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International Aspects of the Great Depression and the Crisis of 2007: Similarities, Differences, and Lessons Downloaded From Oxford Review of Economic Policy, Volume 26, Number 3, 2010, pp. 318–338 International aspects of the Great Depression and the crisis of 2007: similarities, differences, and lessons Downloaded from Richard S. Grossman* and Christopher M. Meissner** http://oxrep.oxfordjournals.org/ Abstract We focus on two international aspects of the Great Depression—financial crises and international trade—and try to discern lessons for the current economic crisis. Both downturns featured global banking crises which were generated by boom–slump macroeconomic cycles. During both crises, world trade collapsed faster than world incomes and the trade decline was highly synchronized across countries. During the Depression income losses and rises in trade barriers explain trade’s collapse. Owing to vertical specialization and more intense trade in durables, today’s trade collapse is due to uncertainty and small shocks to trade costs hitting international supply chains. So far, the global economy has avoided the global trade wars and banking collapses of the Depression, perhaps owing to improved policy. Even so, the global economy remains susceptible to large shocks owing to financial innovation and technological change, as recent events illustrate. at ENS BIOLOGIE on October 26, 2015 Key words: banking crises, gold standard, trade costs, trade collapse, vertical specialization, tariff retaliation JEL classification: E42, E51, F33, F36, F44, F0 2, F15, G21, G28, NG01, 0 1 I. Introduction Despite the severe stagnation that has gripped the world’s economy in the aftermath of the subprime crisis, the Great Depression remains, without question, the longest, deepest, and broadest economic contraction that the industrialized world has ever known. In all 17 of the countries for which data are presented in Figure 1, real GDP per capita growth during 1930– 33 was far slower than during the period before the First World War (1871–1913), the inter- war period as a whole (1919–39), the quarter-century following the Second World War *Wesleyan University, Middletown, CT, and Institute for Quantitative Social Science, Harvard University, e-mail: [email protected] **University of California, Davis, and National Bureau of Economic Research, e-mail: [email protected] We are grateful to our discussant, Forrest Capie, conference participants, the editors of this issue, and two anonymous referees for helpful comments. Any remaining errors are the sole responsibility of the authors. doi: 10.1093/oxrep/grq021 © The Authors 2010. Published by Oxford University Press. For permissions please e-mail: [email protected]. International aspects of the Great Depression and the crisis of 2007 319 Figure 1: Average growth rates of GDP for 17 countries by period, 1870–2006 Downloaded from http://oxrep.oxfordjournals.org/ Source: Maddison (2009). (1948–73), and the subsequent period (1974–2006). More than three-quarters of these coun- tries experienced negative economic growth. Unemployment rates of above 20 per cent were common (Table 1). Banking and financial crises were widespread (Table 2). Trade also de- clined substantially (Figure 3): exports in 27 leading countries declined by over 50 per cent at ENS BIOLOGIE on October 26, 2015 between 1929 and 1932 while real GDP in these countries fell some 15 per cent during those Table 1: Unemployment in industry (%) Country Australia Belgium Canada Denmark France Germany Netherlands Norway Sweden UK US Year 1920 5.5 4.6 6.1 3.8 5.8 2.3 5.4 3.2 8.6 1921 10.4 9.7 8.9 19.7 5.0 2.8 9.0 17.7 26.6 17.0 19.5 1922 8.5 3.1 7.1 19.3 2.0 1.5 11.0 17.1 22.9 14.3 11.4 1923 6.2 1.0 4.9 12.7 2.0 10.2 11.2 10.7 12.5 11.7 4.1 1924 7.8 1.0 7.1 10.7 3.0 13.1 8.8 8.5 10.1 10.3 8.3 1925 7.8 1.5 7.0 14.7 3.0 6.8 8.1 13.2 11.0 11.3 5.4 1926 6.3 1.4 4.7 20.7 3.0 18.0 7.3 24.3 12.2 12.5 2.9 1927 6.2 1.8 2.9 22.5 11.0 8.8 7.5 25.4 12.0 9.7 5.4 1928 10.0 0.9 2.6 18.5 4.0 8.6 5.6 19.2 10.6 10.8 6.9 1929 10.2 1.3 4.2 15.5 1.0 13.3 2.9 15.4 10.2 10.4 5.3 1930 18.4 3.6 12.9 13.7 2.0 22.7 7.8 16.6 11.9 16.1 14.2 1931 26.5 10.9 17.4 17.9 6.5 34.3 14.8 22.3 16.8 21.3 25.2 1932 28.1 19.0 26.0 31.7 15.4 43.8 25.3 30.8 22.4 22.1 36.3 1933 24.2 16.9 26.6 28.8 14.1 36.2 26.9 33.4 23.2 19.9 37.6 1934 19.6 18.9 20.6 22.2 13.8 20.5 28.0 30.7 18.0 16.7 32.6 1935 15.6 17.8 19.1 19.7 14.5 16.2 31.7 25.3 15.0 15.5 30.2 1936 11.3 13.5 16.7 19.3 10.4 12.0 32.7 18.8 12.7 13.1 25.4 1937 7.4 11.5 12.5 21.9 7.4 6.9 26.9 20.0 10.8 10.8 21.3 1938 7.8 14.0 15.1 21.5 7.8 3.2 25.0 22.0 10.9 12.9 27.9 1939 8.8 15.9 14.1 18.4 8.1 0.9 19.9 18.3 9.2 10.5 25.2 Source: Eichengreen and Hatton (1988, pp. 6–7). 