Perhaps the most famous characterization of American austerity thinking comes from a line attributed to Herbert Hoover’s treasury secretary Andrew Mellon in response to the crisis of the late 1920s and early 1930s: “Liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate.” The result would be that “rottenness [will be purged] out of the system. … People will … live a more moral life … and enterprising people will pick up the wrecks from less competent people.” Adam Smith, it seems, was alive and well on the Potomac. Yet, despite the moral invocations, the Hoover administration did not exactly cleave to Mellon’s “liquidationist” line.
America by 1930 hardly looked like a pure laissez faire economy. The Sherman acts of 1912, which regulated monopolies and busted “trusts” were deeply interventionist, and Hoover, as president, urged a variety of interventions to alleviate unemployment. Yet these interventions were, by their design, either voluntary agreements between business and the state that had little teeth, or they were regulations designed to make markets “more” perfect by increasing competition and reducing the size of firms. Thus, both sides of liberalism were present in America at this time: the one that adapted to the state and saw its utility, and the one that sought to limit it and increase the scope of the market.
Tending toward the latter view, American economists of this period did not see depressions as accidents amenable to treatment. They saw them as a part of the nature of capitalism itself: regular, cyclical, and expected occurrences. The basic model drew upon what was called “modern business cycle theory,” which was cut from broadly similar cloth as the Austrian ideas described above. A particularly clear expression of this theory can be found in publications of the 1923 President’s Conference on Unemployment, which Hoover had created as commerce secretary under President Coolidge. The lead author of the report, Columbia University economist Wesley Mitchell, argued that “a period of depression produces after some time certain conditions which favor an increase of business activity … [that paradoxically] also cause the accumulation of stresses within the balanced system of business, stresses which ultimately undermine the conditions upon which prosperity rests.”
These “certain conditions” were elaborated upon a decade later in another authoritative volume, this time by a collection of Harvard economists. In it Joseph Schumpeter, an Austrian émigré and follower of the work of other Austrian economists of the period, such as Hayek and Von Mises, argued that capitalism has at any given point a distinct “capital structure,” that long-run evolutionary form alluded to earlier, which manifests itself as the particular mix of productive assets that investment has generated over a given cycle. When there are investment booms, as there inevitably are in capitalism, both “too much” and “too much of the wrong type” of capital is invested in the economy. Coming off the crash of 1929, when the stock market blew up, and after an entire history of railroad investment booms and busts over the prior century, such a view made more than intuitive sense. What turned this intuitive sense into a theory, however, was the concept of growth that was drawn from it.
Echoing the role Hume and Smith accorded to merchants, Schumpeter put entrepreneurs at the center of his analysis of the Depression and what to do about it. For Schumpeter, entrepreneurs make investments, many of which go bad, but capitalism progresses because of these failures, not despite them. We need failures, or capitalism does not evolve. The process of liquidation, of failure, produces the raw material for the next round of innovation and investment. As such, intervention, whether inflationary or otherwise, would cause two problems. First, it would obstruct the necessary liquidation process, propping up firms with cheap money, only postponing the inevitable day of reckoning. Second, it would disrupt the price signals that entrepreneurs rely upon so that they would not know in which sectors to invest. Investment would fall, despite the government intervention that was intended to increase it.
Liquidationism therefore argues for an inevitability—the slump must happen—and also for intervention’s unintended consequences—if you get in the way of that inevitability you will end up making it worse. The consequence of this line of thinking is austerity—purging the system and cutting spending—which becomes the essence of recovery. Austerity may be painful, but it is unavoidable since undergoing such emetic periods is the essence of capitalism’s process of investment and discovery. There was, therefore, no alternative.
The Hoover administration therefore actively sought not alternatives to austerity, but compliments and palliatives that took the form of voluntary policies to smooth the adjustment of labor and capital to new uses. Those policies were always conceived of as helping adjustment pro-cyclically rather than compensating for it countercyclically. For to do the latter would, Schumpeter warned, “lead to a collapse worse than the one it was called into remedy.”
This Austrian strain in American thinking about the inevitability of cycles, the centrality of the entrepreneur, and the importance of failure, coexisted with and was boosted by another line of American economic thought that stressed the need for a policy of “sound finance.” Favored by the banking community, these ideas reinforced the Austrian flank by insisting that business confidence, the key to supply-side growth, would only be restored if the government credibly signaled that it would allow the emetic process to unfold as it had to via austerity. While temporary relief of the symptoms of unemployment could be countenanced, the state’s role in such moments devolved to balancing the budget, even raising taxes in a recession if this was deemed necessary, to restore the investor confidence. During 1931, the last year of his administration, Hoover did exactly this to signal resolve in the face of financial difficulties. The result was the worst depression in American history.
~~Austerity : The History of a Dangerous Idea -by- Mark Blyth
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