THE COST OF NOT LEARNING FROM THE PAST

RIchard Grossman, professor of economics.

RIchard Grossman, professor of economics.

On Saturday, June 28, 1919, the fifth anniversary of the assassination of Austria’s Archduke Franz Ferdinand, the treaty ending World War I was signed at the Palace of Versailles in Paris. And not a minute too soon. The war that was triggered by the archduke’s murder came close to destroying Europe.  

In his new book, WRONG: Nine Economic Policy Disasters and What We Can Learn From Them, Wesleyan Professor of Economics Richard S. Grossman frames the damages as follows:

“About 8.5 million military personnel lost their lives during the conflict, and another 15 million or so were wounded. To get a sense of the magnitude of the carnage, consider that the combined number of military deaths in every single war during the preceding hundred years—both wars between countries and civil wars—amounted to about 5.6 million. The number of civilian fatalities due to World War I is harder to calculate. If deaths stemming from the [simultaneous] Russian Revolution are included, the total was probably somewhere between 5 and 10 million. The material cost of the war was similarly staggering. Writing shortly after the war’s end, the economist Ernest Bogart estimated the “direct cost” of the war, that is, the money spent by the combatants, to be $186 billion and its “indirect cost,” the value of life and property lost, to be $152 billion. To put this total of $338 billion in context, it represented an amount greater than one-and-one-half times the total output of goods and services produced by the United States during the war’s four years.

The treaty was unequivocal in blaming Germany for the war. It demanded immediate partial payment of 20 billion gold marks (roughly $4.7 billion) to provision peace-keeping armies, and it called for the creation of an Inter-Allied Reparations Commission that would determine the greater amount Germany owed and define a schedule of payments. 

While the scope of economic retribution defined by the treaty was justifiable, it was also shortsighted. When the commission concluded its meeting in London, in May 1921, the reparations required—with a special vengeance by France, where the war’s destructive footprint was still apparent three years later—“approximately 83 percent of one year’s total economic output, 350 percent of one year’s tax revenues, and 500 percent of one year’s exports,” Grossman writes. Whether or not such a staggering burden was deserved, trying to service it threw Germany’s economy into a tailspin and destabilized the new Weimar Republic, neither of which was compatible with longterm peace. 

Despite efforts to keep up with the payments, Germany fell so far short that, in December 1922, the Reparations Commission declared the nation in default. It was at that point—as an army of French and Belgian troops occupied the heavily industrialized Ruhr valley, attempting to collect the reparations directly—that the German economy really began to unravel. German workers went on strike. The government had no alternative but to borrow money from the nation’s central bank, the Reichsbank, which was essentially bankrupt. The bank printed more money and hoped such legerdemain would go unnoticed. 

It did not. Between January 1921 and December 1923, the German currency supply increased 75,000 fold, while the value of money fell like a brick. In the consequential period of hyperinflation, prices increased tenfold in just two years. Then tenfold increases began to occur faster and faster—with 300 of these tenfold increases during the month of October 1923 alone! 

It has been suggested that the hyperinflation of the early 1920s led directly to the rise of Adolf Hitler. Grossman says such claims are extreme. Nevertheless, he notes that it is “impossible to ignore the contribution of reparations to Germany’s descent into hyperinflation, depression, and political instability during the 1920s,” all of which helped set the stage for the Nazi movement.

grossman_inside_book_coverThere are lessons aplenty from this tragic episode, but how well were they learned? That’s one of the questions posed by WRONG. The answer, says Grossman, who has taught economics at Wesleyan since 1990, depends upon the example. The answers to why the policies failed are never simplistic.

Certainly epic-scale economic crises continue to result from policies that seemed sound to at least some “experts” when they were implemented. While the mistakes of the past have been recorded and analyzed, knowledge implies no immunity from error. Still, there are always some who, reflecting on the past, seem able to foresee calamity. 

Consider, for instance, the case of the euro. Noting that economists have been skeptical about the currency since before it was introduced, Grossman says, “The financial woes of Greece and other southern European economies have made substantial parts of the electorates of Germany, the Netherlands, Finland, and other northern European countries skeptical of the whole euro enterprise. And that skepticism is well-founded.

“Early in the second decade of the 21st century, it is hard to imagine how the euro can be seen as anything but a disaster.” Still, Grossman thinks the euro will survive, though it has a “fatal design flaw. In order for a one-size-fits-all monetary policy to work for the entire union, there must be a nonmonetary mechanism that enables the regions within the euro zone to adjust to economic shocks.” Ironically, Germany has benefited from the euro’s flaw. “Much of Germany’s prosperity in recent years has been based on its position as Europe’s strongest exporter,” he observes. “If the euro collapsed or its weaker members exited, Germany would be forced to face export markets with an expensive new currency—either a new German mark or the euro consisting of only the stronger members of the monetary unit.” 

