Overproduction, then and now

In a comment after my previous post, Ken Duda suggested that the authors of this WSJ story may have believed that overproduction was holding back the global economy.  Like almost everything in life, that reminds me of the Great Depression.

In 1933, FDR worried that “overproduction” was leading to deflation and depression.  (Apparently FDR had never read George Selgin.)  FDR first tried to address deflation with monetary stimulus, sharply depreciating the dollar after March 1933.  Industrial production soared by 57% between March and July 1933.  But FDR could not leave well enough alone. Now “overproduction” was getting even worse!  So he ordered firms to cut the workweek from 48 hours to 40 hours, with no change in weekly pay.  This effectively boosted average hourly wages by 20% in just 2 months.

And it worked!!  Industrial production immediately turned negative, and remained below the July 1933 levels as late as May 1935, when that awful Supreme Court that liberals complain about declared the NIRA to be unconstitutional, and saved his presidency.  Industrial production immediately began rising rapidly, until the recovery was again aborted by an FDR wage shock, this time associated with the huge unionization drives following passage of the Wagner Act, which doubled union membership between 1936 and 1938.  With wages rising rapidly the economy stagnated in mid-1937, and then plunged sharply in late 1937 when an adverse demand shock was added to the adverse supply shock of early 1937. The recovery in IP also paused after the minimum wage of late 1938 was instituted, and then again in late 1939 when the minimum wage was raised by another 20%.

PS.  On a related note I highly recommend Alex Tabarrok’s new post on “efficiency wages.”

PPS.  While touring Fallingwater a few days ago the tour guide asked if anyone wanted to guess how much Frank Lloyd Wright paid the unskilled workers at the job site in 1938.  I guessed 25 cents an hour, which turned out to be exactly right. The guide asked how I knew, and I said I just guessed that amount because it was the first minimum wage, instituted in 1938. The rest of the tour group gave me that “who is this jerk showing off” look that I haven’t seen since college.


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27 Responses to “Overproduction, then and now”

  1. Gravatar of Kevin Erdmann Kevin Erdmann
    28. April 2015 at 07:28

    Most people today think the Fed did what was necessary to stop an oversupply of housing….the more things change, the more they stay the same.

  2. Gravatar of John Hall John Hall
    28. April 2015 at 08:27

    Regarding Falling Water, did you proudly exclaim you were an Econ professor or did you give yourself an aura of mystery by keeping quiet?

  3. Gravatar of collin collin
    28. April 2015 at 08:36

    And FDR replaced Hoover and Mellon who also felt the US economy had over-production as well. (Whether Mellon said the liquidate this or that is not proven although most of his actions did little to stop the liquidating.) There were all kinds of complaints that the average work-class family in the late 20s had cars and radios.

  4. Gravatar of Steven Kopits Steven Kopits
    28. April 2015 at 08:44

    Great bit of history.

    “Over production” of oil is just about the end. My call is that oil directed horizontal rig counts bottom on the week of May 8.

  5. Gravatar of joemac joemac
    28. April 2015 at 09:04

    Scott,

    Did IP fall immediately after the Wagner Act was passed, or with a lag? And if it was a lag, how do you know that it wasn’t caused by something else?

    By the way, I recommend you do something like the following to increase the readability of your account of the Great Depression.

    1. Hire an assistant with computer knowledge
    2. Have him create a beautiful time series graph from say, Jan 1929 to Jan 1942
    3. On this graph plot daily Dow Jones for expectations, weekly IP for real production, and a price index for inflation
    4. For each of the dozen or so significant shocks to IP in the 30s add a textbox explaining how that particular IP shock can accounted for by a Wage Shock or shock to supply/demand for gold.

    This would make your ideas much more clear to both academic audience and lay. It would be visually right in their face,

  6. Gravatar of Cameron Cameron
    28. April 2015 at 09:11

    What did economists of the time think about these actions? Clearly economists seem to have regressed since 2007, but not THAT much… or have they?

    P.S. The people on the tour may have given you a break if you told them it was much too *high* and resulted in economic inefficiency. 🙂

  7. Gravatar of Philo Philo
    28. April 2015 at 10:32

    Keep showing off, Scott: we, your readers, are eating it up!

