DRI-135 for week of 1-4-15: Flexible Wages and Prices: Economic Shock Absorbers

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Flexible Wages and Prices: Economic Shock Absorbers

At the same times that free markets are becoming an endangered species in our daily lives, they enjoy a lively literary existence. The latest stimulating exercise in free-market thought is The Forgotten Depression: 1921 – The Crash That Cured Itself. The author is James Grant, well-known in financial circles as editor/publisher of “Grant’s Interest Rate Observer.” For over thirty years, Grant has cast a skeptical eye on the monetary manipulations of governments and central banks. Now he casts his gimlet gaze backward on economic history. The result is electrifying.

The Recession/Depression of 1920-1921

The U.S. recession of 1920-1921 is familiar to students of business cycles and few others. It was a legacy of World War I. Back then, governments tended to finance wars through money creation. Invariably this led to inflation. In the U.S., the last days of the war and its immediate aftermath were boom times. As usual – when the boom was the artifact of money creation – the boom went bust.

Grant recounts the bust in harrowing detail.  In 1921, industrial production fell by 31.6%, a staggering datum when we recall that the U.S. was becoming the world’s leading manufacturer. (The President’s Conference on Unemployment reported in 1929 that 1921 was the only year after 1899 in which industrial production had declined.) Gross national product (today we would cite gross domestic product; neither statistic was actually calculated at that time) fell about 24% in between 1920 and 1921 in nominal dollars, or 9% when account is taken of price changes. (Grant compares this to the figures for the “Great Recession” of 2007-2009, which were 2.4% and 4.3%, respectively.) Corporate profits nosedived commensurately. Stocks plummeted; the Dow Jones Industrial average fell by 46.6% between the cyclical peak of November, 1919 and trough of August, 1921. According to Grant, “the U.S. suffered the steepest plunge in wholesale prices in its history (not even eclipsed by the Great Depression),” over 36% within 12 months. Unemployment rose dramatically to a level of some 4,270,000 in 1921 – and included even the President of General Motors, Billy Durant. (As the price of GM’s shares fell, he augmented his already-sizable shareholdings by buying on margin – ending up flat broke and out of a job.) Although the Department of Labor did not calculate an “unemployment rate” at that time, Grant estimates the nonfarm labor force at 27,989,000, which would have made the simplest measure of the unemployment rate 15.3%. (That is, it would have undoubtedly included labor-force dropouts and part-time workers who preferred full-time employment.)

A telling indicator of the dark mood enveloping the nation was passage of the Quota Act, the first step on the road to systematic federal limitation of foreign immigration into the U.S. The quota was fixed at 3% of foreign nationals present in each of the 48 states as of 1910. That year evidently reflected nostalgia for pre-war conditions since the then-popular agricultural agitation for farm-price “parity” sought to peg prices to levels at that same time.

In the Great Recession and accompanying financial panic of 2008 and subsequently, we had global warming and tsunamis in Japan and Indonesia to distract us. In 1920-1921, Prohibition had already shut down the legal liquor business, shuttering bars and nightclubs. A worldwide flu pandemic had killed hundreds of thousands. The Black Sox had thrown the 1919 World Series at the behest of gamblers.

The foregoing seems to make a strong prima facie case that the recession of 1920 turned into the depression of 1921. That was the judgment of the general public and contemporary commentators. Herbert Hoover, Secretary of Commerce under Republican President Warren G. Harding, who followed wartime President Woodrow Wilson in 1920, compiled many of the statistics Grant cites while chairman of the President’s Conference on Unemployment. He concurred with that judgment. So did the founder of the study of business cycles, the famous institutional economist Wesley C. Mitchell, who influenced colleagues as various and eminent as Thorstein Veblen, Milton Friedman, F. A. Hayek and John Kenneth Galbraith. Mitchell referred to “…the boom of 1919, the crisis of 1920 and the depression of 1921 [that] followed the patterns of earlier cycles.”

By today’s lights, the stage was set for a gigantic wave of federal-government intervention, a gargantuan stimulus program. Failing that, economists would have us believe, the economy would sink like a stone into a pit of economic depression from which it would likely never emerge.

What actually happened in 1921, however, was entirely different.