320 Richard S. Grossman and Christopher M. Meissner Table 2: Banking crises during the Great Depression. Crisis countries Austria, Belgium, Estonia, Finland, France, Germany, Hungary, Italy, Latvia, Norway, Poland, Romania, Switzerland, United States, Yugoslavia Non-crisis countries Bulgaria, Czechoslovakia, Denmark, Greece, Japan, Lithuania, Netherlands, Portugal, Spain, Sweden, United Kingdom Source: Grossman (2010, pp. 314–6). same years. Consequently, the share of exports in world GDP in 1933 was a little more than half the size of that in 1929. Downloaded from Prior to the 1980s, academic research on the Great Depression concentrated disproportion- ately on the United States (Kindleberger (1973) is a prominent exception), focusing in particular on whether the downturn was the result of monetary forces (Friedman and Schwartz, 1963), or a decline in some component of real expenditure (e.g. Temin, 1976). Starting in the 1980s, a growing literature, including Choudhri and Kochin (1980), Eichengreen and Sachs http://oxrep.oxfordjournals.org/ (1985), Temin (1989), Bernanke and James (1991), Eichengreen (1992a), and James (2001), began to take a more global perspective (Bernanke, 1995; Eichengreen, 2004). And although the argument that the Great Depression originated in—and emanated from—the United States is still powerful (Romer, 1993), the importance of international factors in driving the Great Depression is better established than ever. In this article, we focus on two aspects of the Great Depression which had important inter- national dimensions: banking crises and international trade. We conclude with a comparison ’ between the Great Depression and today s global downturn, which we refer to as the Great at ENS BIOLOGIE on October 26, 2015 Recession, and some observations on the path of economic policy and our understanding of how the global economy is evolving. II. Banking crises Financial crises were a defining characteristic of the Great Depression, as they have been of the Great Recession. Of course, the term ‘financial crisis’ encompasses many different classes of episodes, including banking crises, currency crises, debt defaults, and secur- ities-market crises, to name but a few (Kindleberger, 1978, pp. 21–2). We concentrate on banking, rather than currency or securities-market crises for two reasons. First, given that the international gold-standard regime collapsed during the 1930s, virtually every country that had been on the gold standard experienced some sort of currency crisis. All 17 countries catalogued by Bordo et al. (2001, web appendix) underwent at least one currency crisis dur- ing 1930–36. Second, although a number of stock-market crashes took place during the Great Depression, the scholarly consensus is that, with the possible exception of the October 1929 crash on Wall Street (Romer, 1990), crises in securities markets were not important in bringing it about (Kindleberger, 1973, p. 108; Eichengreen, 1992b), but were most often a consequence of the collapse of the banking and non-financial sectors of the economy. By contrast, banking crises play a central role in many analyses of the causes of the Great Depression (e.g. Friedman and Schwartz, 1963; Temin, 1976; Bernanke, 1983). Bernanke and James (1991), for example, find that countries that experienced banking crises fared significantly worse during the Great Depression than those that did not. Table 2 classifies International aspects of the Great Depression and the crisis of 2007 321 26 countries—primarily European, but including Canada, Japan, and the United States—by whether or not they had banking crises during the Great Depression. Although there is compelling evidence that banking crises played an important role in the Great Depression, there is no consensus on the channel through which the crises affected real economic activity. Friedman and Schwartz (1963) and Cagan (1965) argue that banking crises increased the public’s desired currency-to-deposit ratio, as depositors strove to convert deposits into cash, which reduced the money supply and led to a decrease in prices and output.
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