Do Politicians Learn Anything From History?- 3/3 : “The Danger of “Learning” Lessons” – ECONOMICS HISTORY

After analysing both crises individually, it is now important to compare their similarities in terms of causation, effects and response, and therefore conclude whether or not the crises are comparable. This will allow us to hence understand to what extent policy makers were justified in their response to 2007/8, and whether or not they actually learnt from the failures and successes of the response to the Great Depression.  

1929 car

The causation for both crises shares many similarities. For instance, the policy climate created in the 1920s were meant to encourage people to take out loans to fund stock investment, through maintaining low interest rates, and providing the ability to ‘Buy on the Margin’, which allowed the general public to access the overvalued blue chip stocks. This is similar to the situation in 2008. Throughout the 1990s, the Bush administration had been pushing home ownership through ‘help to buy’ schemes. The combination of this as well as cheap mortgages meant that people were easily able to gain credit to buy homes and fuel the bubble.

Both crises are also similar in terms of the overconfidence and over speculation placed in asset values. Namely, the 1920s Stock Market, and the 2000’s housing market. Both markets had been growing in value exponentially over the prior decade, and market speculation from investors suggested that the rise would not stop. Consequently, both the housing market and the stock market became overvalued, which contributed to the extent of effect for the crash.

The economics responses to the crash also share similarities. Namely, both Presidents initiated expansionary fiscal policy to boost growth. Hoover commenced the “Hoover Reconstruction Finance Corp” which allowed him to bail out the stock brokers and collapsing banks, so that they were able to provide necessary credit to cater for loans to encourage growth. This led to an increase in national debt, but an expansion in AD. Obama similarly initiated his “Jobs Bill”, which was intended to alleviate unemployment and therefore encourage consumption to kickstart short term economic growth.Obama and a table

Indeed, both responses were similar also in their shortcomings. Unemployment under Roosevelt rose to 21%, which lead Henry Morgentyav to argue “we are spending more than we have ever spent before, and it does not work.” This is simultaneous to Obama’s policies, which saw unemployment rise from 8%-10%, despite his stimulus packages.

What is also clear is that increasing taxation paid for both eras’ stimulus packages. To pay for Roosevelt “New Deal”, the top marginal income tax rate reached 94% for those earning over $200,000 a year, which leads to large disincentives for companies to expand, and workers to earn more. Obama similarly raised taxes, but he instead levied the taxes on demerit goods, for instance increasing taxes on cigarettes and liquor, in order to reduce over consumption, and raise necessary revenue for his Jobs Bills.

In essence, it becomes clear that both economic situations leading up to the 1929 crash and 2008 crash were similar. They were both consequences of overconfidence and speculation in an accessible market, which resulted in said market becoming overvalued, and prior investments being lost as soon as the market turned. This in turn led to the collapse of banks, a reduction in economic growth, and subsequent derived unemployment. Both era’s responses were equally similar, in their initiation of Keynesian policies to increase government intervention and boost growth through injections. However, the extent to which an economist would judge that policy makers learnt the lessons of the past depends on whether or not you believe Roosevelt and Hoover’s policies were successful. William Hazlitt criticised Roosevelt by saying that for each dollar of tax spent, it must first be raised, and increasing taxes contributes towards worsening Keynesian “animal spirits” through dis-incentivising the labour force, which can be more harmful towards economic growth.

In my judgement, 2008 policy makers did learn the lessons of the past, through their effective implementation of expansionary fiscal policy, which ultimately reduced unemployment and boosted growth. However, this is not to say that policy makers should always fall back on preconceived methods of escaping economic crises. One crash in one époque will never be a carbon copy of a previous crisis, as there will always exist some kind of individuality about every crash, either in terms of causation or effect. Hence, policy makers should not become complacent and presume that just because expansionary fiscal policy helped to resolve the 1929 crash, it will do the same in 2008. To this extent, policy makers must always develop and evolve their theories to fit with that period’s idiosyncrasies, as over-reliance on previously successful policies and falling back on the notion of “learning from history” to then apply history step by step in an incompatible era, is a sure recipe for disaster.

