UCSB European History of Economics Essay


I’m working on a economics writing question and need an explanation and answer to help me learn.analysis of readings on european economic history, 500-600 words max, make relevant connections, demonstrate in depth understanding of readings and provide analysis

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Building a Social Democracy
In 1933 John Maynard Keynes wrote: “The decadent international but
individualistic capitalism in the hands of which we found ourselves
after the war is not a success. It is not intelligent. It is not beautiful. It
is not just. It is not virtuous. And it doesn’t deliver the goods.” 1 Yet the
industrial democracies, unable to develop an alternative, floundered
through the first years of the Depression. A few did better th_a n others,
but none did well, certainly not so well as Germany and other fascist
regimes. Governments in most of western Europe and North America
tried deflation, then a series of stopgap macroeconomic measures,
then trade protection but did not make much of a dent on unemployment or stagnation. Many in the industrialized democracies were
drawn to the German or Soviet model to replace the market system
and to autarkic economic nationalism to replace reliance on the world
The democracies began to find an alternative in the middle 1930s.
Parties of the Left came to power, with working-class and agrarian
bases of support. They enacted more interventionist economic policies,
expanded social programs, and increased government spending. And
the new governments rebuilt cooperative economic ties among the
democratic states.
The new alternative was social democracy. The modem social democratic welfare state would not truly be constructed until after World
War Two, but by the late 1930s its foundations were in place in western
Europe and North America.
Swedish and American roads to social democracy
Social democracy was a new social and political order, even if most
of its features had precedents. Governments backed by coalitions of
workers and farmers took responsibility for macroeconomic management, social insurance and social security, and labor rights. Two countries’ experiences are particularly instructive: Sweden and the United
In the 1920s the Swedish Social Democratic Party polled over 35
percent of the vote and participated in government several times. In the
1932 elections the Social Democrats took 42 percent of the popular vote
(Far Left parties took another 8 percent) and came close to a majority
in the lower house of Parliament. They formed a government with the
Agrarian Party, improved their position in the 1936 elections, and ruled
Sweden for forty years thereafter. 2
The first pillar of social democracy in Sweden was countercyclical
demand management, government commitment to alleviate the business cycle. This was hardly controversial at the depth of the Depression,
when everyone was looking to end the crisis. Social Democratic governments went further, attempting to reduce the amplitude and frequency
of cyclical downturns in general, to maintain full employment. They
used monetary policy to keep prices from falling or rising too much and
fiscal policy (government spending and taxation) to sustain economic
The Swedish government pioneered active monetary management.
After the Conservative government took the currency off gold in 1931,
it asked three eminent economists how it should manage the countiy’ s money. The economists recommended an active monetary policy
to keep consumer prices steady where they were at the time of the
September 1931 devaluation. The central bank accordingly promised
“to prevent the price level in Sweden from following the downward
international price trend.” 3 The Socialist-led coalition that took power in
I 2 31
1933 reaffirmed this course. The Swedish government’s explicit public
commitment to price stability attracted international attention, especially as the Swedish economy quickly recovered.
Sweden’s government took longer to use its second major macroeconomic tool, fiscal policy. Even many who advocated looser monetary
policy believed that deficit spending was folly. The country’s leading
economist, Gustav Cassel, argued that if the government borrowed
heavily for job-creating public works, the effect would be that “the private sector’s supply of capital will dry up or at least be curtailed to the
highest conceivable degree.”4 Cassel’s colleague Eli Heckscher believed
that private enterp1ises used money better than governments and that
deficit spending was bad medicine, “the kind of medical treatment
which used to be applied by market horse-traders with old nags for sale.
They gave them a half a stoup of aquavit to make them pirouette as they
had done in the springtime of their youth, only to revert, of course, to
their former sloth once the intoxication wore off. “5
Sweden’s labor-based government, with unemployment at 25 percent,
needed to do more than lower interest rates and wait for recovery. Some
government advisers, like Heckscher’s student Bertil Ohlin, recognized
“the inadequacy of price stabilization” and argued that monetary policy
was not enough. The unions demanded government efforts to put the
jobless to work. So between 1933 and 1935 the Social Democrats implemented emergency and public works that employed an average of sixty
thousand workers and gave another thirty-five thousand cash assistance.