  8. Gravatar of George Selgin George Selgin
    28. April 2015 at 11:34

    Scott, I bet they all enjoyed watching you bump your head repeatedly on those low door headers!

  9. Gravatar of Christy Ortiz Christy Ortiz
    28. April 2015 at 13:10

    Great article!

  10. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    28. April 2015 at 13:48

    This reminds me of a comment made by Tom Sargent in Feldstein’s book on Privatizing Social Security;

    ‘The U.S. social security system was conceived during the 1930s, when many academic economists believed that excessive saving and overaccumulation of capital were fundamental macroeconomic problems. Because it depressed the prospective returns to new physical investments, a large capital stock promoted unemployment. This was the stagnation thesis. An unfunded social retirement system could “cure” the problem of capital overaccumulation by diminishing incentives to save ….’

  11. Gravatar of E. Harding E. Harding
    28. April 2015 at 13:49

    What caused the deflation of November 1937-April 1939? Wage shocks alone don’t do that. I think Sumner explained it a few years ago as some kind of gold shock, but I’m not too clear on the details.

  12. Gravatar of Major.Freedom Major.Freedom
    28. April 2015 at 14:45

    The WSJ article is wrong but not because it underestimates the glorious free lunch that is printing green pieces of paper.

    It is wrong because when there is “excess” inventory and unsold “surpluses” of goods, what this signifies is not any general or aggregate overproduction.

    It actually signifies a partial relative overproduction in those goods we can see sitting on warehouse shelves, and a partial relative underproduction of goods that we cannot see because they don’t exist.

    There is no such thing as too much wealth in the world. There is always a desire for mor goods, provided they are produced in the right proportion. What the Fed has done is what they have always done, which is mislead investors into producing the wrong goods that significantly deviate from actual saving and consuming patterns, but those patterns could not he communicated because inflation has made the price system ineffective.

    The rebound in the 1930s that Sumner alluded to was just another inflation induced unsustainable period of malinvestment that innocent people later paid for in the next correction in the cycle, which the war masked over to a large degree as standards of living were made lower by such actions as war rationing and price controls.

    “Thanks” to the Fed’s very loose monetary policy since 2009, there has been a gigantic wave of malinvestment that cannot be understood with anti-market monetarist doctrine.

  13. Gravatar of Doug M Doug M
    28. April 2015 at 14:50

    There is a demand shock and the market is not finding the clearing price on its own, so we raise costs to constrain supply and bring the price level to the old price.

    Makes perfect sense.

  14. Gravatar of Elwailly Elwailly
    28. April 2015 at 14:57

    Why should a wage increase cause an IP shock in an environment where monetary policy is correct?

    I’ve learned from you that supply shocks result in an increase in inflation when NGDP is targeted. Correctly handled there shouldn’t have been the kind of downturn that happened in 1937. This is a failure of the Fed again.

    NGDP is the responsibility of the Fed. Wages are fiscal policy. The trade-off of a minimum wage vs. an increase in inflation is a political one. I happen to think there was plenty of room for a slight increase in inflation in 1937. It should never have been a trade-off of minimum wages vs a drop in IP.

    Why blame FDR for the drop in NGDP in this case? You’ve normally always been careful in separating out fiscal responsibilities from monetary responsibilities.

  15. Gravatar of ssumner ssumner
    28. April 2015 at 15:24

    Kevin, Good analogy.

    John, I’ve never proudly proclaimed I’m an econ professor. 🙂

    Collin, That’s right, I recall reading that icebox/auto/radio complaint in one of the NYT articles from the 1930s.

    Hoover planned something like the NIRA if he was re-elected, but without devaluation. Fortunately the voters never gave him the chance.

    Steven, You are the expert. BTW, it does seem oil is gradually becoming less an increasing cost industry and becoming somewhat more like a constant cost industry.

    Joemac, The unionization drives and the wage increases happened with something of a lag, for complicated reasons. When the wages actually go up in the monthly data, you see an almost immediate impact on output (real wages, BTW.)

    Those are good ideas for RAs to work on.

    Cameron, The major economists (Fisher, Keynes, Hawtrey, etc) seemed to oppose the NIRA.