The Depression That Didn’t Materialize

We may well wonder what might have happened if the Democrats had retained control of the White House and Congress. Woodrow Wilson and his advisors (notably his personal secretary, Joseph Tumulty) had greatly advanced the project of big government begun by Progressive Republicans Theodore Roosevelt and William Howard Taft. During World War I, the Wilson administration seized control of the railroads, the telephone companies and the telegraph companies. It levied wage and price controls. The spirit of the Wilson administration’s efforts is best characterized by the statement of the Chief Price Controller of the War Industries Board, Robert Brookings. “I would rather pay a dollar a pound for [gun]powder for the United States in a state of war if there was no profit in it than pay the DuPont Company 50 cents a pound if they had 10 cents profit in it.” Of course, Mr. Brookings was not actually himself buying the gunpowder; the government was only representing the taxpayers (of whom Mr. Brookings was presumably one). And their attitude toward taxpayers was displayed by the administration’s transformation of an income tax initiated at insignificant levels in 1913 and to a marginal rate of 77% (!!) on incomes exceeding $1 million.

But Wilson’s obsession with the League of Nations and his 14 points for international governance had not only ruined his health, it had ruined his party’s standing with the electorate. In 1920, Republican Warren G. Harding was elected President. (The Republicans had already gained substantial Congressional majorities in the off-year elections of 1918.) Except for Hoover, the Harding circle of advisors was comprised largely of policy skeptics – people who felt there was nothing to be done in the face of an economic downturn but wait it out. After all, the U.S. had endured exactly this same phenomenon of economic boom, financial panic and economic bust before in 1812, 1818, 1825, 1837, 1847, 1857, 1873, 1884, 1890, 1893, 1903, 1907, 1910 and 1913. The U.S. economy had not remained mired in depression; it had emerged from all these recessions – or, in the case of 1873, a depression. If the 19th-century system of free markets were to be faulted, it would not be for failure to lift itself out of recession or depression, but for repeatedly re-entering the cycle of boom and bust.

There was no Federal Reserve to flood the economy with liquidity or peg interest rates at artificially low levels or institute a “zero interest-rate policy.” Indeed, the rules of the gold-standard “game” called for the Federal Reserve to raise interest rates to stem the inflation that still raged in the aftermath of World War I. Had it not done so, a gold outflow might theoretically have drained the U.S. dry.  The Fed did just that, and interest rates hovered around 8% for the duration. Deliberate deficit spending as an economic corrective would have been viewed as madness. As Grant put it, “laissez faire had its last hurrah in 1921.”

What was the result?

In the various individual industries, prices and wages and output fell like a stone. Auto production fell by 23%. General Motors, as previously noted, was particularly hard hit. It went from selling 52,000 vehicles per month to selling 13,000 to 6,150 in the space of seven months. Some $85 million in inventory was eventually written off in losses.

Hourly manufacturing wages fell by 22%. Average disposable income in agriculture, which comprised just under 20% of the economy, fell by over 55%. Bankruptcies overall tripled to nearly 20,000 over the two years ending in 1921. In Kansas City, MO, a haberdashery shop run by Harry Truman and Eddie Jacobson held out through 1920 before finally folding in 1921. The resulting personal bankruptcy and debt plagued the partners for years. Truman evaded it by taking a job as judge of the Jackson County Court, where his salary was secure against liens. But his bank accounts were periodically raided by bill collectors for years until 1935, when he was able to buy up the remaining debt at a devalued price.

In late 1920, Ford Motor Co. cut the price of its Model T by 25%. GM at first resisted price cuts but eventually followed suit. Farmers, who as individuals had no control over the price of their products, had little choice but to cut costs and increase productivity – increasing output was an individual’s only way to increase income. When all or most farmers succeeded, this produced lower prices. How much lower? Grant: “In the second half of [1920], the average price of 10 leading crops fell by 57 percent.” But how much more food can humans eat; how many more clothes can they wear? Since the price- and income-elasticities of demand for agricultural goods were less than one, this meant that agricultural revenue and incomes fell.

As noted by Wesley Mitchell, the U.S. slump was not unique but rather part of a global depression that began as a series of commodity-price crashes in Japan, the U.K., France, Italy, Germany, India, Canada, Sweden, the Netherlands and Australia. It encompassed commodities including pig iron, beef, hemlock, Portland cement, bricks, coal, crude oil and cotton.

