Lesson 5: The Crisis of Traditional Liberal Capitalism PDF

Universitat Autònoma de Barcelona World Economic History LESSON 5: THE CRISIS OF TRADITIONAL LIBERAL CAPITALISM Anna Solé Contents • World War I and the economic consequences. • Unbalanced economic growth in the 1920s • The Great Depression (1929-1933) and the anti-crisis policies. • World War II...

Universitat Autònoma de Barcelona World Economic History LESSON 5: THE CRISIS OF TRADITIONAL LIBERAL CAPITALISM Anna Solé Contents • World War I and the economic consequences. • Unbalanced economic growth in the 1920s • The Great Depression (1929-1933) and the anti-crisis policies. • World War II (1939-1945): Economic factors of the conflict. • American financial intervention and European economic recovery. World War I and the consequences • First World War represented the break with the 19th century: • Before WWI: • • • • Political and economic predominance of Europe in the World. Proper functioning of the international payments system. Free movement of factors. Limited intervention of the government in the economic life. • After WWII: • • • • • • Distortions in production and trade. Workers and soldiers’ claims. Poor functioning of the international payments system. Protectionism. Governments assumed an important role in economic decision making processes. USA became the first economic power of the World. The Treaty of Versailles: War Reparations • The Allies imposed sanctions to Germany: • • • • Payments in kind (coal, gold, reserves, weapons...). Territorial cessions. Demilitarization. Payments in kind. • Countries that suffered most destruction, France and Belgium, insisted in receiving enough reparations to cover their debts with the UK and USA. • J.M. Keynes: “The economic consequences of peace”, 1919: • Proposed reparations are economically irrational and politically imprudent. • He alerted of the danger and impossibility that Germany could face up to the reparations. • Social unrest and danger of a Bolshevik revolution. The Treaty of Versailles: War Reparations • Reparations were linked to Germany’s payment capacity: German governments did not foster stabilization and growth policies. Germany deferred the payments as much as possible. • 1923: France and Belgium occupied the Ruhr area tot take possession of coal as payment. German workers started a strike. • 1924: Dawes Plan: • Reduction of the amount to be paid. • Granting of an international loan. • It fostered international trust in the recovery of the mark. Unbalanced economic growth in the 1920s: The German Hyperinflation • Hyperinflation: increase in prices of such a magnitude that economic agents alter their demand patterns. • In 1923 the mark was worth a trillion part of the 1918 mark. The German economy became a barter economy. • Mark stabilization: • Need for believable and convincing measures to rebalance the budget. • Creation of the rentenmark. • The Dawes Plan granted an international loan that allowed Germany to return the Gold Standard. Exchange rates of some European currencies in US dollars Source: Kindelberger, Historia financiera de Europa, Crítica, Barcelona, 1988, pg, 424 Causes of the German Hyperinflation • Two explanations (not mutually exclusive): • Budget deficit: • No political intention to control the public deficit. • Budget deficit was financed through money issuing. • Inflation and depreciation of the mark. • Balance of payments: • Reparation payments and trade deficit led to an increase in the supply of marks. Depreciation of the mark. • Currency depreciation made imports more expensive and increased the internal level of prices. • Money issuing to finance the increase in the costs of the goods and services purchased by the government. Mark stabilization • Need for believable and convincing measures to rebalance the budget. • November 1923: Fixed exchange rate of the mark with respect to the dollar. • The government stopped receiving credit from the Central Bank and reduced the budget deficit. • Creation of the rentenmark, a currency guaranteed by real state property. Issuing of rentenmarks did not exceed the announced amount. • Dawes Plan: granted an international loan that allowed Germany to return to the Gold Standard. Unbalanced economic growth in the 1920s: The Return to the Gold Standard • War financing generated a high inflation. • • • • • Increase in taxes. Spoil of occupied territories. Public debt issuing. International lending. Money issuing. • The increase in fiduciary circulation was the main mechanism to finance the war. • There was a reduction in gold reserves in almost all countries, while paper money circulation increased. It was not possible to guarantee currency convertibility to the previous parity. • All countries suspended the convertibility of their currencies. • The Gold Standard system was abandoned. • Inflation persisted during all the post-war period, even if there was a structural trend to deflation. The Return to the Gold Standard • Two strategies of economic policy: • Return to the gold standard at the pre-war parity. If the currency had depreciated during the period of floating exchange rates, this meant a revaluation of the currency. It entailed the implementation of a deflationary policy. • Establishment of a new parity. It was possible to choose a parity even lower than the market price of the currency. This meant a devaluation of the currency. The Return to the Gold Standard: United Kingdom • The pre-war parity was re-established: Revaluation. Loss of competitiveness. • It was necessary to implement a deflationary adjustment: restrictive monetary and fiscal policies. • Consequences: • • • • Investment, employment