SPEECH: Nothing to fear but fear itself: from depression to recovery in the 1930s and in today’s European Union
European Commission - SPEECH/13/200 07/03/2013
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European Commissioner responsible for Employment, Social Affairs and Inclusion
Nothing to fear but fear itself: from depression to recovery in the 1930s and in today’s European Union
Public evening debate on "80 years of the New Deal: lessons for Europe today"/Brussels
7 March 2013
Ladies and Gentlemen,
“We are stricken by no plague of locusts… Nature still offers her bounty and human efforts have multiplied it. Plenty is at our doorstep, but a generous use of it languishes in the very sight of the supply.”
“Our greatest primary task is to put people to work. This is no unsolvable problem if we face it wisely and courageously.”
These words from President Roosevelt’s first inaugural address are as true in Europe today as they were in America 80 years ago.
And I believe European leaders could draw a lot of inspiration from the resolve with which FDR mobilised nearly all social groups in an unprecedented federal effort to ensure that the real economy recovered from the Great Depression.
When the Barroso II Commission took office, we knew that the 2008 crash on the financial market was comparable to 1929.
We know now that the depression of the past five years has been, fortunately, not as deep as the Great Depression of the early '30s, thanks to more or less accommodating monetary policy, avoiding the pitfalls of protectionism and a fiscal stimulus in the first years of the crisis.
America's GDP fell by 37% between 1929 and 1933, whereas Europe has seen around 2% decrease in its GDP between 2008 and 2012.
America’s estimated unemployment rate peaked between 20 and 25% in 1933, up from about 5% before the crash. EU unemployment is now at about 11%, while in 2008 it was around 7%.
But the crisis in Europe is serious. The number of unemployed people is a record-high 26 million and rising, and our monetary union is experiencing unprecedented divergence in economic and social outcomes.
The Greek GDP, for example, fell by about 20% between 2008 and 2012, Spanish GDP by 5%, and unemployment in both countries is higher than in the US at the peak of the Great Depression.
Unlike the US, we do not have a political union. Our monetary union is more like a chain dependent on the strength of its weakest links.
At the same time, the European economy is much more open and globally interconnected, and our welfare systems are more developed than in America of the ‘30s.
Our economic crisis may not be as deep as the Great Depression was, but the prospect of an economic recovery has been postponed for many times and there is no very credible light at the end of the tunnel.
We do not seem to have anybody like FDR in Europe.
We seem to have stronger examples of other approaches from the early '30s, like Herbert Hoover, suggesting that "prosperity is just around the corner", or that of Hoover's Treasury Secretary Andrew Mellon, who argued that "the government must keep its hands off and let the slump liquidate itself. Liquidate labor, liquidate stocks, liquidate the farms, liquidate real estate". According to this approach, a collapse of the economy, with high unemployment and poverty, helps "purge the rottenness out of the system" and make people "work harder, live a more moral life", so that "enterprising people will pick up the wrecks from less competent people."
Such approaches may appear intellectually tempting to those who are well-protected, but they imply starvation for others. And we know from history that frontloading destruction in order to foster creation is an approach that does not usually produce the expected results.
That’s why it is highly relevant to look at the New Deal and analyse how FDR managed to start a recovery.
The buzzwords that characterised the New Deal are not really present in the European debate today. There is little or no relief or recovery, although we speak a lot about growth in the medium-to-long term. Reform often takes on the meaning of letting the market work spontaneously, with less attention to fairness and to investment that genuine reform would require. Finally, reconstruction is something that people usually contemplate only for extreme cases like Greece, probably because the word reconstruction implies a certain change of direction and many tend to believe that our present direction is still the right one.
Not all that FDR did was great, and not all New Deal programmes were successful. Some of his actions were rather conservative in nature, while others were more progressive. It was a diverse and pragmatic mix of measures prepared by a diverse mix of people. Only much later was Keynesian theory associated with the New Deal.
Compared to FDR, we have an extra 80 years of experience to learn from, so we should know what should and should not be done to bring an economy out of a recession.