Banks that had speculative commodity positions were caught short. Among these was the largest bank in the U.S., National City Bank, which had loaned extensively to finance the sugar industry in Cuba. Sugar prices were brought down in the commodity crash and brought the bank down with them. That is, the bank would have failed had it not received sweetheart loans from the Federal Reserve.

Today, the crash of prices would be called “deflation.” So it was called then and with much more precision. Today, deflation can mean anything from the kind of nosediving general price level seen in 1920-1921 to relatively stable prices to mild inflation – in short, any general level of prices that does not rise fast enough to suit a commentator.

But there was apparently general acknowledgment that deflation was occurring in the depression of 1921. Yet few people apart from economists found that ominous. And for good reason. Because after some 18 months of panic, recession and depression – the U.S. economy recovered. Just as it had done 14 times previously.


It didn’t merely recover. It roared back to life. President Harding died suddenly in 1923, but under President Coolidge the U.S. economy experienced the “Roaring 20s.” This was an economic boom fueled by low tax rates and high productivity, the likes of which would not be seen again until the 1980s. It was characterized by innovation and investment. Unfortunately, in the latter stages, the Federal Reserve forgot the lessons of 1921 and increases the money supply to “keep the price level stable” and prevent deflation in the face of the wave of innovation and productivity increases. This helped to usher in the Great Depression, along with numerous policy errors by the Hoover and Roosevelt administrations.

Economists like Keynes, Irving Fisher and Gustav Cassel were dumbfounded. They had expected deflation to flatten the U.S. economy like a pancake, increasing the real value of debts owed by debtor classes and discouraging consumers from spending in the expectation that prices would fall in the future. Not.

There was no economic stimulus. No TARP, no ZIRP, no QE. No wartime controls. No meddlesome regulation a la Theodore Roosevelt, Taft and Wilson. The Harding administration and the Fed left the economy alone to readjust and – mirabile dictu – it readjusted. In spite of the massive deflation or, much more likely, because of it.

The (Forgotten) Classical Theory of Flexible Wages and Prices

James Grant wants us to believe that this outcome was no accident. The book jacket for the Forgotten Depression bills it as “a free-market rejoinder to Bush’s and Obama’s Keynesian stimulus applied to the 2007-9 recession,” which “proposes ‘less is more’ with respect to federal intervention.”

His argument is almost entirely empirical and very heavily oriented to the 1920-1921 depression. That is deliberate; he cites the 14 previous cyclical contractions but focuses on this one for obvious reasons. It was the last time that free markets were given the opportunity to cure a depression; both Herbert Hoover and Franklin Roosevelt supervised heavy, continual interference with markets from 1929 through 1941. We have much better data on the 1920-21 episode than, say, the 1873 depression.

Readers may wonder, though, whether there is underlying logical support for the result achieved by the deflation of 1921. Can the chorus of economists advocating stimulative policy today really be wrong?

Prior to 1936, the policy chorus was even louder. Amazing as it now seems, it advocated the stance taken by Harding et al. Classical economists propounded the theory of flexible wages and prices as an antidote to recession and depression. And, without stating it in rigorous fashion, that is the theory that Grant is following in his book.

Using the language of modern macroeconomics, the problems posed by cyclical downturns are unemployment due to a sudden decline in aggregate (effective) demand for goods and services. The decline in aggregate demand causes declines in demand for all or most goods; the decline in demand for goods causes declines in demand for all or most types of labor. As a first approximation, this produces surpluses of goods and labor. The surplus of labor is defined as unemployment.

The classical economists pointed out that, while the shock of a decline in aggregate demand could cause temporary dislocations such as unsold goods and unemployment, this was not a permanent condition. Flexible wages and prices could, like the shock absorbers on an automobile, absorb the shock of the decline in aggregate demand and return the economy to stability.

Any surplus creates an incentive for sellers to lower price and buyers to increase purchases. As long as the surplus persists, the downward pressure on price will remain. And as the price (or wage) falls toward the new market-clearing point, the amount produced and sold (or the amount of labor offered and purchases) will increase once more.