The deficits needed to run the “Crisis Policy” were small, 2_or 3 percent
of GDP, and the policy was phased out after 1935. By then Sweden was
recovering from the Depression, primarily because of the devaluation
and the gradual improvement in international conditions. Nonetheless,
the deficit-financed job programs set a precedent of concerted government spending to reduce unemployment. 6
After countercyclical macroeconomic policy, the second pillar of
Swedish social democracy was social insurance. The country had instituted some social policies in the first decades of the century, but they
were very limited. Social Democratic leader Gustav Moller recalled the
fate of his mother, the widow of a blacksmith who died of tuberculosis
at forty-one. “There was,” Moller said, “no public pension for my grandmother that could lighten mother’s burden; there was no aid for widows
with children and miserably low incomes; society did nothing to eliminate housing that helped cause people to become deathly ill and depart
from life at a relatively early age; there were no legally regulated working
hours; there was no paid vacation, still less the possibility of housewives’
vacations.” Moller became the minister of social affairs in the 1930s and
pressed for sweeping social ·reforms “to prevent the occurrence of fate’s
like my mother’s.”7
During the 1930s Sweden implemented most of the programs
associated with the modem welfare state. 8 The government adopted
unemployment insurance in 1934 and mandated universal participation
in a national health insurance program a few years later. It instituted
maternity, infant, and child care; subsidized school lunches; increased
old-age pensions; and made housing grants and subsidies to poor families. By the late 1930s the Swedish government was providing its people
something approaching cradle-to-grave social assistance, even if benefit
levels were relatively low. The Social Democrats had kept their promise
to mitigate the social effects of a market economy.
Swedish farm policy also had a social dimension, for there was substantial rural poverty. But the motivations for agricultural assistance
were more political than social. The Swedish Social Democratic success
relied on an alliance with the Agrarian Party-the “cow trade” or “cowlition” (kohandel), as the Swedes called it. Before this, the free trade labor
movement and the protectionist farmers were at loggerheads-workers
wanted access to cheap imported food, and farmers wanted access to
low-wage labor-but during the Depression they made a deal, giving
the Agrarians tariffs and price supports for dairy products, meat, bacon,
eggs, and other locally produced food goods, in return for supporting
the Social Democrats’ prolabor policies. As the 1936 Social Democratic
election platform put it, with some resignation, “the Swedish working
class will pay the price necessary to guarantee workers in agriculture and
small farmers a tolerable living standard.”9 The farmer-labor alliance,
unusual before the 1930s, became a hallmark of the social democratic
welfare state.
The social democratic solution included the incorporation of labor
into the political system. In Sweden this meant organized consultation
between business and labor leaders to manage industrial relations.
During the early 1930s many Swedish businesses remained hostile to
the Social Democrats, but the 1936 elections made it clear that the Left
was going to dominate politics for the foreseeable future. The Social
Democrats’ finance minister Ernst Wigforss told business leaders that
capitalists “should not base their actions on the assumption that the
present political tendencies of the state will abate, that a political change
will occur in the near future …. On the other hand, this also means that
I 233
the representatives of political power admit the necessity of maintaining
favorable conditions for private enterprise.” 10
At the end of 1938 representatives of the government, business, labor
unions, and others signed the sweeping Saltsjobaden accord. Business
and labor agreed to manage labor relations at a centralized, nationwide
level. More broadly, in the words of political scientist Peter Gourevitch,
“the terms of the agreement were business acceptance of Social
Democratic government, high labor costs (high wages and the benefits
of the welfare state), full-employment fiscal policy, and government
activism for social services, in return for labor peace in labor markets
(i.e. no strikes), continued private control over property and capital
markets, and openness in relation to the world economy.” 11 The Social
Democrats were now allied with one traditional antagonist, farmers, and
at peace with another, big business. Social democracy had arrived.
Across the Atlantic a different political configuration led to similar
outcomes. The Hoover administration’s policies were belated and
ineffectual, when not actually harmful. The Democrats did not seem
to offer anything more novel, and in fact Franklin D. Roosevelt ran
for president in 1932 on a platform that accused Hoover of insufficient commitment to orthodox economic policies. He complained, for
example, that the Republicans were not balancing the federal budget:
“Let us have the courage to stop borrowing to meet continuing deficits …. Revenues must cover expenditures by one means or another.
