, the monetary situation, and practically every legal condition under which industry must operate. Then then observed that is was impossible to guess if new restrictions were placed on capital or limits on profits. [18] Thus, unnecessary regulation and uncertainty caused the New Deal to fail.

Why did the New Deal fail? It shifted the economy from the private to the public sector. Shlaes signals that Roosevelt?s domestic policies failed because he created regulatory aid, and relief agencies based on the premise that recovery could be achieved only through a large military-style effort. [19] As Einhorn reveals, the lesson of the ?Roosevelt recession? of 1937-38 is that GDP created by massive fiscal stimulus is artificial, and that is exactly why the New Deal failed. [20] It temporarily brought the economy out of recession, but did not solve the underlying problem. Further, the benefits of programs such as the NRA, AAA, and WPA did not outweigh the direct and indirect costs of the New Deal. In the end, it is important to understand why the New Deal failed. If it is generally accepted that the New Deal did not fail, then mistakes are likely to be made by future policy makers.

Bibliography

Best, Gary Dean. Pride, Prejudice, and Politics (Connecticut: Praeger Publishers, 1990)

Chandler, William (1984) The Myth of the TVA (Cambridge, MA: Ballinger Publishing,

1984)

Conlin, Joseph (2007) The American Past (Belmont: Wadsworth, 2007)

Fisher, Irving. Irving Fisher Papers. RPL, Aug 30, 1934

Folsom Jr., Burton (2008) New Deal or Raw Deal (New York: Threshold Editions, 2008)

Friedman, Milton (1963) A Monetary History of the United States (Princeton: Princeton UP,

1993)

Higgs, Robert. Regime Uncertainty (Washington: The Independent Review, Spring 1997)

Krooss, Herman (2008) ?Executive Opinion?, in New Deal or Raw Deal,

(New York: Threshold Editions, 2008)

McJimsey, George (2000) The Presidency of Franklin Delano Roosevelt (Kansas: UP of

Kansas, 2000)

Leuchtenberg, William (1963) Franklin D. Roosevelt and the New Deal (New York: Harper,

2009)

Powell, Jim. (2004) FDR?s Folly (New York: Three Rivers Press, 2004)

Schlesinger, Arthur (1958) The Coming of the New Deal, 1933-1935 (New York: Mariner

Books, 2003)

Shlaes, Amity (2008) The Forgotten Man (New York: HarperCollins, 2008)

[1] Leuchtenberg, William. Franklin D. Roosevelt and the New Deal. New York: Harper,

1963, p.347

[2] McJimsey, George. The Presidency of Franklin Delano Roosevelt. Kansas: UP of

Kansas, 2000, p.287-88

[3] Conlin, Joseph. The American Past. Belmont: Wadsworth, 2007, p.833

[4] Schlesinger, Arthur. The Coming of the New Deal, 1933-1935. New York: Mariner

Books, 1958, p.572

[5] Leuchtenberg, William. Franklin D. Roosevelt and the New Deal. New York: Harper,

1963, p.346

[6] Folsom Jr., Burton. New Deal or Raw Deal. New York: Threshold Editions, 2008, p.130

[7] Friedman, Milton. A Monetary History of the United States. Princeton: Princeton UP,

1963, p.256

[8] Folsom Jr., Burton. New Deal or Raw Deal. New York: Threshold Editions, 2008, p.43

[9] Folsom Jr., Burton. New Deal or Raw Deal. New York: Threshold Editions, 2008, p.50

[10] Fisher, Irving. Irving Fisher Papers. Rochester Public Library, Aug 30, 1934

[11] Folsom Jr., Burton. New Deal or Raw Deal. New York: Threshold Editions, 2008, p.82

[12] Folsom Jr., Burton. New Deal or Raw Deal. New York: Threshold Editions, 2008, p.81

[13] Shlaes, Amity The Forgotten Man. New York: HarperCollins, 2008, p.57

[14] Chandler, William. The Myth of the TVA. Cambridge, MA: Ballinger Publishing, p.108

1984, p.73-80

[15] Powell, Jim. FDR?s Folly. New York: Three Rivers Press, 2004, p.149-50

[16] Best, Gary Dean. Pride, Prejudice, and Politics. Connecticut: Praeger Publishers, 1990, p.106

[17] Krooss, Herman. ?Executive Opinion?, in New Deal or Raw Deal, New York: Threshold Editions, 2008, p.189

[18] Higgs, Robert. Regime Uncertainty. Washington: The Independent Review, Spring 1997

[19] Shlaes, Amity The Forgotten Man. New York: HarperCollins, 2008, p.156

[20] Einhorn, David. Speech at the Value Investing Congress, October 19 2009

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