Flexibility of wages and prices is really a two-part process. Part one works to clear the surpluses created by the initial decline in aggregate demand. In labor markets, this serves to preserve the incomes of workers who remain willing to work at the now-lower market wage. If they were unemployed, they would have no wage, but working at a lower wage gives them a lower nominal income than before. That is only part of this initial process, though. Prices in product markets are decreasing alongside the declining wages. In principle, fully flexible prices and wages would mean that even though the nominal incomes of workers would decline, their real incomes would be restored by the decline of all prices in equal proportion. If your wage falls by (say) 20%, declines in all prices by 20% should leave you able to purchase the same quantities of goods and services as before.

The emphasis on real magnitudes rather than nominal magnitudes gives rise to the name given to the second part of this process. It is called the real-balance effect. It was named by the classical economist A. C. Pigou and refined by later macroeconomist Don Patinkin.

When John Maynard Keynes wrote his General Theory of Employment Interest and Income in 1936, he attacked classical economists by attacking the concepts of flexible wages and prices. First, he attacked their feasibility. Then, he attacked their desirability.

Flexible wages were not observed in reality because workers would not consent to downward revisions in wages, Keynes maintained. Did Keynes really believe that workers preferred to be unemployed and earn zero wages at a relatively high market wage rather than work and earn a lower market wage? Well, he said that workers oriented their thinking toward the nominal wage rather than the real wage and thus did not perceive that they had regained their former position with lower prices and a lower wage. (This became known as the fallacy of money illusion.) His followers spent decades trying to explain what he really meant or revising his words or simply ignoring his actual words. (It should be noted, however, that Keynes was English and trade unions exerted vastly greater influence on prevailing wage levels in England that they did in the U.S. for at least the first three-quarters of the 20th century. This may well have biased Keynes’ thinking.)

Keynes also decried the assumption of flexible prices for various reasons, some of which continue to sway economists today. The upshot is that macroeconomics has lost touch with the principles of price flexibility. Even though Keynes’ criticisms of the classical economists and the price system were discredited in strict theory, they were accepted de facto by macroeconomists because it was felt that flexible wages and prices would take too long to work, while macroeconomic policy could be formulated and deployed relatively quickly. Why make people undergo the misery of unemployment and insolvency when we can relieve their anxiety quickly and compassionately by passing laws drafted by macroeconomists on the President’s Council of Economic Advisors?

Let’s Compare

Thanks to James Grant, we now have an empirical basis for comparison between policy regimes. In 1920-1921, the old-fashioned classical medicine of deflation, flexible wages and prices and the real-balance effect took 18 months to turn a panic, recession and depression into a rip-roaring recovery that lasted 8 years.

Fast forward to December, 2007. The recession has begun. Unfortunately, it is not detected until September, 2008, when the financial panic begins. The stimulus package is not passed until January, 2009 – barely in time for the official end of the recession in June, 2009. Whoops – unemployment is still around 10% and remains stubbornly high until 2013. Moreover, it only declines because Americans have left the labor force in numbers not seen for over thirty years. The recovery, such as it is, is so anemic as to hardly merit the name – and it is now over 7 years since the onset of recession in December, 2007.


It is no good complaining that the stimulus package was not large enough because we are comparing it with a case in which the authorities did nothing – or rather, did nothing stimulative, since their interest-rate increase should properly be termed contractionary. That is exactly what macroeconomists call it when referring to Federal Reserve policy in the 1930s, during the Great Depression, when they blame Fed policy and high interest rates for prolonging the Depression. Shouldn’t they instead be blaming the continual series of government interventions by the Fed and the federal government under Herbert Hoover and Franklin Roosevelt? And we didn’t even count the stimulus package introduced by the Bush administration, which came and went without making a ripple in term of economic effect.

Economists Are Lousy Accident Investigators 

For nearly a century, the economics profession has accused free markets of possessing faulty shock absorbers; namely, inflexible wages and prices. When it comes to economic history, economists are obviously lousy accident investigators. They have never developed a theory of business cycles but have instead assumed a decline in aggregate demand without asking why it occurred. In figurative terms, they have assumed the cause of the “accident” (the recession or the depression). Then they have made a further assumption that the failure of the “vehicle’s” (the economy’s) automatic guidance system to prevent (or mitigate) the accident was due to “faulty shock absorbers” (inflexible wages and prices).