Any government, like any family, can for a year, spend a little more
than it earns. But you and I know that a continuation of that habit
means the poorhouse.” 12
Once he was in office, Roosevelt reversed himself and abandoned
traditional austerity. He took the dollar off gold and devalued, which
helped recovery. Within a hundred days the Roosevelt administration
adopted emergency programs to regulate industrial prices, support agriculture, and build and manage large public works. These early measures
smacked to many of fascism, with their attempt to encourage businesses
to cartelize and set prices and the administration’s hostility to international economic cooperation. The more controversial of them were in
any case ruled unconstitutional by the Supreme Court, and by 1935 the
Roosevelt administration had settled on a different course, sometimes
called the second New Deal. This included job-creating government
programs, social insurance, and labor rights. An array of “alphabet soup”
federal agencies and programs-the Works Progress Administration
(WPA), Civilian Conservation Corps (CCC), Agricultural Adjustment
Administration (AAA), and dozens of others-created social democracy
The New Deal government focused on reducing unemployment and
providing social insurance. In March 1935 Congress approved its largest
peacetime allocation ever, almost five billion dollars, for unemployment
relief. Much of this went to the WP A, which eventually put nearly nine
million people to work to build 650,000 miles of roads, 800 airports, and
hundreds of thousands of public buildings, parks, bridges, and other
projects. Other billions of dollars went to cash relief to the indigent who
could not work.
A few months later Congress passed the Social Security Act, the country’s first national social insurance system. Roosevelt recommended
it “to provide at once security against several of the great disturbing
factors of life-especially those which relate to unemployment and old
age.” The act provided for a public pension system with benefits for
widows and other survivors, disability insurance, and relief for the aged,
children, and the blind. It also established the nation’s first unemployment insurance scheme, to be run by the states. 13
Farm policy, as in Sweden, reflected the new farmer-labor coalition.
Before the 1930s American labor had typically been hostile to agrarian demands for farm supports that would raise food prices, just as
American farmers had opposed industrial demands for trade protection
that would make manufactured goods more expensive. The New Deal
forged a new Democratic alliance of urban labor and southern farmers,
with some support from midwestem farm state Republicans. Roosevelt
poured billions of dollars into farm debt relief, cash payments, and price
supports. These programs, it is estimated, saved nearly two hundred
thousand American farm families from foreclosure and assisted millions
more in less dramatic ways. 14
New Deal programs were motivated by pressing political imperatives,
not by a conscious desire to engage in deficit spending. Indeed, Roosevelt
constantly promised to balance the budget and vetoed some congressional
spending bills because he thought they were profligate. Even at the peak
of their activity, in the midst of the worst economic crisis in the nation’s
history, New Deal governments ran deficits of only 3 or 4 percent of GDP.
But the government was spending at an unprecedented rate, as nondefense federal spending increased from 3 to 10 percent of GDP between
1927 and 1936. Given the commitment of the Roosevelt administration
to balance the budget, most of this increase was financed by higher taxes.
The administration became more tolerant of deficits after the 1937-1938
I 2 35
recession, which was probably worsened by budget-balancing efforts,
but by then it was hard to distinguish deficit spending for countercyclical
purposes from preparations for rearmament.
As in Sweden, the reorientation of economic policy was accompanied by a transformation of labor’s role in politics. The Roosevelt
administration’s biggest innovation in labor markets was the 1935
National Labor Relations Act, which set up a procedure for the recognition of unions and required employers to bargain with them. When
the crafts-dominated American Federation of Labor seemed slow to
take up the new opportunities, the upstart Committee for Industrial
Organization worked to organize the nation’s labor force. Organizing
drives, punctuated by highly visible demonstrations, sit-down strikes,
and public protests, swept through the country’s steel, auto, tire, and
rubber industries. In 1930 the country had barely three million union
members, representing less than 11 percent of the nonagricultural labor
force; by 1941 there were nine million union members, and they were
23 percent of the labor force. 15 The labor movement had become an
integral part of the New Deal Democratic coalition, and the business
community was resigned to its influence.
