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16.09.2010

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Lessons from the Great Depression

On August 9, 1941, the Prince of Wales sailed into Placentia Bay on the coast of Newfoundland, after a risky journey from Scapa Flow. It was bringing Winston Churchill to a meeting with Franklin D. Roosevelt, which culminated in the agreement of the Atlantic Charter. This was an eight-point statement outlining the principles that the British, and later the Americans, were fighting for. Most of the points were a familiar restatement of Wilsonian internationalism -- a rejection of military aggression, the principle of self-determination, a commitment to international trade. The fifth point, however, was different. It stated that the two leaders desired "to bring about the fullest collaboration between all nations in the economic field, with the object of securing for all improved labour standards, economic advancement, and social security."

Whatever else may be said of Sir Winston, he was not one of history's instinctive social democrats. What was he doing including a reference to improved labour standards and social security, in what amounted to a statement of British war aims?

To someone who had lived through the 1930s, this would not have seemed at all strange. The 1920s had seen a gradual reconstruction of the international economy, and with it signs that Germany was being successfully reintegrated into the international community: the signing of the Locarno Treaties in 1925, Germany's admission to the League of Nations in 1926, the agreement of the Young Plan in August 1929. Moderates had reasons to be optimistic. The Nazis obtained just 2.6% of the vote in 1928.

Then, in  late 1929, the Great Depression hit and everything fell apart. Thanks to Brüning’s deflationary policies, Germany’s national income fell by more than a quarter, and official unemployment rose to almost a third of the labour force. Optimism was replaced by a profound sense of insecurity. Inevitably, the extremist parties benefitted. In 1930 the Nazis increased their share of the vote to 18.3%, while in July 1932 they scored 37.8%. By this stage Brüning was gone, his successor adopted some modestly stimulative policies, and there were signs of a partial recovery. Not coincidentally, in November 1932 the Nazi share dipped to 33.1%; but by then it was too late, and the Weimar Republic was doomed.

The lesson was clear: states needed to provide their citizens with the security which the gold standard and the market system, left to their own devices, had so conspicuously failed to do.  The alternative was nationalism in all its guises: economic nationalism at best, but potentially something much uglier and far more dangerous. And so the democracies of the postwar period became social democracies – although British voters in 1945 judged that Churchill was not the man best suited to bringing this about.

For three decades or so after 1945, the three R’s learned during the Depression – regulation (above all of the financial sector), reflation (when needed) and redistribution – were used by social democracies to provide workers with the security they so badly craved. The strategy was so successful that voters eventually took this security for granted.  

Over the past thirty years, a backlash has swept away much of this postwar political consensus.  The supposed competitive pressures of globalization were used as an excuse to undermine welfare protections, even as globalization increased the need for them by contributing to a widening income distribution. And the financial sector was extensively deregulated, which explains the mess we’re in today.

Thankfully, the third R was not forgotten. The reflationary policies adopted in 2009 are the main reason we avoided a second Great Depression. However, their initial success has bred a dangerous complacency, while the right used the Greek crisis of 2010 far more effectively than the left used the disasters of 2008. The result is a variety of austerity packages which threaten the fragile Western recovery.

At this point, a reader might well object that the original purpose of post-1945 social democracy – to protect democracy from extremism, by protecting capitalism from itself – is no longer relevant. After all, Europe is no longer the cesspool of prejudice and nationalism that it was eighty years ago: the political consequences of recessions are no longer so dangerous.

I am not so sure. Anyone who believes that people are getting better has not been paying sufficiently close attention to the history of the twentieth century – up to and including the 1990s. Have the past fifteen years really made such a dfference? The bestseller on amazon.de is Thilo Sarrazin’s anti-immigrant screed, which amazon helpfully bundles with a book on young deliquents. In France, the government has been fishing in National Front waters, expelling Roma and linking immigrants with crime. The Nazi vote in 1928 is tiny compared with that of the Dansk Fokeparti in 2007 (13.9%), or Geert Wilders’ anti-Muslim party in 2006 (5.9%).

Our Great Recession has strengthened the political extremes. Wilders’ party received 15.5% of the vote in 2010, while Jobbik got 16.7% in the first round in Hungary. A recent study by Markus Brückner and Hans P Grüne found that a one percentage point decline in economic growth was associated with a one percentage point increase in the share of extremist parties in 16 OECD countries between 1970 and 2002.

To quote Tony Judt: “why have we been in such a hurry to tear down the dikes laboriously set in place by our predecessors? Are we so sure that there are no floods to come?”

 

Kevin O’Rourke is a Professor of Economics at Trinity College Dublin, and a co-organiser of the CEPR’s Economic History Initiative.

 

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