How the New Dealers Gained the Ability to Implement the New Deal Order

By making sure they got credit for their policy

In previous posts, I have talked about how rising inequality leads to crisis through Peter Turchin’s secular cycle model. Rising inequality, as manifested by the end of a rising trend in real wages, has led to the death of the American dream and the lack of progress for African Americans since the Civil Rights era. Rising Inequality is explainable in terms of business culture evolving in an economic environment transformed by the tax cuts and high interest rates of the 1980’s. Both of these became possible after 1960’s Democratic policymakers so mismanaged the economy that they lost control of policy to the Republicans who proceeded to systemically dismantle the New Deal. What I have not fully addressed was how were the New Dealers able to create the economic environment that made the New Deal Order possible in the first place? I have given partial answers. Tax rates were important, as was wage and price controls during WW II, as I described here.

Key to the WW II policy was the existence of a policy team with years of experience dealing with economic management in their efforts to solve the problem of the Great Depression. They never succeeded in this task, and yet the American people kept reelecting them. President Obama faced a similar situation to that of FDR when he came to office. Unlike the New Dealers, his team successfully dealt with the crisis. But they were unable to make the crisis (which had happened on the Republican’s watch) work politically for them as FDR had done. Had FDR gotten Obama’s 2010 midterm results, instead of actually happened in 1934, Democrats would have lost the House in 1938 and been reduced to a four-seat majority in the Senate. There is a good chance Democrats would have lost in 1940 and there would have been no postwar widely shared prosperity, but rather a repeat of the 1920’s with a panic in the early 1950’s. The world would be a very different place.

What the New Dealers did right out of the gate was critical to their eventual success. Previously I had focused on the implementation of high top tax rates and expansionary monetary policy as important elements of the New Deal. Obama did the later, but not the former so I assumed top tax rates were the key difference. But it is hard to see how increased top tax rates on the rich would translate into strong electoral gains. After all, Reagan cut taxes on the rich in 1981, a fact that was widely publicized, and yet he won in a landslide in 1984. Republicans have repeatedly cut taxes on the rich and have gained working class support, if anything. So, taxes don’t seem to matter electorally. In fact, it does not seem that economic recovery matters either, Obama achieved this while the New Dealers did not and yet he was punished, while FDR was rewarded.

Real wages are a plausible candidate for what matters. The economic statistics under President Biden are very good, yet he gets poor grades from voters on the economy. Real wages today are still well below their levels at the beginning of his term, despite one of the longest periods of very low unemployment on record. Biden has produced an economy that has delivered stellar growth and low unemployment and yet the wages for people working in low-wage fast-food jobs where I live are the same as two years ago, while the price of everything has risen substantially. For the 64% of Americans living paycheck to paycheck, higher prices with flat wages causes distress. They are not going to rate the economy as good no matter what the statistics say.

But when I look at the 1930’s I am struck by the fact that real wages rose after 1933 despite very high unemployment, which is strange. This might explain FDRs different electoral experience. What was going on? Hanes (1996) looked into this. Wage levels should be affected by labor supply and demand. Increased labor supply should lead to falling wages. Labor supply is positively related to unemployment. So, wage growth should be negatively related to unemployment. Conversely, wages should rise with rising demand for labor. Industrial labor demand is positively related to industrial production (IP). Thus, the growth rate in industrial wages should be positively related to growth in industrial production. Hanes constructed models for what industrial wage growth should be based on unemployment and IP data from the postwar period and used them to predict wage growth over 1890-1940. The predicted values were within 3 percentage points of the actual values before 1933. Hane’s analysis shows there were two separate episodes of anomalous wage growth (i.e., deviations way above 3 points), one over 1933-34, and a second over 1936-37.

What happened was an example of what I have been calling “New Dealer economic policy”:

In July 1933 the NRA (National Recovery Act passed in June 1933) approved industry codes for cotton textiles, woolen textiles, and shipbuilding. All three codes set industry-specific wage minimums and hiked wages of all industry workers by requiring universal cuts in weekly hours with no cuts in weekly pay. The cotton and shipbuilding codes also required wage hikes for higher-paid jobs to maintain differentials over jobs directly affected by wage minimums. In late July 1933 Roosevelt “invited” nearly all nonagricultural employers in other industries to sign the “President’s Re-Employment Agreement” or “blanket code” to regulate employment until their own industry codes were approved. The blanket code forbade wage cuts for any workers, set wage minimums (the rate applying to an establishment depended on the local municipality’s population and the establishment’s wage level back in 1929) and called for hikes in above-minimum wages "by an equitable readjustment of all pay schedules."