and economic growth were depressed. High unemployment. Restrictive fiscal policy: increase in taxes and reduction in social benefits. Social unrest: general strike in 1926. The Return to the Gold Standard: France • During the war, in France there were higher levels of debt and a larger increase in money supply. • Between 1919 and 1926 the franc was stabilized and the gold standard was re-established. France chose an undervalued currency. • French products became more competitive in international markets. Trade surplus. • French government sterilized the increase in gold reserves that trade surplus produced. The franc was kept systematically undervalued. Conditions under which the gold standard was restored • End of the British supremacy. • New parities did not adjust to economic conditions to each country. • New York had become the new World financial centre. • No observance of the functioning rules of the Gold Standard System. • Higher gold concentration. USA and France accumulated gold. • Less flexibility in labour market and international trade. • Excessive dependence from short term capital flows. Unbalanced economic growth in the 1920s: A New Economic Model: the USSR central planning economy • First successful “proletarian revolution”. • Paradox: Russia was an underdeveloped country from the industrial perspective. • Collapse of the absolutist tsarist regime. The Bolshevik party took the power and became a communist party. • Creation of the Union of Soviet Socialist Republics (USSR). • New Economic Policy (NEP): • Designed by Nikolai Bukharin. • Combination of private property (small agrarian units, small business and workshops) and public property (banking, large corporations and transport). • Reduction in the agrarian prices. • Political debate: How to start the process of industrialization. • Slow industrial growth (Bukharin): growth based on light industry, the maintenance of a mixed economy and Socialism in One Country (USSR). • Fast industrial growth (Trotsky and Preobrazensky): growth based on heavy industry, public property and the expansion of the revolution. • Stalin took power. • 1929: Abandonment of the NEP and collectivization. The USSR: central planning • Forced accumulation of capital leaded by the State. • Objective: industrial revolution leaded by the State. • 5-year plans: elimination of the market as the mechanism of allocation of resources and central planning. • Priority to heavy industry. • Under-financing of agriculture and consumption industries. • Extensive model of growth based on mobilization of resources. The Great Depression • Most important crisis suffered by rich capitalist economies in the Contemporary Age. • Recession started in the USA + crash of the stock market + wrong economic policies + bankruptcy of the American banking system: Deflationary spiral that fed back depression until 1933. • Transmission of the depression-deflation spiral to Europe and the rest of the World. The Great Depression: origins • Unbalanced economic growth during the 1920s: wages increased less than productivity and growing inequality in income distribution. • Tendency to overproduction. • Changes in trade: • Slow and limited recovery of trade and reduction in the European participation. • Increase in protectionism and economic nationalism. • International movements of capitals: • Dependence with respect to the American lending. (short term capital flows). • High levels of debt in some countries. Production, productivity and wages in American industry, 1920-1929 Causes of the crisis in the USA: Problems in agriculture • During the war, there was an important increase in agrarian production (increase in cultivated land and introduction of new capital intensive techniques). • After the war, prices began to fall: • Increase in land. • Increase in productivity. • Reduction in demand. • Difficulties to return the loans that were used to finance mechanization • Loss of purchasing power and worsening of terms of trade in agrarian exporting countries. Causes of the crisis in the USA: Income distribution • Important increase in productivity. • Great increase in profits and minor increase in wages. • Increasing inequality in income distribution. • Production grew faster than population’s purchasing power. • Relative excess of capitalization in some industrial sectors. • Investment was reduced in order to avoid relative overproduction. • Profits were diverted to the financial sector. Causes of the crisis in the USA: Profits and stock market speculation • Profits were diverted to the financial system: speculation in the stock market. • While there was people willing to buy, prices would continue increasing. • Portfolio societies: • Raising of small savings. • Purchase of “bad” assets to avoid reductions in their prices. • Investment financed with credit: • Money directly injected had a multiplicative effect. From the crisis to depression: crash of the stock market • August 1929: The Federal Reserve Bank of New York increased the discount rate in order to stop speculation. • Reduction in the credit to brokers. • 3rd October 1929: the stock market started to fall: panic. • 29th October 1929: Black Tuesday. Wall Street: from mania to the crash of 1929 Index of stock prices in New York Stock Market From the crisis to depression: from the crash to the bankruptcy of the banking system • Liquidity run (banking panic and crisis of expectations): Many savers hurried to withdraw their deposits, causing a bankruptcy. • The crisis occurred between December 1930 and June 1931. • As a whole, money supply fell a 33% between 1929 and 1933. • Deflation spread the vicious circle of the depression. From