The federal government dramatically increased its role during the
New Deal. This was the American analogue to European measures to
remake national labor and social policies. The Roosevelt administration
centralized government spending: In the late 1920s state and local government spending was nearly three times federal nondefense spending,
but by 1936 federal nonmilitary expenditures were substantially greater
than state and local combined. 16 The federal government expanded its
regulation of everything from banking arid monetary policy to electric
utilities and social insurance. The New Deal remade a highly decentralized political economy, with low levels of social insurance and limited
labor rights, into a new federal government committed to demand
management, national social programs and public works, and a place for
labor in collective bargaining and in politics.
Most industrial nations moved in similar directions. In Denmark
and Norway, powerful Socialist parties led worker-farmer alliances to
power. 17 In Belgium and Switzerland, multiparty coalitions enacted
substantial social reforms and organized national consultations between
business and labor. 18 In Canada and New Zealand, conservative governments reacted to the Depression with reform measures; when the Left
(Liberals in Canada, Labour in New Zealand) came to power in 1935, it
extended these reforms.
In France, a Popular Front took power in dramatic circumstances.
Initially, unstable centrist and Center-Left governments confronted the
crisis weakly, although they introduced minor reforms, such as a family
allowance and subsidized housing. In February 1934, right-wing rioting
racked Paris. The Communists, sobered by the fascist threat and by
Hitler’s recent rise to power in neighboring Germany, dropped their
previous hostility to the Socialists and proposed a common platform.
The resulting Popular Front was, as its leader Leon Blum said, “a reflex
of instinctive defense .. . against the prolongation of the economic crisis
which was crushing the working classes, the farmers, the middle class
of the country.” 19
The Popular Front swept the 1936 elections, and in June 1936
Blum took office as France’s first Socialist (and first Jewish) premier,
in the midst of a massive strike wave. A day after taking office, Blum
brought together business and labor representatives to hammer out
the Matignon agreement, committing management to recognize labor
rights and raise wages substantially. Within two months the Popular
Front government enacted 133 laws. The Left government reformed
the central bank, put in place massive public works and new agricultural supports, and mandated unemployment insurance, a new collective bargaining system, a forty-hour workweek, and two weeks’ paid
vacation. Although the Popular Front ruled for less than two years, it
had a lasting effect both on legislation and on the political position of
labor. 20
Great Britain lagged behind. Despite the fact that the Labour Party
was in office when the Depression hit, despite the power of British
organized labor, despite a long tradition of social reform, despite the
influence of John Maynard Keynes, successive British governments
did little to follow the examples of western Europe and the other
Anglo-American nations. The same was largely true of Australia and the
Netherlands. In these three countries, demands for social democratic
measures may have been tempered by the fact that they already had
relatively extensive social insurance systems.
By the late 1930s the alternative to fascism and communism was in
place. Every advanced industrial country except Germany and Italy
remained democratic, and almost every industrial democracy traced
the basic outlines of the social democratic welfare state. Governments
were committed to stabilize the business cycle, provide social insurance, and reserve a central place for organized labor in politics and
B UtLDJNG t1 So c I,1L DEM0 c1ucY
I 237
Keynes and social democracy
The reasons for the development of the new social democracy
are not obvious. A common view is that Keynesian economic ideas triumphed. This was certainly Keynes’s own view, not so much of his own
success as of the general way in which economic policies evolved. He
wrote in 1936: “The ideas of economists and political philosophers . . .
are more powerful than is commonly understood. Indeed the world is
ruled by little else. Practical men, who believe themselves· to be quite
exempt from any intellectual influence, are usually the slaves of some
defunct economist. “21
Keynes’s ideas were certainly influential. Keynes was well
known for his polemics on Versailles and the gold standard and for
his analysis of how government mishandling of monetary policy
had contributed to the ills of the era. These views were not unique
to Keynes , though. With his 1930 book A Treatist on Money, he
began developing more innovative interpretations of contemporary economic problems. He expounded this view in more and
more detail-in print, in his well-attended Cambridge University
lectures, and in presentations to other economists around the
world. By 1932 the basic lines of the Keynesian approach to the
Depression were clear. It took Keynes three more years to build
a theoretical edifice with which he was satisfied, which he published in 1936 as The General Theory of Employment, Interest,
and Nloney.
Keynes’s principal contribution to the economic debates of the time,
and to economic theory, had to do with fiscal policy. Most economists
already regarded budget deficits in times of crisis as unavoidable; after
all, they were almost automatic, as economic decline reduced tax revenue much more quickly than spending. Keynes went further, to argue
that deficit spending was essential to reactivate stagnant economies . The
economy was caught in a trap, from which only gov€rnment spending
could free it.