Do Politicians Learn Anything From History?- 1 : “The Great Depression vs 2008 Crash” – ECONOMICS HISTORY

Could politicians have looked to the past to predict the 2008 Financial Crash?

Philosopher George Santayana famously quipped that “Those who cannot learn from history are doomed to repeat it.” In many ways, this is a motto adopted by politicians and investors alike world wide. If an institution is about to invest in capital or start a new scheme, surely it makes sense to look to the past and gain foresight through reflection.  Often, politicians can learn a great deal from the mistakes made by their predecessors, and act to not repeat them. Here, I will try to draw parallels between the causes of the Great Depression of 1929, and the causes of the Financial Crash of 2008, and therefore answer the question as to whether or not politicians did indeed learn from the past.

The Great Depression of the 1930s began on the 24th October 1929, when the American Stock Market crashed. However, this collapse did not come from nowhere; rather it was the inevitable consequence of decreased market regulation, investor over speculation, and overconfidence within the stock market. During the 1920s, wartime technologies (such as the radio and hoover) were seen as necessities rather than luxuries, hence increased output resulted in short run economic growth within America. This translated to the increase in value of share prices, averaging an increase of 20% per year in the 1920s. Banks were eager to lend out credit to potential investors because as long as the money was invested in the Dow Jones, investors would see their asset prices rocket, and therefore encourage investors and consumers alike to borrow even more credit from banks (40% of bank loans during the 20s were used to fund investment). This level of borrowing to fund investment meant that stock prices soon became overvalued, as investors would pump money into shares, which would in turn increase their value, and therefore encourage even more people to invest in these blue-chip stocks (ie General Motors). As credit was near limitless due to the lax monetary policy of the Federal Reserve, this process was able to repeat, leading to the creation of a stock market “bubble”.

Indeed, this bubble was able to develop due to the “Buy on the margin” scheme, which meant that that investors would only have to pay upfront 10-20% of a transaction in order to buy the shares, as the rest could be borrowed from a broker. This meant that only a small amount of “real” credit was used in stock transactions, meaning that for the first time the stock markets became accessible to the general public, rather than just the extremely wealthy. This in turn made the effects of the crash more widely encompassing.

Indeed, the growing bubble was further fuelled by a lack of government regulation within stock markets. Republican Presidents Warren Harding, Calvin Coolidge, and Herbert Hoover were great believers in Laissez-Faire economics, (the belief the Adam Smith’s invisible hand behind market forces will ultimately result in the optimum allocation of resources, and any government interference prevents this action). However, this interpretation of the Austrian School of Economics allowed for the forming of monopolies, as wealth inequality reached record levels. The reduced levels of regulation allowed for the stock markets to go unmonitored, allowing small elite firms such as JP Morgan to control vast amounts of the stock exchange, and manipulate share prices.

However by October 1929, investors began to realise the expanding difference between share price and actual share value. It became clear that stocks had become overvalued, hence, on October 24th 1929, share prices began to fall. Immediately, investors and the general public alike rushed to sell their stocks, resulting in 16,410,310 shares being sold on Black Thursday, to the tune of $40 billion, a fall of 12%.

The Dow Jones continued to decrease in value for another 3 years. Labour demand is derived from RNO, hence as output shrunk unemployment grew to 25%. The decrease in demand for labour meant that workers lost their bargaining power, so wages fell by 42%, which lead to a regressive decrease in living standards, hence inequality grew (show in the creation of “Hooverville” slums for the unemployed).

Black Thursday Newspaper
London Herald Friday 25th October – The effects of the Crash were felt worldwide.

Therefore, the Great Depression came from a culmination of overconfidence, the public’s newly found hobby of investment in shares, and a seemingly endless supply of credit from banks and brokers alike. These ultimately fuelled the bubble that would eventually collapse to cripple the worldwide economy (international trade fell by 65%). In my next blog on ECONOMIC HISTORY, I will analyse the causation of the 2008 Financial Crisis, and then draw parallels between the two events, to conclusively decide whether or not the politicians of 2008 did learn the lessons of history.