- The Foundry: Conservative Policy News from The Heritage Foundation - http://blog.heritage.org -

Does 'Austerity' Work?

Posted By David Weinberger On October 27, 2011 @ 10:55 am In Economics | Comments Disabled

Remember the Great Depression of the 1920s? If not, that’s because it didn’t happen. The recession of the early ‘20s quickly ended after spending and taxes were cut dramatically. It provides a clear lesson in “austerity [1]” that President Obama should heed.

In 1920, newly elected President Warren Harding inherited a very sharp downturn from his predecessor, Woodrow Wilson. According to Cato economist Jim Powell [2], the downturn was “almost as severe, from peak to trough, as the Great Contraction from 1929 to 1933 that FDR would later inherit. The estimated gross national product plunged 24 percent from $91.5 billion in 1920 to $69.6 billion in 1921. The number of unemployed people jumped from 2.1 million to 4.9 million.”

Unlike President Herbert Hoover, who dealt with the initial downturn precipitating the Great Depression, President Harding knew that the market would best recover if left to do so on its own. He loosened government’s inflexible grip and gave the economy the breathing room it needed. He cut spending sharply, from $6.3 billion in 1920 to $5 billion in 1921 and $3.2 billion in 1922.

At the same time, Harding took the advice of his Treasury Secretary, Andrew Mellon, and steeply slashed tax rates. The top income tax rate went from 73 percent to 24 percent. The bottom rate went from 4 percent to 0.5 percent [3].

These combined cuts resulted in economic recovery in 1922, only a year-and-a-half later. Gross national product (GNP) rebounded, and unemployment fell to 2.8 million. [2] The cuts fueled an explosion of growth and prosperity through the rest of the ‘20s.

Powell notes that “GNP expanded year after year without inflation. Productivity improved, and real wages increased. The stock market tripled. There was a dramatic expansion of the middle class.” The unemployment rate was as low as 1.8 percent in 1926!

The policy lesson of the 1920 downturn becomes even more accentuated in light of the mistakes and mismanagement of policy during the 1930s, which enabled the 1929 downturn to become a decade-long depression. The contrast could not be clearer: Government meddling is counterproductive to economic growth.

Lamentably, thus far with our current troubled economy, lawmakers have decided to pursue policy decisions closer to those of Presidents Hoover and Roosevelt than those of President Harding. The results are as predictable as the severity and duration of the Great Depression were avoidable.

The real lesson is that government “austerity” leaves room for private-sector growth. It’s not too late to pursue it [4].


Article printed from The Foundry: Conservative Policy News from The Heritage Foundation: http://blog.heritage.org

URL to article: http://blog.heritage.org/2011/10/27/does-austerity-work/

URLs in this post:

[1] austerity: http://www.heritage.org/research/reports/2013/02/budget-cuts-would-not-harm-the-economy

[2] According to Cato economist Jim Powell: http://www.cato.org/pub_display.php?pub_id=9880

[3] The top income tax rate went from 73 percent to 24 percent. The bottom rate went from 4 percent to 0.5 percent: http://books.google.com/books?id=HwTPk00QMHIC&pg=PA130&lpg=PA130&dq=table+percentage+of+total+personal+income+tax+paid+by+different+net+income+groups+1920+1925+1929+under+%245,000&source=bl&ots=5vBXRI76gI&sig=07Gpmv2qz2GHSJ7s27DBleze5-4&hl=en&ei=KG-FTMzHLY

[4] It’s not too late to pursue it: http://www.heritage.org/research/reports/2011/05/saving-the-american-dream-the-heritage-plan-to-fix-the-debt-cut-spending-and-restore-prosperity

Copyright © 2011 The Heritage Foundation. All rights reserved.