Keynes put investment at the center of his argument. In most classical approaches, investors simply responded to profit opportunities:
If wages got low enough, new investment would be forthcoming,
and the economy would revive. But Keynes understood that investment depended also on expectations of the behavior of others. No
capitalist would expand his factory if there was no prospect of demand
for his products-no matter how low wages or interest rates were. If
all capitalists invested on the basis of how they expected other capitalists (and consumers) to behave, the economy could be “stuck” in
a self-reinforcing trap, a bad equilibrium. Expectations of stagnation
would depress investment, which would ensure continued stagnation.
The market economy would not right itself. The problem was what
today might be called a coordination failure: If every capitalist invested,
hired more workers, and produced more goods, demand would rise, and
there would be a market for the goods; but since no one capitalist could
be sure that this would happen, all preferred to hold on to their money
and keep things as they were. In Keynes’s words, “An individual may be
forced by his private circumstances to curtail his normal expenditure,
and no one can blame him. But let no one suppose that he is performing a public duty in behaving in such a way. The modem capitalist is a
fair-weather sailor. As soon as a storm rises, he abandons the duties of
navigation and even sinks the boats which might carry him to safety by
his haste to pusn his neighbor off and himself in.”22
The usual monetary stimulus could not overcome this depressed equilibrium because it relied on lower interest rates to spur investment. If
capitalists did not anticipate a recovery, however, no rate of interest was
low enough to induce them to invest; why produce goods that would
not be sold? Investors preferred to keep their money in cash rather than
lose it, so even zero interest rates could not stimulate investment. “I am
not confident,” Keynes wrote at the depth of the Depression, “that on
this occasion the cheap-money phase will be sufficient by itself to bring
about an adequate recovery of new investment. It may still be the case
that the lender, with his confidence shattered by his experiences, will
continue to ask for new enterprise rates of interest which the borrower
cannot expect to earn.”
Keynes had an alternative:
. . . direct state inteivention to promote and subsidize new investment.
Formerly there was no expenditure out of the proceeds of borrowing that
it was thought proper for the State to incur except for war. In the past,
therefore, we have not infrequently had to wait for a war to terminate a
major depression. I hope that in the future we shall not adhere to this
purist financial attitude, and that we shall be ready to spend_on the enterprises of peace what the financial maxims of the past would only allow us
to spend on the devastations of war. At any rate, I predict with an assured
confidence that the only way out is for us to discover some object which is
I 239
admitted even by the deadheads to be a legitimate excuse for largely
increasing the expenditure of someone on sometl1ing! 23
Government could break out of this vicious circle by borrowing and
spending heavily. This would stimulate demand and change expectations; capitalists would see the new conditions and would increase
investment, increase employment, and increase output. Countercyclical
fiscal policy-deficit spending-could alter expectations and get the
economy going.
To some, Keynes’s ideas were almost Marxist in their reliance on government. At times, in fact, Keynes characterized his ideas provocatively.
“The State,” he wrote in the General Theory, “will have to exercise
a guiding influence on the propensity to consume partly through its
scheme of taxation, partly by fixing the rate of interest, and partly, perhaps, in other ways …. I conceiv€, therefore, that a somewhat comprehensive socialisation of investment will prove the only means of securing
an approximation to full employment.”24
In fact, as Keynes himself noted, his message was profoundly
anti-Marxist, because it allowed the government to overcome the
weaknesses of the capitalist economy. Keynes accused the classical
economists, who argued that government could not improve conditions,
of being the true allies of Marxism: “The Marxists have become the
ultra-orthodox economists. They take the Ricardian [classical] argument
to show that nothing can be gained from interference. Hence, since
things are bad and mending is impossible, the only solution is to abolis~
[capitalism] and have quite a new system. Communism is the logical
outcome of the classical theory.” 25 Keynes, on the other hand, wanted
more energetic attempts to save the market economy, without which, he
said, “the existing order of society will become so discredited that wild
and foolish and destructive changes will become inevitable.”25
Keynes inspired a reformist zeal, as reflected in the memories of a
Cambridge student who called the development of the ideas in the
General Theory “joyful revelation in dark times. We thought that Keynes
had … found the ‘flaw in the capitalist system’ and had proclaimed its
remedy. . . . The mystery of contemporary iniquity had been unveiled
by a masterpiece of sustained intellectual effort. . . . Thus the General
Theory was to us less a work of economics theory than a Manifesto for
Reason and Cheerfulness …. It gave a rational basis and moral appeal
for a faith in the possible health and sanity of contemporary mankind
such as the youths of my generation found nowhere else.”21
Keynes had a powerful effect on modern economics, even though
many historians of economic thought would argue that what he said was
not actually new. 28 This was true about specific policies, such as deficit
spending, and about the theoretical justification for these policies. But
Keynes’s 1936 book fundamentally rethought modern economies and
government policy. And in fact Keynes and his followers did remake
economics, if not always in ways he might have endorsed. Keynes
invented modern macroeconomics, the analysis of such general economic variables as unemployment and output, and in his wake came
generations of new economic thinking.