the crisis to depression • The effects of the crash diffused beyond the investors circle, affecting all the American economy. Causes: • General regressive situation of the country. • Disastrous measures of economic policy implemented by the Federal Reserve and the Hoover administration. • Connection of the crash with the bankruptcy of the banking system. From the crisis to depression: the role of economic policies • Although there is debate about the causes of the crisis, agreement on the fact that the economic policy implemented once the crisis had started was completely wrong. • Restrictive monetary policy (imposed by the gold standard system) in a context in which it was necessary to implement an expansionary monetary policy. • The USA defended the dollar convertibility to gold beyond what was reasonable. From the crisis to depression: reduction in production and unemployment From the crisis to depression: reduction in production and unemployment The diffusion of the depression: reduction in international trade: consequences for Europe • Mechanisms of transmission of the Great Depression: • Reduction in international trade: • • • • Reduction in exports (reduction in demand). Tariff war. Reduction in World prices. Deterioration of the terms of trade against agrarian products. The diffusion of the depression: Collapse of the capital markets • Mechanisms of transmission of the Great Depression: • Collapse of the international capital markets: • USA: negative flow of capitals. • Reduction in financing sources: deflationary policies to defend the parity of the currency. • The most damaged countries rebalanced their economies abandoning the Gold Standard System. Economic Policies to fight the depression: the New Deal • Hoover administration: • Orthodox policy. • Restrictive monetary policy: maintenance of the convertibility. • Belief that the government must not intervene in the economy. • Elections 1932: • Hoover: non intervention. • Roosevelt: New Deal. • 1933: New Deal. The New Deal: monetary and fiscal policy • Regulation of banks and the stock market: • Banking Holiday: provisional closure of banks. • Glass-Steagall Banking Act: Separation of commercial banks from investment banks. • Securities and Exchange Commission: control of the stock market. • Monetary policy: • Suspension of the gold standard and devaluation. • More unbalances in other countries. • Fiscal policy: • Breaking off of the principle of budget orthodoxy. • Budged deficit was limited and was not used as an economic policy instrument. • Increase in government spending but no reduction in taxes (or in its distribution). The New Deal: public employment programs • Public Works Administration: • Unemployment was the main problem (25%). • Creation of employment programs. The New Deal: agrarian policy and other sectorial policies • Agrarian policy: • Objective: reduction in cultivated land. • Rural credit: avoid foreclosures. • Industrial policy: • Objective: beat deflation. • Suppression of antitrust legislation, recognition of strike rights and collective bargaining. • Social benefits: • Recognition of trade unions and collective bargaining. • Retirement, unemployment and accident subsidies. The New Deal • Limited macroeconomic coherence. • Contributed to stimulate economic recovery and improved the situation of the most disadvantaged. • Limited scope: • Obstruction from the Republican Party. • Social conflict. • Contradictions in the plan. • From 1938: general mobilization to a war economy. Depression and economic policies in Germany • Germany was one of the most affected countries in Europe by the Great Depression. • Objective of the Nazi regime: full employment and autarky. • Suppression of trade unions and hierarchical organization of factories. • Four-year plans: centralized organization of the economic system. • First plan: unemployment. • Second plan: war economy. • Amazing results in industrial production (not in agrarian production) and fast reduction in unemployment. Second World War II • Conflict between fascist countries and the Allies. • Stages of the war: • 1939-1942: Nazi army advancement. • 1942-1945: Allied counteroffensive. Causes of the conflict • Legacy of World War I and the Treaty of Versailles. • Militarism and remilitarization of Germany. • Rise of Fascism. • Japan’s expansionism. Consequences: human and material losses • Consequences: • • • • • Human and material losses. Population movements. Reduction in income in participant countries. Interruption of commercial relationships. Europe’s weakness and USA leadership. American financial intervention and European and Japanese economic recovery • 1944-45: Food and medicines​. • 1945-47: Basic products supplied by UN program UNRRA (UN Relieve and Rehabilitation Admin)​. • US financed aid: 4.000 million $ to Europe: 3.000 million $ to Asia & Africa.​ • 1947-48 Change in US political position due to USRR clash. ​ • Beginning Cold War.​ The European Recovery Program (Marshall Plan) • USA offered economic aid to European economies. • 13.000 millions $ to Western Europe between 1948-1952 on loans and aid. ​ • Aim: finance the recovery of European countries and avoid shortages of international currencies. • Reception of aid was conditioned to the acceptance of the principles of Bretton Woods. • Administration of the Marshal Plan: • Mixed Institution: ​ 1) Economic Cooperation Administration​ 2) Organisation of European Economic Co-operation OEEC. ​ • Later: Organization for Economic Cooperation and Development, OECD.​ • Two phases:​ • 1948-1949→ food and basic products for the primary sector.​ • 1950-1952 → fuel, raw materials, capital goods for the industry. ​