    Thanks Philo.

    George, No problem, the door frames are 6’4″ and I am only 6′ 3″ 1/2, so only my hair was mussed a little bit.

    Thanks Christy.

    Patrick, That’s very interesting. And sad.

    E. Harding. It was quite complicated, I have three chapters on 1937-38 in my “book.” (New pub. date in December 1, BTW) Short answer is mostly international gold hoarding (in fear of dollar devaluation), with some influence from earlier tight money policies (gold sterilization and higher reserve requirements.)

    Elwailly, Much of what I’ve said about recent policy doesn’t apply under a gold standard, or even the quasi-gold system of 1937. Even under NGDP targeting, higher wages (due to regulation) will reduce output. FDR was partly responsible for the fall in NGDP because he had a substantial impact on monetary policy during the 1930s. But it doesn’t really matter much (today) whether the key mistakes were made by FDR, or by FDR appointees at the Fed (who would do whatever he said to do.)

  16. Gravatar of ssumner ssumner
    28. April 2015 at 15:24

    Doug, Do I detect a bit of sarcasm? 🙂

  17. Gravatar of benjamin cole benjamin cole
    28. April 2015 at 15:37

    At Fallingwater, those were looks of admiration! Believe that and always everywhere. I find this makes life more enjoyable.

  18. Gravatar of Jim Glass Jim Glass
    28. April 2015 at 16:14

    FDR first tried to address deflation with monetary stimulus, sharply depreciating the dollar after March 1933. Industrial production soared by 57% between March and July 1933.

    But FDR could not leave well enough alone. Now “overproduction” was getting even worse! So he ordered firms to cut the workweek from 48 hours to 40 hours, with no change in weekly pay. This effectively boosted average hourly wages by 20% in just 2 months. And it worked!! Industrial production immediately turned negative…

    FDR and the New Dealers associated falling prices with Depression and rising prices with prosperity, so they tried to force up prices to increase prosperity. That was the logic behind it all. But not only did they conflate policies affecting supply and demand, they generally got their effects backwards.

    E.g. while there was a lot of political support for price floors, cartels, reducing farm output, minimum wages and the like to push up prices, FDR’s Treasury and finance people were “hard money” men dedicated to defending the US position on the gold standard and prevent inflation.

    FDR himself was the big exception on this point.Lords of Finance paints a priceless picture of FDR calling his money policy people together and then springing his devaluation of the dollar on them pretty much literally as a party surprise, laughing…

    “Congratulate me, we are off the gold standard!”, displaying a last-minute amendment to the Agricultural Adjustment Act that gave him the authority to devalue by up to 50% against gold.

    At that moment hell broke loose in the room, remembered Raymond Moley. Herbert Feis, economic adviser to the State Department, looked as if he were about to throw up. The Adviser to the President on Monetary Affairs, James Warburg, and Budget Director Louis Douglas were so horrified that they began to argue with the President, scolding him as if he were a perverse and particularly backward schoolboy. Warburg declared that the legislation was completely hair-brained and irresponsible and would lead to uncontrolled inflation and complete chaos. Imperturbable as ever, Roosevelt bantered good-naturedly with them until midnight…

    That’s how FDR got his prices-raising devaluation. From there he went on to his prices-raising attacks on over-production.

    Here’s a great New Deal newsreel explaining how money, prices and inflation work, and how “inflation is seen as the nation’s salvation”, 1933-style. Compare to today’s analysis:

    https://www.youtube.com/watch?v=KDpUDUVORDI

    “Lords” I found to be a very good telling of the economic tale from WWI to the late 1930s, deserving of its Pulitzer. Nobody who reads it will ever want to go back to the gold standard or be impressed by the “aura” of central bankers again, I guarantee.

    However as it mostly dwells on the persons at the top of the major monetary systems at the time, it pays less attention to the details and analysis of the economic issues — for which I await the coming book of our host!

  19. Gravatar of E. Harding E. Harding
    28. April 2015 at 16:27

    @Major.Freedom
    -Excellent point about there being no general overproduction (esp. in Russia, Ukraine, Belarus). But where’s the huge malinvestment boom going on right now (in the U.S.)? Are we Portugal, c. 2005 or something? And, as Sumner pointed out, there is no strong correlation between strong general price inflation and large credit bubbles.