Would an accident investigator fail to visit the scene of the accident? The economics profession has largely failed to investigate the flexibility of wages and prices even in the Great Depression, let alone the thirty-odd other economic contractions chronicled by the National Bureau of Economic Research. The work of researchers like Murray Rothbard, Vedder and Galloway, Benjamin Anderson and Harris Warren overturns the mainstream presumption of free-market failure.

The biggest empirical failure of all is one ignored by Grant; namely, the failure to demonstrate policy success. If macroeconomic policy worked as advertised, then we would not have recessions in the first place and could reliably end them once they began. In fact, we still have cyclical downturns and cannot use policy to end them and macroeconomists can point to no policy successes to bolster their case.

Now we have this case study by James Grant that provides meticulous proof that deflation – full-blooded, deep-throated, hell-for-leather deflation in no uncertain terms – put a prompt, efficacious end to what must be called an economic depression.

Combine this with the 40-year-long research project conducted on Keynesian theory, culminating in its final discrediting by the early 1980s. Throw in the existence of the Austrian Business Cycle Theory, which combines the monetary theory of Ludwig von Mises and interest-rate theory of Knut Wicksell with the dynamic synthesis developed by F. A. Hayek. This theory cannot be called complete because it lacks a fully worked out capital theory to complete the integration of monetary and value theory. (We might think of this as the economic version of the Unified Field Theory in the natural sciences.) But an incomplete valid theory beats a discredited theory every time.

In other words, free-market economics has an explanation for why the accident repeatedly happens and why its effects can be mitigated by the economy’s automatic guidance mechanism without the need for policy action by government. It also explains why the policy actions are ineffective at both remedial and preventive action in the field of accidents.

James Grant’s book will take its place in the pantheon of economic history as the outstanding case study to date of a self-curing depression.

DRI-247 for week of 10-12-14: Rhyming History in the Middle East

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Rhyming History in the Middle East

The historian George Santayana is best known for the comment that “those who do not remember the past are condemned to repeat it.” Another commentator amended Santayana by noting that, while history does not repeat itself literally, “it does rhyme.” Anybody literate in world history can cock an ear to the sound of developments in the Middle East today and recognize the rhymes.

Pedagogy is the art of focused oversimplification. Movies are a painless way of teaching history because they focus our attention through dramatic depiction on a visual canvas. Two famous movies provide a narrative paradigm for our Middle East historical rhyme.

Khartoum: The Death of “Chinese” Gordon and the Fall of the Sudan to Islamic Fanaticism

The 1966 film Khartoumdepicts one of Great Britain’s most famous military debacles: the capture of the Sudan from Egypt by forces led by Muhammad Ahmad, the Islamic religious fanatic known as “the Mahdi” (the “chosen one”). At first blush, no association with Great Britain is visible here, since Sudan was a protectorate of Egypt and part of the Turkish Ottoman empire – Sudan, Egypt and Turkey were not a part of the British Commonwealth. But Great Britain had long exercised influence in the Middle East for various reasons, and that influence extended to the use of military force in the region. One of the most famous of all British soldiers, General Charles G. Gordon, was Governor General of the Sudan and led the defense of its capital of Khartoum at the time of the invasion. Gordon’s death may have been the worst public-relations disaster ever suffered by British arms.

(1)Gordon was a professional soldier-for-hire, having served the Empire of China in putting down the Taiping Rebellion during one of the famous Opium Wars in the early 1860s. His talents included not only skill as a military commander but also formidable engineering skills. He also served with distinction in India and the Congo. Prior to the Islamic revolt, Gordon had served a previous stint as Governor General in the Sudan, during which he had played a key role in suppressing the slave trade. This was the culmination in Great Britain’s century-long crusade against slavery. It was fitting that Gordon, world-renowned as an evangelical Christian (albeit non-denominational in his belief), should have delivered this coup de grace to the institution of slavery. It was Christianity, alone among the world’s great religions, which had spearheaded the fight against slavery across the globe.