Grossman says he decided to write his book for several reasons, one of which speaks to its highly accessible style. “Most of the writing I’ve done has been academic. That kind of writing tends to be overly technical, which can make it a little dry. I wanted to write about economics in a different way. I find it frustrating that normal, intelligent people can’t get through a lot of economics writing because it is dense. I want people to be interested in economics and what they can learn from past mistakes.”

At the same time, writing about those mistakes, many of which are covered in the courses he teaches on American and European economic history, forced him to revisit and rethink those flawed policies.

“I’m a pragmatist,” he adds. “WRONG is my attempt to conduct an autopsy on bad economic policies, figure out why they went bad…and most important, help us avoid making the same mistakes in the future.”

WRONG recounts eight other economic policies that went awry. Each, noted below, is accorded its own chapter: 

• British imperial policy in North America, as encoded in the Navigation Acts, that was intended to enrich England at the expense of its colonies but, instead, helped to precipitate the American Revolution, ruinous for Britain 

• the two failed efforts to create and maintain a United States central bank during the late 18th and early 19th centuries, which made the young nation vulnerable to a string of devastating financial crises until the Federal Reserve System was established after the Panic of 1907  

• the Great Hunger, the Irish “potato” famine of 1845 to 1852 that resulted in the deaths of an estimated 12 percent of Ireland’s population, when the British government pursued economic policy with clench-jawed rigor rather than addressing the suffering of the Irish

• Britain’s return to the gold standard in the 1920s, which helped to set the stage for the Great Depression

• the Smoot-Hawley Tariff Act of 1930, passed by Congress after intensive lobbying by agricultural and industrial special interests, which had an impact quite counter to those interests, protracting the Great Depression by inhibiting trade

• the failure of Japanese leadership to allow poorly performing banks to fail in the early 1990s, which caused a decade of sluggish economic growth and high unemployment

• the recent subprime “meltdown” that brought about the worst financial crisis since the Great Depression

• the failure of the euro.

Grossman says he chose the nine flawed policies described in WRONG because “I wanted chronological and geographic balance. I didn’t want the book to be just about modern crises. I have been thinking and writing about some of the policies discussed in WRONG for a long time. Some, like the Irish famine, I have not written about before, but they were so dramatic that they demanded to be included.”

The theme that most consistently unites the nine policies is blind adherence to ideology, says Grossman. “Again and again these are stories of people who had the tools at their disposal to make much better policy decisions but chose rigorous devotion to theory over cold, hard analysis of the unique circumstances of the time and place.”

The risk of such behavior, hubristic in nature, is compounded by the fact that the decisions to engage in such policies “are rarely made solely on the basis of economic merits, assuming that economists could agree about the merits of a proposed policy, or in a vacuum,” he notes. “Rather, policies are usually the result of a complex web of interrelated—and sometimes conflicting —economic, political, and historical forces.” In addition, he notes, “some misguided policies seem to have had accidental—almost random – causes.” The most important lesson that can be learned from the disasters he chronicles in WRONG is “to reject policy proposals based primarily on ideology.”

Another significant cause of policy mistakes, evident throughout the book, has been the excessive influence of private interests. “Although politicians typically embrace newly enacted economic policies with proclamations that they are being adopted in furtherance of the public good, these policies often also reflect the interests—and influence—of distinct groups within society,” he writes. Policy mistakes also are often predicated on efforts to shift costs to foreigners. Grossman points to the reparations imposed on Germany in the aftermath of World War I as an example. Compounding the damage resulting from mistakes of either kind is delay, often extreme, in taking steps to implement a beneficial policy or to reverse a policy mistake, Grossman says.

Though economic policy errors continue to be made, he notes that some important lessons learned by policymakers reflecting upon disasters like those described in WRONG seem to have become “hard-wired.” Among the most important have been those related to trade policy. 

“Throughout the seventeenth and eighteenth centuries, and for much of the nineteenth, world commerce was conducted from behind massive tariff walls,” he writes. “Britain’s repeal of the Corn Laws in 1846 marked the beginning of steady progress toward more open trade by the world’s leading commercial and industrial powers. This trend was reversed during the interwar period, when the fall in world trade due to the declining incomes associated with the Great Depression was amplified by tariff hikes in many countries. After World War II, the General Agreement on Tariffs and Trade began a decades-long process of uninterrupted multinational trade liberalization. Certainly, protectionist pressures have reared their heads now and then.” 

But policymakers have, for the most part, shown a disinclination to raise tariffs. The world has been a more prosperous place thanks to trade liberalization, demonstrating that correct economic policy—like incorrect policy—can have profound results extending over many generations.