The Wall Street Crash

1929 was one of the most serious economic crises of the last century and even today it is often cited and compared with more recent crises to evaluate their effects and to compare the measures launched by governments to support economic recovery. Once again, studying the past can help us better understand the present and the political debate that characterizes it.

The economic boom

In the aftermath of World War I, the United States experienced an unprecedented economic boom. The economic recovery of Europe, thanks above all to American loans and the Dawes plan, allowed the expansion of the American economy, which began to see the loans granted repaid, thanks above all to an increase in exports of goods and capital towards the Europe. In the two-year period 1925–1926 there was an increase in the production of cars, radios and household appliances, supported by some determining factors: the rationalization of work and Taylorism, the assembly line and financial speculation.

The causes

The increase in industrial production did not correspond to a fair distribution of income and an improvement in the well-being of Americans, in particular the poorest sections of the population. The economic expansion was accompanied by a fiscal policy based on the disciplined management of public spending and high indirect taxation, which particularly affected the rural and less well-off classes. This contributed to determining the progressive decline in demand for consumer goods, already in a context of excess supply of durable goods compared to demand. Simultaneously, demand from European countries also decreased. In fact, the heavy customs tariffs imposed by the United States prevented these same countries from exporting their goods and balancing their trade balance. Furthermore, in 1928 US bankers began to withdraw capital from Europe to invest in more profitable speculative stock market operations.

The crack

The result was a crisis of overproduction resulting in the collapse of commodity prices and the bursting of the stock price bubble. On October 24, 1929, the New York Stock Exchange collapsed and the consequences for the real economy were dramatic. The USA suspended the disbursement of loans abroad and further tightened customs tariffs with a contraction of trade by up to 60%. Thousands of businesses failed and in 1932 there were 14 million unemployed in the USA and 15 million in Europe. Furthermore, the Americans demanded the repayment of loans still unrepaid by European countries, leading to the collapse of European banks.

The effects on the european economy

In Europe, the crisis was addressed with various monetary and trade policy measures. On the monetary policy front, England opted for increasing inflation in order to devalue the pound and benefit exports by making its products more affordable abroad. France and Italy instead opted for a restrictive monetary policy with an increase in interest rates and cuts in public spending in order to support the value of the currency. The result was a collapse in exports. From the point of view of trade policy, the USA adopted a marked protectionism, resulting in a real trade war. Great Britain, in fact, responded with the creation of the Imperial Customs Union with its dominions and its colonies. Germany and Italy inaugurated the season of autarky. However, these measures did not prove sufficient to counteract the recession. In those years, common interest began to spread at a global level towards rearmament and the development of war production, given the growing worsening of international tensions. Within some countries, unemployment and the exasperation of the middle classes strengthened criticism of liberal systems and in Germany favored the rise of Nazism.

The New Deal

In 1932 the newly elected Democratic president Franklin Delano Roosevelt inaugurated the New Deal based on state intervention in the economic field and on the development of social and trade union democracy, to revive the fortunes of the American economy. On the monetary policy front, we proceeded on the one hand with the devaluation of the dollar to boost exports, and on the other, with the regulation of the financial market. On the fiscal policy front, the objective was set of reducing the agricultural deficit in order to control production. To avoid inflating the market, tax incentives were provided to farmers to limit the production of the main commodities: rice, sugar, wheat, cotton and tobacco. But the most significant economic policy measure was certainly the National Industrial Recovery Act (NIRA), a program of deficit-financed public investment in infrastructure, with the aim of creating jobs by boosting domestic demand. The program also aimed to promote agreements between companies and trade unions. Additionally, the Tennessee Valley Authority was established, a government enterprise tasked with exploiting the water resources of the Tennessee Basin by providing a public option for the provision of energy at a political price. Trade union organizations were protected and strengthened, wages were defended, working hours were reduced; benefits for the unemployed, elderly, sick and disabled were increased. A tax reform was passed which increased the progressivity of income tax.

Keynes

The increase in public spending responded to the theory of deficit spending, theorized by the English economist John Maynard Keynes. Keynes proposed a new conception of the functioning of the capitalist economic system. Keynes criticized inflationary doctrines which, by compressing incomes and wages, restrict demand. He argued that to increase effective demand, it is necessary for the State to intervene energetically in economic activity, promoting large public works, even at the cost of the budget deficit, as opposed to the promotion of a balanced budget of the classical economists. To finance this policy, a reform of the tax system would have been necessary, with the introduction of progressive taxes, particularly high for the wealthy classes. Keynes’ proposal arises from his study of the dynamics of prices and labor: these do not remain in equilibrium in periods of depression.

The moltiplicator

Classical economists, on the other hand, argue that this should happen automatically with the efficient functioning of the free market. Keynes concluded that the quickest way to get the economy growing again after a recession is to increase demand through short-term expansion of government spending. At the basis of this position is the concept of multiplier. According to this theory, if a government invests in large projects (infrastructure and public services) during a recession, employment will increase more than the number of directly employed workers. National income will have a greater value than public spending.

Neoclassical economists, however, attack the Keynesian multiplier principle by stating that governments must necessarily increase taxes or the public deficit to finance an increase in public spending. Higher rates take money away from the economy, discouraging consumption and investment spending, ultimately weakening supply (businesses) and internal demand (individuals and families). Alternatively, a government could decide not to raise taxes but to finance public deficit spending by borrowing money. At that point the debt creates inflation, causing prices to rise and real wages (net of inflation) to fall.