According to the movie, Gordon returned to the Sudan in early 1884 at the request of British Prime Minister William Gladstone. Gladstone was responding to public pressure created when another British professional soldier, Col. William Hicks, led an ill-fated expeditionary force of 10,000 Egyptian soldiers against the forces of the Mahdi. The Islamic leader had organized an army in revolt against Egyptian and Turkish rule in the Sudan, urging his followers to kill Turks. The movie’s narrator blames Hicks for failing to grasp the “one essential feature of the [Sudanese] desert: its immensity. The Mahdi led him on and on.” At the opportune moment, the Mahdists attacked and annihilated Hicks and his forces. In fact, the incompetence and indifference of the Egyptian military was also a factor in its defeat.

Can we hear the rhyme? For over 60 years, the United States has intervened militarily in countries that it did not own or officially protect. These included Korea, Vietnam, Cuba, Grenada, the Dominican Republic, Panama, Kuwait, Iraq, Afghanistan and Pakistan. In none of these cases was war declared, yet U.S. military forces were deployed and saw action. In each large-scale conflict, local forces were under the command of U.S. officers. The ability and spirit of the natives were questioned and success hinged at least partially on their efforts. In essence, then, the United States today is playing a role directly analogous to that played by Great Britain in the 19th century.

(2)An outcry to “avenge Hicks” prompted Gladstone to review his options. Gladstone was a liberal in the 19th-century sense of the word. He believed in free international trade as a medium to encourage peace among nations. He knew full well that British investors had a financial stake in the region and that the Suez Canal was considered a vital strategic interest of Great Britain. But Gladstone was viscerally reluctant to use the military power of the British government to bail out private investors. In the movie’s most chillingly prescient moment, he utters the line: “Britain will not assume the obligation to police the world.”

Can we hear the rhyme? That line of movie dialogue reverberates in our ears today. Every policy discussion of every undeclared war involving us has raised the specter of the U.S. as “world policeman.” In 1884, there was no concept of international law and no international agency with the mission of enforcing it, let alone a mandate to deter or punish international aggression. After World War II, though, the World Court and the United Nations existed. Yet the U.S. still found itself intervening in conflict after conflict and maintaining a military presence in most of the countries of the world. To be sure, this is a function of the ineffectual, corrupt status of the U.N. and the dubious legitimacy of “international law” in the realm of national aggression. Even so, no thoughtful American can watch Khartoumwithout shuddering at this point.

(3)The movie Gladstone escapes his dilemma, at least temporarily. The British public is clamoring for Gordon to be sent back to the Sudan, the scene of one of his greatest triumphs. Queen Victoria herself supports this plan. (The Egyptians welcome the return of Gordon, whom they regard reverentially as a potential savior.) Gladstone’s advisor, Foreign Secretary Granville, suggests that Gordon be sent to the Sudan but put on a tight leash, with orders only to evacuate British and European military and civilian personnel. Gladstone objects that Gordon, notorious for keeping his own counsel, will exceed his orders and do his best to “embroil the government” in war. Another advisor, army officer J.D.H. Stewart, interjects that if Gordon were sent to the Sudan without powers or army, he could not hope to stand up to the Mahdi. “He would simply fail.” At which point, Granville ripostes, “What a pity.” Gladstone understands that Granville is implying that Gordon be set up to fail as a scapegoat for an administration that is unwilling to take responsibility for employing the necessary military force.

Can we hear the rhyme? Once again, the reverberations from this exchange are painful to our modern ears. In Korea, the U.N. – but acting as a token front for a venture under U.S. leadership and predominantly staffed by U.S. forces – began by prosecuting a so-called “police action” rather than a full-fledged war. What was the result of this moderate, carefully calibrated, half-hearted military action? The U.N. forces came within an eyelash of being pushed off the Korean peninsula by North Korean forces (aided by Chinese and Russian advisors and materiel). Only when the U.S. dropped all pretense of fighting a police action and began to fight a war of annihilation against North Korea did our forces turn the tide of battle, first against North Korea and later against the combined North Korean and Chinese forces.

Later in Vietnam, this scenario repeated itself. The U.S. began by sending military advisors under the Eisenhower and Kennedy administrations. This half-measure proved inadequate against a North Vietnam aided by China and the Soviet Union, so the Johnson administration began a policy of gradual escalation of hostilities. Bombing of Viet Cong sanctuaries and, later, North Vietnam itself were a key part of this strategy. But only when U.S. forces annihilated the Viet Cong in South Vietnam during the Tet Offensive did we emerge militarily victorious. We were victorious in the sense that the Viet Cong were eliminated and North Korean forces were evicted from the South. But just as Gordon’s first victory in the Sudan did not prove decisive, so did our military victory in Vietnam not prove lasting. Our support was withdrawn from South Vietnam while Communist support was maintained in the North, and South Vietnam could not stand on its own against the subsequent North Vietnamese invasion.

