The US and cyclical economic theory – Part 1

The US and cyclical economic theory – Part 1

Based on the theories of the mentioned economic thinkers, economical models were developed. The only country though that understood the importance of switching economic model based on cyclical theory has been, in my opinion, the US. We will take an overview of the last 200 years of economic history. In the period of 1800s to 1887 the population had just experienced massive changes in technology and business which gave way to social economic changes which was caused by the Industrial Revolution. Agricultural advances, steam engines, railways and the factory system gave way for cultural move away from agrarian lifestyle to urban lifestyles and in addition increase the overall productivity of the Nation. Travel across oceans and rivers became easier connecting markets like never before. America became an exporter of cotton to Britain through the cheap expenses of slavery as Britain was the first to enter the Industrial Age by opening textile mills, which America was able to follow through. Financing the development of these technologies was of the upmost importance to advance the industrialization of the Nations. The Market Revolution (based on the economic liberal ideology of Adam Smith) shaped the way people think in the US. It saw many americans move away from producing things by themselves largely on independent farms and towards producing goods to sale to others. The first thing that enabled this massive shift was new technology, specifically in transportation and communication. In the 18th century it was difficult to bring things to market and that meant that markets where local and small. New transportation systems changed this, making it cheaper to transport goods. The government build the National Railroad. The steamboat set up a mania for channel building, causing cities like New York to flourish. But the most important innovation was the factory, which more than just a technological development was an organization. The American system of manufacturing centered on mass production of interexchangeable parts grew up steadily. Roads, channels, railroads, factories, they all required massive upfront capital investment. The state also had a big role in development, by passing laws to create corporations, issuing bonds for financing, offering good deals to companies that build railroads. The market revolution changed the landscape of work, which for most of the prior 200 years happened at home. Small scale production of clothes and other goods had been done at home largely by woman, and initially this is how industrial production was done as well. Factory owners would produce some of the products like patterns for shoes and then farmed the finishing out to people working in their houses. Eventually they realized that it would be easier to gather the workers in one place. Americans started “going to work” instead of working from home. Work is now regulated by the clock, instead of by the daylight cycle. The nature of work changed. In the farms, artisans worked for a price which was linked to what they produced. In a factory, workers would be paid a wage according to the number of hours they worked regardless of how much they produced. Migration flowed to the West, to take new land. Since it was difficult to find enough workers for the factories, those jobs where filled in by immigrants. Due to periods of booms and busts in the economy, the workers created unions to protect themselves, calling for higher wages and better conditions. The Civil War helped boost industrialization by giving massive contracts to army related businesses. Communications where also improved significantly (the telegraph). Immigration flourished, New York City becoming the center of finance and commerce. At the time, the US was seen by Europe as a developing economy, and investments in the US had a much higher return than in Europe. Railroads were one of the keys to the countries’ 19th century success. Consider that, in the beginning of the 20th century, 7 out of the 10 top companies in the Dow Jones where railroads. They also developed organizational management systems to organize themselves. Rockefeller established Standard Oil, becoming the richest person in the world. Vertical integration was another innovation. Firms bought up all aspects of the production process from raw material, to production to transport and distribution. Horizontal integration was when big firms bought up small ones. Unions flourished and organized themselves better. Unions continued to grow and fight for better conditions, sometimes violently. In the 1920s, there was large scale consumption of relatively new consumer products which was good for American industry. But much of this consumption was fuelled by credit and instalment buying which was unsustainable. When economic uncertainty increases, credit bubbles burst. Signs of economic slowdown already started to appear in the mid-1920s. The stock market crash in 1929 and the Great Depression were not the same. People lost a lot of money in the market crash, but it was massive unemployment which led the main depression. In 1930 a wave of bank failures spread (due to the fact that they did not have enough reserves) as depositors lined up to take the money out before the banks went belly up, banks call in loans and sold assets. This meant that credit froze up, what really destroyed the economy. A frozen credit system meant that more money was in circulation and that led to deflation. When prices drop businesses cut costs mainly by laying off workers. These workers then can’t buy anything, inventories continue to build up and prices drop further. Banks weren’t lending money so importers couldn’t borrow it to make payroll to pay their workers, making more and more businesses go bankrupt, leaving more and more workers unable to purchase the goods and services that would keep the businesses open. Although no-one starved, people were forced to search trash-cans for food and had to ask for unemployment relief. The response to the Great Depression was called “the New Deal”. The New Deal meant that it was the government’s responsibility to guarantee every man the right to make a comfortable living but he didn’t say how he meant to accomplish this. It meant a series of programs whose objective was to fix the depression and prevent future depressions. The New Deal consisted of: a relief program, gave money to people in need; recovery programs, where intended to fix the economy on the short run, and put the people back to work; and lastly, reform programs defined to regulate the economy in the future to prevent future depressions. The National Recovery Administration was defined to be business leaders working together to create industry standards for production, standard and working conditions. One section of the NRA, the Public Works Administration employed 4 million people building bridges, schools, and airports. The crisis has been caused by under consumption and the best way to combat this was to raise workers’ wages, so that they could buy lots of goods. The thinking was that if people experienced less economic insecurity they would spend more of their money, so there were widespread causes for public housing and universal health insurance. The crowning achievement was the Social Security Act of 1935. Social security included unemployment insurance, aid to poor families with children and of course retirement benefits. This is funded by payroll taxes rather than general tax revenue. This was a transformation between the federal government, and the American citizen. Before the New Deal American did not expect them to help them in times of trouble. After the New Deal, the question was not IF the government was going to intervene, but HOW. This is Keynesian Economics, the idea that the government should spend money even if it means going into deficits in order to prop up demand. The State was now much more present in people’s lives. For some people it meant relief and social plans, for others it meant jobs and employment programs. It paid painters to make murals, it paid actors and writers to put together plays, it employed 3 million Americans until it ended in 1943. The program got the support from most of the population bringing the people from different social classes together. The New Deal changed the way of thinking about economics. Liberalism in the 19th century meant limited government and free-market economics. The New Deal changed the people’s expectation about the government. Now when things go sour we expect the government to do something. The New Deal made the government an institution directly experienced in american’s daily lives and directly concerned with their welfare. More American history and economy to come in our next chapter.