The effective dates of the blanket code and the first industry codes were precisely coincident with the extraordinary increases in the manufacturing wages in August and September 1933. It is plausible that these codes were responsible for most, perhaps all of the 14 percent increase in manufacturing wages across those months. (Hanes 23-4)

Hanes continues:

The NRA had required every industry code to include a provision "That employees shall have the right to organize and bargain collectively through representatives of their own choosing, and shall be free from the interference, restraint or coercion of employers..no employee..shall be required as a condition of employment..to refrain from joining, organizing or assisting a labor organization of his own choosing…”

A strike wave began in June 1933 and lasted until late 1934. Hane notes:

some employers had responded to strikes by recognizing unions and raising wages, others raised wages but did not recognize a union. Many set up employer-controlled "Employee Representation Plans" (ERPs or "company unions") to serve as the collective bargaining representative called for by the NRA; some gave wage increases "negotiated" by an ERP to draw employee support away from outside, independent unions. Employers continued to fire employees involved with unions.

The NRA was ruled unconstitutional in May 1935. We see a direct intervention by the government over July 1933 through 1934 that causes rising wages by replacing 48-hour work weeks with 40-hour ones with no change in weekly pay, establishment of industry-specific minimum wages, and provisions supporting unions. Hane shows that the sharp rise in wages coincides with the start of these rules and the end of the first round of wage growth coincided with the end of the strike wave and when employer counter moves became more successful.

Roosevelt explained what he was doing in his periodic fireside chats. In an October 1933 chat, right in the middle of the extraordinary wage increases he said:

If all employers will act together to shorten hours and raise wages, we can put people back to work. No employer will suffer, because the relative level of competitive cost will advance by the same amount for all. But if any considerable group should lag or shirk, this great opportunity will pass us by, and we will go into another desperate Winter. This must not happen.

There are, of course, men, a few of them who might thwart this great common purpose by seeking selfish advantage. There are adequate penalties in the law, but I am now asking the cooperation that comes from opinion and from conscience…In war, in the gloom of night attack, soldiers wear a bright badge on their shoulders to be sure that comrades do not fire on comrades. On that principle, those who cooperate in this program must know each other at a glance. That is why we have provided a badge of honor for this purpose, a simple design with a legend (see Figure 1). "We do our part," and I ask that all those who join with me shall display that badge prominently.

The essence of the plan is a universal limitation of hours of work per week for any individual by common consent, and a universal payment of wages above a minimum, also by common consent. I cannot guarantee the success of this nationwide plan, but the people of this country can guarantee its success. I have no faith in "cure-alls" but I believe that we can greatly influence economic forces. I have no sympathy with the professional economists who insist that things must run their course and that human agencies can have no influence on economic ills. One reason is that I happen to know that professional economists have changed their definition of economic laws every five or ten years for a very long time…

By 1933 the country had endured three years of a steadily worsening economy with a president proclaiming that prosperity was just around the corner. Hoover said this because this is what his economic advisors said would happen, yet things just got worse. Roosevelt refers to how he is ignoring the advice of his economists and instead is proposing this bold program, the success of which he cannot guarantee. Then he says that he believes that collective action of the population can influence economic forces to fix the problem. Roosevelt explains what he is doing, and those listening have seen the effects of the “blue eagle” either in their own workplace (by seeing their work week shortening to five days instead of six for the same paycheck) or they have heard about it from friends who work for employers who “do their part.” Others were themselves (or knew of those) involved in union activities made possible through the NRA.

Figure 1. The NRA “Blue Eagle”

Those listening knew what the president was talking about, they had seen it in action in their own lives. And when the conservative Supreme Court declared the Blue Eagle unconstitutional, they knew what that was too, and they knew which party was on their side and which one was not. This was manifest in the 1934 elections, which is a second 1930’s anomaly. Normally, the president’s party loses its first Congressional election, particularly during hard times. Times were still very hard in 1934, and the economic statistics, had they been available then, would have painted a very bleak picture, leading Republicans to crow about the abject failure of the Democratic “Socialist” New Deal.

But the New Deal was not a failure, as those who worked for employers who did their part could see in their own lives and could tell friends and relatives about. Rather than the massive gains the out-party would normally achieve, Republicans in 1934 lost 10 Senate and 14 House seats to add to their massive losses in 1932. The 1934 election was important, because it demonstrated to the opposition the strength of the New Deal message, and established Roosevelt’s status as a Reconstructive president. Compare this with what Bill Clinton offered after winning the Presidency on a slogan, “It’s the Economy, stupid.” I recall clearly, the first big issue was “gays in the military.” And the next big news was that his wife was going to spearhead development of a complicated national health program. Where was the economy? And what happened in the next year’s elections? Democrats lost 8 Senate seats, returning control to the Republicans after six years. Even worse, they lost 54 House seats, allowing Republicans to gain control after forty years in the minority (a dominance that was originally created by the political success wrought by the New Deal program).

Returning to the 1930’s wage anomaly, two months after the Supreme Court declared the NRA unconstitutional in May 1935, the New Dealers responded with the Wagner Act, which banned company unions and reinstated the National Labor Relations Board (NLRB) set up by the NRA and gave it additional enforcement powers. Employers fought the new law believing that Roosevelt would lose in the 1936 election, or the Court would rule the Wagner Act unconstitutional. The changes wrought by the NRA could not really be reversed. Once a firm went to a 40-hour work week it was committed. So, the gains made then were not going to be undone. Contracts made in 1934 in the face of Labor resurgence, were also done deals. What changed with the conservative opposition in 1935 and 1936 was the possibility of future gains.