In Kuwait, our military victory was swift and decisive, since the volunteer U.S. army was far superior to any other military force in the world. But rather than eliminate the enemy, we stopped short of proceeding to Baghdad and deposing Saddam Hussein.

In the Iraq invasion of 2003, the initial military effort was once again irresistibly successful. But subsequent terrorist activities, based in surrounding nations, were treated using police tactics rather than full-fledged, rapid military force. Only when a change in leadership produced a “surge” in military force did the U.S. succeed in retaking its lost ground, much as it had in Korea and Vietnam earlier. Then the U.S. withdrew its forces – and within a short time, the opposition had reformed and reasserted itself.

Now the U.S. has returned to the Middle East again – to fight Islamic fanaticism, again. We are proposing a moderate strategy of limited involvement, using bombing as a gradual step with the possibility of using ground troops later. Again.

We should note that the movie’s conference between Gladstone and his advisors was a dramatic invention by Khartoum‘s screenwriter Robert Ardrey. (Ardrey was highly respected in Hollywood and received an Oscar nomination for this screenplay. He eventually left Hollywood to write best-selling books on anthropology [!].) Among the numerous complications left out of the movie is the army actually sent to Egypt prior to Gordon’s arrival. But the movie’s implication of vacillation and inconsistency in the Gladstone administration’s military actions is fully justified.

(4)Six months after the fall of Khartoum, the Mahdi himself died of typhus. He has provided a line of succession, however, and his successors continued to stir up trouble in the Sudan for years after his demise. This, coupled with the political furor caused by Gordon’s death and the abortive and futile military actions by the Gladstone administration, eventually motivated Great Britain to send another army to the Sudan. This one was commanded by an expert in desert warfare, General Kitchener, who had been a major serving in the Sudan during Gordon’s tenure. Kitchener’s forces destroyed the Mahdist army at the famous battle of Omdurman in 1898. Eventually, the Sudan attained independence from Egypt and freedom from the orbit of Great Britain.

Can we hear the rhyme? In Korea, moderation in the pursuit of war led to a stalemate that has lasted for a half-century. In Vietnam, it led to a Communist victory after American military victory. In Iraq, it left Saddam Hussein free to create havoc and necessitate our eventual return to Iraq – an outcome analogous to the British return to the Sudan. And now the U.S. has returned to the Middle East again to fight the same old aggressor – Islamic fanaticism – with a new name.

Douglas MacArthur said “In war, there is no substitute for victory.” Victory consists of complete subjugation of the enemy by the destruction of its means to fight and the surrender of its political authority. The attainment of these objectives requires a declaration of war and prosecution of war with a single-minded and wholehearted devotion to those ends. The U.S. has abandoned both of these principles, much as did Great Britain in the 19th and 20th centuries.  


(5)When Gordon arrived in the Middle East, his first move was to fortify his position by enlisting allies among local governments. The movie shows him visiting a neighboring sultan and former slaver named “Zobeir Pasha.” Gordon asks for aid against the Mahdi, whom Gordon depicts as a common enemy. This request is hindered by the fact that Gordon had ordered the execution of Zobeir Pasha’s son during his war against the slave trade. Sure enough, Gordon meets with a stony refusal. This movie interlude is a stand-in for various real-life efforts by Gordon to build a coalition against the Mahdi – efforts that enjoyed little success.

Can we hear the rhyme? In every major military conflict of the last 60 years, the U.S. has faced the task of recruiting local support. In most (but not all) cases, this has entailed appealing to local tribes and factions. In Vietnam, for example, the U.S. was able to recruit the Montagnards, mountain tribesmen who were bitter enemies of the Viet Cong dating back to the time when they were called the Viet Minh. Unfortunately, winning over the “hearts and minds” of the remaining South Vietnamese population was a tougher job that took most of the war to accomplish. Distinguishing between friendly or neutral South Vietnamese and hostile Viet Cong was one of the biggest day-to-day headaches plaguing U.S. troops. In Iraq, most of the publicity surrounding the Bush administration’s agonizing struggle against terrorist counterattacks has focused on tribal and ethnic feuds between Sunni, Shiites, Kurds and other sects and factions.