  20. Gravatar of Major.Freedom Major.Freedom
    29. April 2015 at 02:37

    E Harding:

    Much like most thinking in economics, it is not possible to know what counterfactual worlds would look like, and thus it is not possible to know to what extent that which is factual deviates from counterfactual worlds.

    We can only guess, and make general inferences based on what we know about the effects of non-market interest rates, among other consequences of CB activity.

    It is quite possible, depending on the severity of malinvestment, for most goods we can see to all be examples of partial relative overproduction. This would entail our existing observable world to significantly deviate from sustainable counterfactual worlds.

    I don’t know for sure whether this house here or that factory there is an example of malinvestment, because ultimately the only way I can know of these things would be through learning in a free market process, which does not exist. I can only know by way of me observing you and everyone else make their choices if you are constrained to private property activity which is a prerequisite to free market production, pricing and interest rates.

    This of course goes the other way as well, in that I can’t know whether and to what extent there is malinvestment even if the world was a pure free market for the last 100 years. Again, I would only be able to answer that by learning what people will do going forward from there in economic freedom, with the resulting market production, prices and interest rates. It can’t guarantee perfection, but it will guarantee the best information we can possibly have in order to even address the question.

    I know there is malinvestment. What it is exactly I do not know.

    But if I had to speculate, and totally contradict my own premises above with judgments I really have no business in making, then given what I know tend to be the effects of artificial interest rates on productive activity, in the general sense of temporality of investment, then given the extent of what I think has been Fed delaying and exacerbating corrections, then as a first estimate I would guess that we have a bubble in almost everything we see, and a corresponding underinvestment that is fully encapsulated in the counterfactual world. That may be very wrong, but I don’t expect anything but a lot of bad to come from near zero rates for this many years.

  21. Gravatar of George Selgin George Selgin
    29. April 2015 at 04:08

    ‘”Lords” I found to be a very good telling of the economic tale from WWI to the late 1930s, deserving of its Pulitzer. Nobody who reads it will ever want to go back to the gold standard or be impressed by the “aura” of central bankers again, I guarantee.’

    The so-called “gold-standard” of the 20s and 30s, actually a motley assemblage of different sorts of central-bank administered gold exchange and gold bullion standards, had little in common with the real pre-WWI McCoy, in part because the former was undermined by central bank sterilization of gold inflows and consequent gold hoarding.

    I don’t personally believe that the pre-WWI system can ever be replicated. But if I could wave a magic wand and have it back, I’d do it in a heartbeat. Dismissing “the” gold standard based on the interwar experience is overlooking both the real virtues of the prewar arrangements and the real causes of the interwar monetary meltdown.

  22. Gravatar of W. Peden W. Peden
    29. April 2015 at 05:12

    George Selgin,

    The sad thing is that even many of the supporters of a gold-backed currency one comes across, at least online and in libertarian groups, don’t have much time for the pre-WWI gold standard, for one reason or another e.g. because it didn’t have 100% reserves or it didn’t have full free banking. A case of the good facing a tough enemy in the form of the perfect.

  23. Gravatar of ssumner ssumner
    29. April 2015 at 06:03

    Jim, Yes, Lords of Finance is an excellent book.

  24. Gravatar of Jim Glass Jim Glass
    29. April 2015 at 08:03

    The so-called “gold-standard” of the 20s and 30s, actually a motley assemblage of different sorts of central-bank administered gold exchange and gold bullion standards, had little in common with the real pre-WWI McCoy, in part because the former was undermined by central bank sterilization of gold inflows and consequent gold hoarding…

    Well, first, the problem with the familiar argument that “there was nothing wrong with the gold standard, it was just that the people of the day botched and abused it to cause the Great Depression, a ‘real’ gold standard is far superior …” is that it is pretty much the same as saying that there was nothing wrong with, oh, the Chernobyl nuclear reactor design — it was really a superior design, which is why the Soviets chose to use it even with full knowledge of western alternatives — so long as no idiots running it grossly violated its operating rules to blow it up. (It had lower construction costs, no expensively wasteful containment dome, could be placed right in the middle of a city…)

    But when designing a system one has to ask what are the chances that the people operating it will violate the rules — do they actually have incentives to do so? — and when sooner-or-later they do, will the system fail relatively safely or disastrously?

