The Real Reason We're in a Recession: A Controversial Economic Theory

The Real Reason We're in a Recession: A Controversial Economic Theory

When trying to solve any problem, it's important to get to the root cause.

But what happens if you start at the wrong beginning?

That might be what the U.S. has done, argues economist and Columbia University professor Joseph Stiglitz, in trying to solve a major problem: the current recession.

In the latest issue of Vanity Fair, Stiglitz says that prominent economists the world over have completely misunderstood the causes of not only the Great Depression but our own recession—and in doing so have bungled our recovery.

In saying so, Stiglitz has taken on Ben Bernanke, Chairman of the Federal Reserve, former Fed Chairman Alan Greenspan and other economic heavyweights. But we have good reason to take Stiglitz’s argument seriously. In addition to Columbia, Stiglitz has taught at Yale, Princeton, Stanford, MIT and Oxford, been named one of Time’s 100 Most Influential People in 2011 …. and won a Nobel Prize in economics.

So, we broke down the theory Stiglitz worked out with Columbia Business School's Bruce Greenwald to discover the surprising ways our current economic rut is similar to the Great Depression, the real lessons we can learn from that time period (as a country, and as individuals) and how he proposes we turn the economy around.

The Real Cause of the Great Depression

Many economists, including Bernanke, believe that the major cause of the Great Depression was the “tightening” of the money supply, which meant that the Federal Reserve decreased the amount of money available for private banking and lending. Learning from the "mistakes" of the past, Bernanke made much more money available in 2008, when it appeared that our country was on the verge of another economic crisis.

But Stiglitz argues that the Great Depression was well under way before the banking system crumbled in 1933 and that the culprit was our country’s increased productivity in agriculture. Huh? Agriculture? Increased productivity? The first seems unrelated—and the second seems like it would be a good thing.

But Stiglitz posits that agriculture was a victim of its own success—and took the economy down with it.

In 1929, more than a fifth of all Americans worked on farms, producing enough food for the entire country. But today it takes only 2% of the American workforce to produce more than we can consume. Just before the Great Depression, a revolution in agricultural efficiency (sparked by mechanization, as well as better seeds and fertilizer) caused farmers' output to exceed demand, leading the incomes of farm-based workers to be slashed by up to two-thirds. Farmers then had to borrow heavily, leading to a credit crunch, and could not afford to buy as many factory-produced goods, which in turn hurt the manufacturing sector ... all of which snowballed into the Great Depression.

The Parallels Between Then and Now

Just as the Great Depression was set in motion long before 1933, Stiglitz says, our economy was headed into what he calls the "Long Slump" long before the housing crisis and the bank bailouts of 2008.

Yet again, he says, our country was coping with the downsizing of an industry that used to employ a significant percentage of Americans. Sixty years ago, one-third of the U.S. workforce was in manufacturing; today, that industry employs fewer than 10% of our country’s workers. Increased productivity was once again at the root of this transition, coupled with the globalization of many manufacturing jobs.

Why Increased Government Spending Will Save Us

World War II marked the end of the Great Depression. The real reason for this, according to Stiglitz, was the dramatic increase in government spending as our country prepared itself for war. Government spending for the manufacturing of wartime supplies led to higher employment and facilitated the transition of workers to a new industry, as they were trained in factory skills. Additionally, the G.I. Bill (also funded by the government) led to a more highly educated workforce postwar, smoothing over the move away from agriculture.

In the same way, he believes that government spending—though not on another war—could save our economy now, helping us shift from manufacturing toward a services-based economy. He suggests investing in infrastructure, technology and education, all of which he argues the government has under-invested in for decades. Funding for technology and education will keep us on the cutting edge of innovation and help create profitable companies in the future. Additionally, spending on renovations to our infrastructure, including roads, railroads, bridges and power plants, will employ many while helping to make our country more efficient and productive.

The Takeaway

Whether or not Stiglitz’s theory will affect current economic policies remains to be seen; as election fever rises, we’ll hear more and more about the role the government should (or should not) play in our economic recovery. Regardless of your take on his argument, there’s one thing we can all agree on: While we may not be able to depend on the markets, we can invest in our own future so we can weather any future storms.

You can invest in yourself by gaining a career mentor, getting further training in your field or, depending on your industry, pursuing higher education. Taking the reins of your financial life will always help you succeed, regardless of whether or not our government takes a stronger hand in spending for our country's future.

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