I want to focus today on five main lessons from the New Deal era:
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Leadership and strengthening of the federal executive
Ladies and Gentlemen,
FDR was not the mastermind or initiator of all the New Deal reforms.
He was pushed into many of them by various more radical initiatives in the Congress or in the field, like in the case of industrial policy based on sectoral agreements coordinated by the National Recovery Administration, which was his response to an effort in Congress to legislate a maximum 30 hour working week.
When he launched the Committee on Economic Security in June 1934 and signed the Social Security Act one year later, he was responding not only to the Depression itself but also to a boom of similar initiatives, like the Townsend pension plan in California.
But FDR acted against the Depression from day one, on many fronts, and he decisively strengthened the powers of the federal government to act. He didn’t hesitate to draw parallels with wartime, and the unprecedented wave of reforms which the Congress approved during his first hundred days in office was largely based on confidence in his leadership.
FDR’s decisiveness and charisma enabled a major shift of power – and of responsibility – from the states and from Congress to the White House. And it is evident that without federal policies like bank regulation, deposit insurance, mortgage refinancing, crop destruction, reconstruction finance, commodity credit and later social security, the crisis could not have been addressed.
Roosevelt masterfully balanced the concerns and interests of a great variety of constituencies, from bankers to farmers to the industry and the unemployed.
What does this mean for Europe today?
We are also experiencing a strengthening of the federal executive, in the sense that stronger economic governance has been established through the European Semester, the Six-Pack, the Fiscal Compact and the Two-Pack. This strengthens coordination and oversight of budgetary and structural policies, and underpins the macroeconomic stabilisation mechanisms which we have created to provide emergency loans to troubled sovereigns.
This effort is characterised by an expectation to restore financial market confidence in each of the individual Member States, with a hope that this will defeat the crisis in Europe as a whole.
The solutions we are pursuing in Europe are by and large not federal.
The EU budget is being reduced on the basis of a questionable assumption that if Member States are cutting, so must the EU, as if the EU budget was not predominantly a budget for investment of trans-national importance.
We are also still quite far from EU-wide deposit insurance or a bank resolution framework.
There are some solutions which resemble the New Deal, for instance EU project bonds and the increase in the capital of the EIB, but these are relatively small and don’t directly address the employment and social crisis. And while there is a plenty of money in the market, it often fails to reach companies in the real economy, especially in the higher-risk countries.
When it comes to decision-making, the EU is of course very different from FDR’s America. Nothing happens without an agreement in the Council of 27 Member States. Occasionally some of the Members opt out like on the Fiscal Compact, or they go ahead in a smaller group like on the financial transaction tax.
The leaders of the strongest countries often attempt to lead the process, for example through preparatory discussions on a beach in Deauville. However, so far this has not resulted in federal solutions or in any sort of a grand bargain that Europe needs to overcome the crisis.
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From laissez-faire to proactive government
Besides the quality of FDR’s leadership, the New Deal was a breakthrough also because it changed the prevailing economic paradigm. Roosevelt’s call for “action now” meant that the society would no longer wait for the market to achieve the optimal allocation of resources and to set prices at the right level.
During his first hundred days in office, Roosevelt stabilised the banking sector, renounced the gold standard, launched industrial policy, public works and a farm programme, and created public sector financial institutions.
The fundamental common feature of his policies was the effort to combat deflation and get money flowing into economic activity again.
He didn’t do this by fiscal policy as much as by monetary and structural policies.
The key thing, of course, was to increase money supply by scrapping the dollar peg to gold.
But he also embarked on crop destruction and agricultural regulation to reflate commodity prices, while boosting farm activity through refinancing of agricultural mortgages.
Moreover, the sectoral industrial agreements coordinated by the National Recovery Administration established minimum wages and maximum working hours and helped eliminate child labour, which helped to reflate the price of labour and increase demand.
Monetary and structural policies in today’s Europe are quite different. The monetary union is dealing with asymmetric developments predominantly through internal devaluation in the labour market, which leads to deflation and rising debt-to-GDP ratios rather than to reflation.