Nonetheless, he had very limited influence on government policy,
and his ideas did not affect the evolution of the social democracies in
the 1930s. For example, Keynes’s principal weapon of macroeconomic
policy was fiscal, deficit spending. Yet very few democratic governments
in the 1930s made conscious, concerted, or sustained use of fiscal policy
as a tool against the Depression. Governments that ran budget deficits
saw them as necessary evils and always promised to reduce them as soon
as possible. Expansionary monetary policies were much preferred and
seemed to work reasonably well. And Keynes had nothiqg to say about
social insurance, labor unions, farm subsidies, or the other policies that
were central to the emerging social democratic welfare states.
Keynes did participate in important discussions of policy. He visited
the United States in May 1934, talked to scores of New Dealers, and
met with Franklin Roosevelt for an hour. Their meeting had no discernible impact on Roosevelt, who said that Keynes seemed “a mathematician rather than a political economist.”29 But Keynes was enthusiastic
about American policy, calling himself “more of an admiring observer
than … an instructor.” 30 He supported the administration in public lectures and meetings with business leaders, academics, and others, which
helped counter some of the anti-Roosevelt sentiments of business and
economic traditionalists. His principal suggestion, in an open letter to
Roosevelt published by Walter Lippmann in the New York Times, was
that emergency federal spending be increased from three hundred
million to four hundred million dollars a month, hardly a revolutionary
Despite his importance to the development of economic theory,
Keynes was just one of many voices arguing for countercyclical macroeconomic policy. The Stockholm school of young economists ·is credited
by many-especially in Sweden-with inventing Keynesianism before
Keynes. In the United States in the early 1930s Utah’s Marriner Eccles
——- –

I 241
was one of a group of iconoclastic businessmen who argued for gdvemment to assume major fiscal tasks in a way that later became known a-‘i
Keynesian. Eccles, a provincial banker with a high school education,
was blunt: «A bank cannot finance the building of more factories and
more rental properties and more homes when half of our productive
property is idle for lack of consumption and a large percentage of our
b:i-isiness properties are vacant, for want of paying tenants. The goven1ment, however, can spend money, because the government, unlike the
bankers, has the power of taxation and the power to create money and
does not have to depend on the profit motive. The only escape from a
depression must be by increased spending. We must depend upon the
government to save what we have of a price, profit, and credit system.”31
The Roosevelt administration spotted Eccles early on, and the president
appointed him head of the Federal Reserve in 1934, a post he held until
1948. 32
Keynes believed that policy makers were subconsciously applying the
ideas of defunct (or, in his case, living) economists, but the experience of
his own ideas was much the opposite. Political leaders all over the industrial world were clawing their way toward a new political economy that
could pull away from the maelstrom of the Depression. That political
economy included loose money, public works, and intensive employment programs. Keynes the public figure applauded developments that
had taken place independently of Keynes the economist. Eventually
economists would find Keynes’s writings valuable in constructing a
theoretical edifice appropriate to understanding the new social democracies. For the origins of these social democracies themselves, we have
to look elsewhere from the world of ideas.
Labor, capital, and social democracy
Social democracy was not an application of Keynesian thinking,
but its developers shared with Keynes the idea that governments
needed to act forcefully to save modern capitalism. Like him, the pioneering Scandinavian Social Democrats had long since decided that
their duty was to make capitalism work better. The