Here is where the ground sown by the now defunct NRA and Roosevelt’s fireside chats paid dividends. Workers knew who was blocking their path to a decent standard of living. When Roosevelt talked of the malefactors of wealth and the enemies of the peace in his 1936 pre-election speech, voters knew of whom he spoke, and they made their will clear in the 1936 landslide election, which reduced the Republican share of the House and Senate to just 20% and 23% of seats, respectively.

The election victory spurred a wave of strikes, including devastingly-effective sit-down strikes, which lasted to October 1937. By the end of March 1937, Hanes reports, “employers in large-scale manufacturing industries including automobiles, steel, chemicals, electrical equipment and rubber gave in, recognized unions and entered into written agreements with them which usually involved immediate pay hikes and more generous overtime provisions.” Hanes notes that the strike wave over November 1936 to October 1937 was precisely coincident with the second spike in wage growth.

This period was followed by a second economic downturn, resulting in a massive electoral defeat in 1938, showing that New Deal Democrats were susceptible to electoral displeasure just as modern Democrats are. When they stopped delivering, they paid the price at the polls.

Because of their previous victories, Democrats had an enormous cushion and retained control of Congress. But Republicans, allied with conservative Southern Democrats, were able to prevent much additional New Deal policy over 1939-40. Roosevelt was able to win an unprecedented third term in 1940, which put the New Dealers in charge of policy when the US entered WW II the following year.

Figure 2. Wage differentials 1907-1952 (Goldin and Margo, Figure IIIA).

As I previously described, the New Dealers were able to achieve a compression of income levels through wartime rationing and wage and price controls (see Figure 2). The result was a substantial reduction in the top 1% income share. Even more important, wage compression and strong wage growth for working people continued for decades after the war because of the impact New Dealer policy changes had made on business culture, union strength, and taxation of the rich. High taxes meant executives were not monetarily incented to focus on shareholder value, and even if they were, the easiest way to do this (stock buybacks) were illegal. Strong unions made it risky to try to retain all of the increased cash flows generated by labor productivity improvements as profits. The best business use of profits was to invest them in the business rather than use them to make larger dividend payments. There were two reasons for this. First, the latter were taxed and the former were not, which encouraged investment. Second, between 1940 and 1980 the return on capital (ROC) from business was greater than that available from financial investment alternatives (meaning it was likely business would achieve a higher return on shareowners’ capital through reinvestment than the owners could obtain by investing increased dividend income themselves). This situation is illustrated by the enterprise premium (ROC from business less ROC from finance) in Figure 3.  

Figure 3. Enterprise premium, executive pay, and financial:nonfinancial relative wage over time

Business executives are ambitious, competitive people who want to win. The constraints described above created a business environment that selected against what I call shareholder primacy business culture via the mechanism of cultural evolution. It does this by preventing executives from directly boosting share price through stock buybacks, leaving two options for profits, reinvestment into the business to grow a bigger, better company (and more prestige for you) or pay profits out to shareholders where they will be heavily taxed and likely fetch an inferior return. If you do a good job in your business investments, the stock will rise in price, generating capital gains for the owners that will be taxed much more lightly than dividends. So, it was a no-brainer to reinvest in the business rather than pay out everything to shareholders, as is done today under shareholder primacy culture.

Besides this, under the New Dealers, there was the external reality of government policy of full employment (maximizing labor bargaining power) and strong unions, making it a prudent choice to fairly share gains from rising worker productivity through rising wages for workers and increased dividends for owners.  Today government policy is centered on inflation control generated through suppression of wage increases via interest rates, an environment which makes serious labor organizing very difficult, if not impossible. The external environment in which today’s business culture evolved in the late 1970’s through early 1990’s featured labor surplus and weak unions, making it easy to translate gains from rising productivity into higher profits. And with stock buybacks legal since 1982, using profits to directly generate higher stock prices via buybacks makes sense. The shift in business environment caused by the end of policy directed by the New Dealers and the rise of “Reaganomics” (also known as neoliberalism) now selected for shareholder primacy culture, as proxied by rising economic inequality.

In conclusion, the cause of the post War economy was economic policy formulated and deliberately implemented by the New Dealers to achieve positive results for working Americans in such a way as to win major electoral victories. In the postwar era, the US was so dominant economically, financially and militarily that what its domestic policymakers did affected the rest of the non-communist world. So, when 1960’s Democratic policymakers, though their choice to prioritize international hegemony (by spending too much on defense and waging the Vietnam War) instead of maintaining the balanced budget necessary to maintain the New Deal Order, they ended not only the postwar economic boom in the US, but also Les Trente Glorieuses in France and “economic miracles” elsewhere in Europe.