(6)The biggest set-piece scene in Khartoumand the movie’s dramatic highlight is the climactic battle scene, in which Mahdist forces invade the city and butcher the inhabitants. The death of Gordon himself is a memorable scene based on a famous painting by George Joy, entitled “Death of Gordon.” Gordon is shown descending the staircase from his office residence in the midst of the battle for the city. Such was the awe commanded by his presence among friend and foe alike that the battle stops dead for a few eerie seconds as the Mahdists pay the infidel devil his due by allowing him to descend a few steps unmolested. Then a soldier launches a spear into Gordon’s chest and the great soldier falls off the steps in perfect imitation of the painting. Acting in violation of the Mahdi’s personal injunction, his men behead Gordon and carry the head in triumph on a spear across the city. On Gordon’s lips, it was said, was an ironic smile.

Although the locale of Gordon’s death was apparently correct, the battle itself was another dramatic invention by Ardrey. A local official betrayed Gordon and the Egyptians by allowing the Mahdists nocturnal access to the city, vitiating the necessity of launching an assault. Estimates of the ensuing slaughter vary from a conservative 10,000 to a more expansive 30,000. Interestingly, the movie shifts the locus of local corruption to economics; the local official hoards grain and sells it on the outside. When his corruption is discovered, Gordon orders his execution.

Can we hear the rhyme? A recurring theme in U.S. military conflicts has been that the people on whose behalf we are ostensibly fighting reject our help or even line up against us. In Korea, the early-arriving troops on the Korean peninsula noted that North Korean troops could blend in with the local population so well that pursuit was especially frustrating. In Vietnam, numerous stories of GIs betrayed and booby-trapped by locals made American troops wary and trigger-happy in their interactions with the South Vietnamese. In Iraq, the kickoff of American intervention with the subjugation of the country created a climate of mistrust that lasted for the remainder of the U.S. occupation. This creates the anomalous picture of an American military purportedly serving a noble, altruistic cause but in practice having to convince the beneficiary or even browbeat him to fight off opposition. What accounts for this picture, let alone its repetition?

The common factor is rebellion or revolt against the established order. Great Britain in the 19th century and the U.S. in the 20th century found themselves defending the established order against change. In a rebellion, it is often difficult to tell friend from foe and one never knows when one may become the other. In the movie, there is a key scene when Gordon boldly infiltrates the Mahdi’s camp, accompanied only by his friend and servant, Khaleel. While there, he learns that the Mahdi’s intention is to attack Khartoum and massacre all opponents – indeed, to conquer the entire Ottoman Empire, massacre all Turkish opposition and create an Islamic empire on the world stage. This meeting never took place – it was inserted to bolster the movie’s position that Gladstone should have decisively intervened militarily in support of Gordon and against the Mahdi. In other words, the Mahdi was portrayed as more than just a local rebel. He was an international aggressor. Gordon knew this and was a hero for single-handedly resisting him and warning the world. Gladstone displayed political cowardice in ignoring this warning – or so the movie contends.

This same theme resounded throughout U.S. military interventions. In Korea and Vietnam, Communism was the international aggressor. There were certainly good grounds for adopting this stance, since modern Communist doctrine vacillated between the export of international revolution a la Lenin and the more cautious doctrine of “socialism in one country.” But even after the collapse of Communism at the close of the 20th century, the doctrine of international aggression was preserved as justification for military action.

The Practical Value of the Middle East Rhyme

To be useful, historical rhyme must not only present a discernible pattern. It must also point the way to a desirable plan of action. It is one thing to suggest that the U.S. has fallen victim to the same political temptations as did Great Britain before her, for largely the same reasons. Of what practical value is this knowledge?

Our analysis suggests that both Great Britain and the U.S. were trying to do what Las Vegas gamblers would call “making their point the hard way.” It is one thing to say “I find this state of affairs deplorable and I want to see it changed.” That does not make the statement “I will change it using the means I propose” necessarily correct. The next EconBrief will explore the reasons why both these great powers found it so excruciatingly difficult to effect change using military force. