Remember the right 1920s depression!

In the midst of an economic collapse of historic proportions, the Great Depression has become everyone’s favourite cautionary tale. In one example of many, William White, former deputy governor of the Bank of Canada, recently warned the National Post that policy-makers must “remember the lessons of the Great Depression.”

We should be mindful, however, that the history lessons we’re remembering are those most relevant to our current situation.

With this in mind, anyone hoping for a rapid, V-shaped recovery once the pandemic finally ends should probably spend less time on the disastrous policies of the Great Depression and more on government responses to past economic disasters that actually worked — such as Canada’s remarkable recovery from the depression of 1920-21.

What was the secret to that miraculous success a century ago? Governments that did nothing.

The North American slump of 1920-21 (whether it was a recession or depression remains a matter of debate) was set off by a collapse in global commodity prices at the end of the First World War, as well as the sudden appearance of the Spanish flu epidemic in 1919. The Dow Industrial stock index fell 40 per cent. Corporate profits declined 92 per cent. Unemployment spiked. It was an economic collapse every bit as serious as today’s.

But as Wall Street investment guru and historian James Grant explains in his fascinating book, The Forgotten Depression: 1921 The Crash that Cured Itself, political sentiment at the time held that markets were largely self-correcting. Despite all the economic hardship, Republican Warren Harding won the 1920 U.S. presidential election with a promise to balance the budget and leave the economy alone. “Less government in business and more business in government,” was his slogan. Demands to lower interest rates or boost government spending were flat-out ignored by the laissez-faire Harding administration.

As Harding left the market to deal with the downturn, employers responded by reducing wages. According to the U.S. Bureau of Labor Statistics, by 1921 over 90 per cent of businesses cut their employees’ salaries to survive. While controversial in the short-term, this allowed the labour market to quickly reach a new level commensurate with output and prices.

And it worked. By the end of 1921 the downturn was over and the ’20s proverbially “roared.” It was a time of tremendous growth, exuberance and innovation. The same thing happened in Canada. Conservative Prime Minister Arthur Meighen cut spending in the midst of the 1920-21 downturn, left employers alone and the economy reaped the benefits. According to the textbook Canadian History: Post-Confederation, “In 1920-21 there was a brief but sharp economic collapse … the state pulled back at this time, trying to allow the capitalist market economy to take the lead (and) the substantial improvement in the economy after 1921 vindicated this approach.”

Now consider the Great

Depression. After the stock market crash of 1929, governments decided it was untenable to allow wages to fall as abruptly as they had a decade earlier. Newly powerful labour unions eagerly abetted this new policy of keeping workers’ wages high.

As a result, only seven per cent of U.S. firms lowered their employees’ pay in 1930 as the depression took shape. Canada experienced a similar thing. Businesses were caught in a vice of falling prices and artificially high wages, leading to mass bankruptcies and high unemployment that lasted until the Second World War.

The Great Depression staggered on for a decade. The “forgotten depression” of 1920-21 was over in a yearand-half. Which history lesson would you prefer?

If we’re willing to learn from the past, the experience of the 1920s demonstrates the importance of flexible wage rates in jumpstarting an economic recovery. The ability of the labour market to respond to dramatic price changes is crucial to reviving a moribund economy.

Yet most current federal government policies have the effect of fixing wages at existing levels through subsidies and handouts. While this may make short-term political sense, over the long-haul sticky or inflexible wages are an economic disaster, as the Great Depression demonstrates.

What’s worse, most post-lockdown policy proposals threaten to further calcify the labour market at artificial levels. A universal basic income would leave large swaths of the population uninterested in returning to work — putting a floor under existing wage rates. The same thing could happen if temporary lockdown bonuses paid to low-skilled workers are mandated to become permanent raises, as some unions are now demanding. If anything, minimum wage rates should be lowered or abolished in the post-coronavirus era to allow for maximum flexibility.

Of the two great depressions of the 20th century, we should be remembering the lessons of the one that was over the quickest.

THE ‘FORGOTTEN DEPRESSION’ OF 1920-21 WAS OVER

IN A YEAR-AND-HALF.