    Yes, post WWI the central banks especially of the US and France sterilized huge amounts of gold with deflationary world-wide impact. But how can one expect national central banks to operate an international gold standard without putting their own national interests first, compromising the international interests?

    The Fed sterilized because huge gold inflows into the US, resulting from the international situation of the day, otherwise would have caused major inflation in the US — Ben Strong did just what the Fed would do today, stabilized prices and headed off inflation, for the good of the US economy. The French sterilized a huge amount of gold to build a war chest (literally) against Germany and (figuratively, to contest political economic influence) against gold-depleted Britain, among other reasons, putting power politics ahead of economics. Looks pretty bad to us from here, but the trade-offs looked good to them then.

    OK, one might argue such actions violated the rules of a “real” gold standard — but how realistic is it to rely on rules that require national institutions to operate against their own national interest as they perceive it? To say Ben should have inflated away, and the French should not have worried about those ever-friendly Germans, or have used gold stocks as a political weapon against perpetual-rival Britain.

    Well, given what they actually did, with flexible international exchange rates, the Chernobyl-like operators of the Bank of France might have blown up their own country but left the rest of the world intact. Instead, with the international gold standard they intensified world-wide deflation that took the rest of the world down with them.

    Secondly, the rules for any system have to be applied as they are understood at the time — not with the hindsight understanding of a generation later of how they should have been applied differently. At the time, the cardinal rule of the gold standard was that you kept your country’s currency valued at its fixed parity to gold. If you did that, you were on the gold standard. Ben Strong fully understood the impact of international gold flows and the risks of sterilizing gold — but never thought for a moment that by sterilizing so much of it he was violating the gold standard.

    He and the rest of them thought and believed they were applying the “real McCoy” rules of the system. And when the top professionals running a system can’t figure out the real McCoy rules for running it until after it blows up, there’s a genuine problem with the system, IMHO.

  25. Gravatar of Major.Freedom Major.Freedom
    29. April 2015 at 16:20

    Jim Glass:

    “Well, first, the problem with the familiar argument that “there was nothing wrong with the gold standard, it was just that the people of the day botched and abused it to cause the Great Depression, a ‘real’ gold standard is far superior …” is that it is pretty much the same as saying that there was nothing wrong with, oh, the Chernobyl nuclear reactor design “” it was really a superior design, which is why the Soviets chose to use it even with full knowledge of western alternatives “” so long as no idiots running it grossly violated its operating rules to blow it up. (It had lower construction costs, no expensively wasteful containment dome, could be placed right in the middle of a city…)

    But when designing a system one has to ask what are the chances that the people operating it will violate the rules “” do they actually have incentives to do so? “” and when sooner-or-later they do, will the system fail relatively safely or disastrously?”

    Have we forgotten already that the 4 worst economic calamities in US history occurred with central banks allegedly there to prevent such calamities?

    Your faith in socialism seems to not be dissuaded by empirical facts.

  26. Gravatar of George Selgin George Selgin
    29. April 2015 at 18:30

    Jim Glass, your analogy with Chernobyl makes no sense to me.The interwar sustain was a deeply flawed design precisely because it was bound eventually to suffer a meltdown. That was not the case with the pre-WWI system. Nor will it due to say that central banks were bound to do what they did, because part of the superiority of the prewar system is precisely that central banks weren’t that important in it. Yes, there was the Bank of England. But many other participants, including the U.S, Canada, Switzerland, Australia, South Africa, and Sweden (before (1901) didn’t have central banks at all.

    The real “Chernobyl”-like flaw of the pre-WWII monetary system was, in other words, not gold but central banking. And that flaw is still present, in part because so many people don;t recognize it as such, preferring to apologize for it while reserving their vehement criticisms for gold convertibility,, which is itself actually not a such a bad idea.

  27. Gravatar of George Selgin George Selgin
    29. April 2015 at 18:31

    Sorry; read “do” for “due” in my last post. It’s late, and I should be in bed!

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