In surplus countries, wages are reflating by modest measures, but not in the whole economy, as some sectors or types of labour contracts have very low or non-existent minimum wages.
The ECB’s pledge to maintain the integrity of the Eurozone action has been vitally important in stabilising the euro crisis for some time. But otherwise, the ECB is the most conservative of the large central banks of the world, with price stability remaining its primary objective. When it comes to refinancing, the ECB has provided a lot of short term liquidity for the banks, but investment in the real economy is still hampered by uncertainty, and uncertainty also looms over each refinancing tranche for troubled sovereigns.
In terms of fiscal policy, Roosevelt never really embarked on Keynesian solutions before the war. He campaigned on budgetary responsibility, entrusted the Treasury to strict proponents of balanced budgets, and his first steps in office included cuts in payments to veterans and civil servant salaries.
He allowed budget deficits to finance the New Deal programmes for a couple of years. But by mid-1937, Treasury Secretary Henry Morgenthau convinced him that this was an unsustainable policy which discouraged private investment through a spectre of high future inflation and taxes.
The fiscal contraction of 1937 was rapidly followed by a double-dip recession, something which we know very well in Europe since 2011. It is worth keeping the 1937 lesson in mind as we debate – or do not debate – the issue of fiscal multipliers.
But if FDR managed to change the prevailing economic policy paradigm so quickly, why is it so difficult today?
Perhaps we are still living in the long shadow of Thatcherism. After all, FDR's approach was also influencing US economic policy for another 25 years after his departure.
Perhaps it is a generational issue, and today's policies are shaped mainly by people who professionally grew up at the prime time of the Washington consensus and during the neoliberal transition in Central and Eastern Europe.
Perhaps the economic strength of Germany is translating into hegemony of ordoliberal thinking, where the least regulated market with unbridled competition is assumed to be the most social one and where what is good for the Schwabian housewife is considered to be good for Europe as a whole.
In reality, an approach focused predominantly on policy stability and restraint from intervention is not proving very effective in countering the growing economic and political instability and destruction in Europe. Simply letting markets work is unfortunately producing deeply anti-social outcomes.
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Financial sector regulation
Let me now briefly highlight the importance of financial sector regulation, about which FDR was very eloquent in his first inaugural address.
The Great Depression as well as our present crisis have been largely self-inflicted due to belief in the self-regulatory capacity of financial markets.
The bubbles of the roaring ‘20s were repeated in the roaring ‘90s, as Stiglitz has called them, and a roaring first decade of the new century, when the concept of sovereign risk almost completely disappeared in the EU, even if people knew that the construction of our currency union was incomplete.
Large capital flows produced real estate bubbles and pushed up wages in the peripheral Member States. Those wages are now going down, but there has been much less progress in cleaning up bank balance sheets.
A major element of the financial deregulation movement was to water down and eventually repeal the separation between deposit and investment banks introduced in the US by the Glass–Steagall Act of 1933. Europe is now engaged in a difficult debate on whether and how this separation could be restored and what the rules for bank resolution should be.
Experience from past years suggests that EU institutions, governments and central banks were too lenient when it comes to resolution of financial institutions. Today, the economy is awash with liquidity but we have a credit crisis – banks do not lend to SMEs. It may therefore be worth remembering that FDR had no intention to please the markets or use them as judges of good economic behaviour. He wanted to discipline them.
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Dealing with unemployment and social crisis
As the fourth lesson, let me highlight FDR’s action to address the urgent problem of unemployment and poverty.
He launched the Public Works Administration and the Federal Emergency Relief Administration within his first hundred days in 1933 and the Works Progress Administration in 1935. The WPA built or renovated over 2,500 hospitals, nearly 6,000 schools, 1,000 airport landing fields and some 13,000 playgrounds. The Emergency Relief Appropriation Act of 1935 provided for the single biggest financial appropriation in US history, to be spent at the President’s discretion.
Unemployment relief meant also expansion of employment within the government, and provision of federal grants to states for this purpose.
In current employment policies, public works are considered to be a rather extreme tool, and public sector employment is generally being slashed given the need for fiscal consolidation.
