San José State University
Department of Economics
& Tornado Alley
Great Depression of the 1930s
The Depression of the 1930s was notable among depressions not only for its severity but also for its duration. In order to explain its duration it is necessary to point out that there are two related but distinct phenomena involved in such an economic crisis. First there is the phenomena of an output recession. The production of goods and services declines and consequently there is a decline in the number of jobs available. Usually this means there is an increase in the unemployment rate. There is also a decline in the utilization of the plant and equipment in the economy. A depression is when the economy is operating significantly below capacity. This is often identified as an unemployment rate of 15 percent or above.
It doesn't take a recession for the unemployment rate to increase. The unemployment rate increase if the rate of growth of real output is less than the rate of growth of the labor force plus the rate of increase of labor productivity. Thus the growth of production could be a healthy 3 percent but if the rate of increase of labor productivity is 1.6 percent then the rate of creation of jobs is only (3.0−1.6)=1.4 percent. If the rate of increase in the labor force is 2 percent then there will be an increase in unemployment. This discrepancy between jobs and labor force is especially severe in an output recession. There is a pool of unemployed that does not necessarily get eliminated when the recession ends and the economy begins to grow again. If the growth in output is normal then it may prevent the unemployment from increasing but does not do anything about the pool of unemployment created by the recession. It takes a supernormal rate of growth in production to wipe out the accumulated pool of unemployment created by the past recession or subnormal growth. Thus the recession that produced a depression can end but the depression can continue indefinitely.
Now consider the Depression of the 1930's. The statistic which best represents the social impact of the Depression is the unemployment rate.
As the above graph indicates that while the economy recovered somewhat from its state in 1933 the unemployment rate remained in the 15 percent range for the rest of the decade. The unemployment rate did not drop from depression levels until the economic impact of World War II was felt. The high level of demand during that war reduced the unemployment rate to minuscule levels. While the unemployment rate should be the defining characteristic of economic depression the standard definition is in term of GDP. The level of production did recover its previous high level of 1929 fairly quickly but this was still significantly below what the economy was capable of producing. The output of an economy is measured by its Gross Domestic Product (GDP) and the graph below shows the decline in production from its high point in 1929 to its low point in 1933 and its subsequent recovery.
The rise in GDP after 1933 was not sufficient to drop the unemployment rate from depression levels because while the GDP was growing the labor force also was growing. Furthermore increases in productivity meant that for the same level of GDP there were fewer jobs. In order to bring down the unemployment rate the rate of growth of GDP has to be greater than the sum of the growth rates of productivity and the labor force. Thus if there is a period in which the rate of growth of GDP is less than the sum of the rates of growth of the labor force and labor productivity then there is a near-permanent rise in the unemployment rate. Only if there is some extraordinary increase in aggregate demand will the accumulated pool of unemployment be absorbed.
The table below tells what was happening to the components of demand.
|The National Income Accounts for the
Great Depression in the U.S.
The above table indicates that consumers, investment and government purchases were generally increasing after 1933. However the level of investment did not exceed its 1929 value until 1937. Note however the decline in GDP and Investment in 1938. This was a recession within the Depression. After peaking in 1937 investment dropped back and did not exceed the 1929 level until 1940. Because of the uncertainty created for business investors by the multitude programs of the New Deal those efforts to stimulate the economy were offset by their adverse on business investment. This is part of what prolonged the Depression. However unless some exceptionally great stimulus led to extraordinary growth in production the pool of unemployment created by the years of recession would continue indefinitely. This is the other part of what prolonged the Depression.
Here is the graph of investment purchases which shows how volatile this component of aggregate demand is.
The drop in investment in 1942 reflects the U.S. government taking over the financing of plant and equipment for World War II.
At this point it is worthwhile establishing a more general theory of what determines the level of demand and output in an economy. If consumer purchases is a function of income which, in turn, is a function of GDP then we must look to the components which are not functions of GDP, what are called autonomous demands, for the determinants of demand. The level of autonomous demand is the sum of investment purchases, government purchases and net exports. The graph below shows GDP plotted versus Autonomous Aggregate Demand (AAD) for the years from 1929 to 1997.
The relationship between GDP and AAD is strong but the World War II years do not fall on the line because during that time consumers were not allowed to buy as much as they wanted to and had the income for. Nevertheless there does appear to be a strong correlation indicating that generally if AAD goes up then GDP goes up and if AAD goes down then GDP goes down. The graph below shows the times series for AAD and GDP plotted over time. The GDP graph seems to reproduce the ups and downs of the AAD graph. The conclusion is that GDP recovered from the Depression because the combined total of investment, government purchases and net exports grew to a level that pushed GDP to full employment and the full utilization of capacity. Thus business saw the need for additional capacity and hence investment recovered.
The immediate cause of the recession that became the Great Depression was the collapse of private investment. This major component of demand fell from $92 billion in 1929 to $9.9 billion in 1932. Exports fell as well but so did imports. During this recession in output the unemployment rate increased from 3.2 percent to 25 percent. Government purchases were increasing somewhat during the period 1929 to 1932 but not nearly enough to compensate for the decrease in investment. After 1932 there were increases in investment and goverment purchases and a resulting growth in GDP but the increase in production was not enough to wipe out the pool of unemployment that had accumulated during the recession period. Therefore unemployment remained high and the economy was thus still in a depression. Investment remained volatile during the period of the 1930's, in part because of the uncertainty created for business by the radical and shifting policies of the Roosevelt New Deal.
The economy recovered from the Depression only with the advent of World War II which pushed demand for goods and services to the limit of its capacity.
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