In the April 2012 Employment Package, the European Commission highlighted the importance of boosting labour demand by shifting taxation away from labour and by proactive policy in areas with greatest job-creation potential like the green economy, health and care and ICT. Unfortunately, as regards reducing the tax wedge on low-paid labour, not much has been implemented at national level.
Because of the under-developed political union in Europe, fiscal transfers from the federal level to individual states for employment relief are difficult to agree. We have structural funds of about 0.4% of EU GDP, which finance vital investment in infrastructure and human capital, i.e. they operate mostly on the supply side.
But there have been interesting fresh developments. Last week the Council agreed on the Commission’ proposal for a Youth Guarantee. The Member States committed to ensure that no young person should be left without a quality offer of a job, apprenticeship, traineeship or continued education after four months of leaving school or becoming unemployed. Implementation of the Youth Guarantee can be financed from the European Social Fund, and in Member States with the highest youth unemployment rates, this support will be reinforced through additional € 3 billion funding under the new Youth Employment Initiative.
Lack of economic opportunities for young people was obviously a big problem during the Great Depression, as in Europe now. FDR’s National Youth Administration created part-time public sector jobs for more than 600,000 college students, 1.5 million high-school students and 2.6 million jobless young people out of school.
With the Youth Guarantee, Europe is trying to give a real chance of employment to every young person, and prevent a destruction of human capital. The federal fiscal transfer underpinning it is not huge, but it definitely represents a step in the right direction.
Besides combating unemployment, one of the biggest legacies of the New Deal is of course the creation of a social security system in 1935, including unemployment insurance, old-age insurance and federal contributions to the states to finance care of dependent mothers and children, disabled and blind, and provision of public health services.
While seven US States had national unemployment insurance systems before 1935, all of them did so by 1937, and the first payments were made in 1936. As regards social security, the 1935 law foresaw a seven-year period for the build-up of the trust funds. Eventually, the start of monthly benefit payments was advanced to 1940.
It was a reform with long-term ambition, even as it responded to a crisis in the short term. But the key point is that the federal level took responsibility for dealing with the social crisis.
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Fifth, let me highlight how Roosevelt sought to give voice to every interest group and to actively balance their interests.
An early example was the launch of sectoral negotiations resulting in agreements on minimum wages, maximum working hours and elimination of child labour.
The New Deal era saw a rise in the importance of trade unions, and the National Labor Relations Act of 1935 provided legal protection to organised labour and encouraged collective bargaining.
At the same time, an important transformation of industrial relations took place through the bitter break-up between the well-established craftsmen's unions and the younger industrial unions.
Roosevelt was visibly disinterested in the nitty-gritty of whom exactly which trade union was representing, but he cared very much about giving everybody a stake and a voice. If the nation-wide mobilisation for recovery were to succeed, no particular interest could be allowed to gain the upper hand over the rest.
Today in Europe, the economy is more diverse than in interwar America, and trade union membership is decreasing due to the rise of services and labour market segmentation. While capital moves globally, there is no coherent counterweight bringing together unionised workers, young people on precarious contracts, the unemployed and the inactive. Rather than striving to broker between the different interests in society, governments in some countries are engaged in emptying social dialogue of substance.
European governance and policy coordination is developing quite rapidly, but we would certainly need a New Deal in terms of strengthening social dialogue and bringing the whole of society on board.
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Solving the crisis of Europe’s monetary union
Ladies and Gentlemen,
Allow me now to briefly project the lessons of the New Deal into our present debates on the social dimension of the Economic and Monetary Union.
Much of economic strategy in Europe today is centred on the notion of confidence.
For FDR, re-establishing confidence meant decisively addressing the real problems of people, rather than focusing mainly on the financial markets. And he strengthened confidence by pursuing reflation and supporting social dialogue, not the other way round.
Measures to tackle the employment and social crisis, in cooperation with business and unions, were at the centre of his recovery effort. And this was also what legitimised the transfer of power to the federal executive.
Last week we had an interesting debate in the Employment and Social Affairs Council with President Van Rompuy on the meaning of the social dimension of EMU and on concrete steps that should be taken.
There is growing recognition that a currency union of 17 or eventually some 26 countries cannot be sustained if there is excessive divergence in socio-economic outcomes, and if employment and social problems within the currency union are not addressed.
There is also growing recognition that because of one-size-fits-all monetary policy and constrained fiscal policy, individual countries may not be able to deal with employment and social crises on their own.
Especially if national debt is as high as it is today, individual countries may be unable to deploy the necessary structural reform and investment. However, because a social crisis in one Member State of a currency union quickly becomes an economic problem for the rest, fiscal transfers are necessary if we want to maintain growth and unity.
In short, we need federal solutions.
Without social union, national welfare states have very little chance to survive.
If we want Europe to be fair and democratic, we need a social union.
One important idea, which the Commission will develop already this year, is a scoreboard of employment and social imbalances in the EMU. Because the currency union cannot collectively address employment and social problems and rising disparities if its economic governance framework does not pay attention to them.
We need greater consideration of employment and social issues in the European Semester and in formulation of macroeconomic policies. We need policy benchmarks for adequate action on employment and social problems, like the Youth Guarantee. And possibly we need minimum social standards in order to prevent macroeconomic adjustment relying too much on internal devaluation.
It is good that debate has opened on issues like introduction of minimum wages throughout the currency union. You may remember that Jean-Claude Juncker suggested precisely this during his farewell appearance in the European Parliament, and that the Franco-German non-paper on social Europe circulated last week is also explicitly discussing the idea.
But perhaps the key lesson from FDR’s New Deal for EMU 2.0 is that the issue of federal fiscal transfers should not be a taboo. A large and diverse economic union needs solidarity at the federal level if it is to emerge from a deep crisis united.
We know that the stabilisation function of national budgets has largely weakened after the first two years of the crisis, and that it is inadequate in the situation of massive asymmetric shocks impacting the European economy.
Federal solutions like the establishment of an EMU automatic stabilisation mechanism in the form of EMU unemployment benefit scheme should be openly discussed.
Such an unemployment insurance or unemployment benefit scheme, focused on the short term, would allow both for more automatic stabilisation of individual member economies and for more consistency between their labour markets.
If such a scheme had been in place when the euro was launched, Spanish workers would likely have been net contributors for the German unemployed. Today it would be the other way round.
The point is that better and automatic stabilisation within the EMU would move some cyclicality from national budgets to the federal level, where it is more easily absorbed.
This would benefit not only the EMU members' economies, but would also generate positive spill-overs to the rest of the EU and beyond, as neighbouring economies would also be less exposed to the fluctuations of the economic cycle.
Finally, such a federal unemployment benefit scheme would confirm that the monetary union cares for the weak, and that it therefore makes sense to trust such a union to deliver a prosperous future. In a word, it would strengthen confidence.
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Ladies and Gentlemen,
We cannot assume that the New Deal solutions of 80 years ago could be directly applied in the current situation. However, the factors behind the Great Depression and our present crisis are similar, notably financial sector deregulation, weakness of macroeconomic demand, sluggishness of private sector investment, an imperfect inherited monetary system and the half-built nature of federal institutions in the US before FDR and in Europe today. The length of the crisis is also similar, and the social consequences too, at least in the South European periphery. So it does make sense to look for parallels in terms of possible solutions.
As in the '30s, the solution lies in closer economic policy coordination with greater focus on employment, tighter financial sector regulation, greater solidarity on the federal level and more democratic legitimacy.
A 21st century New Deal would need to be adapted to current reality. It would need to be resource efficient and low-carbon. Employment and social policies would need to take into account much greater polarisation of the labour market due to automation and other technological developments. A new New Deal would need to respond to the specifics of Europe’s Economic and Monetary Union. And it would have to be more international in character, building on formats like G20 and Rio+.
To conclude, FDR’s New Deal remains one of the best available examples and sources of inspiration we have for a progressive crisis response. It would be good to act on some of the lessons sooner rather than later. We have nothing to fear but fear itself.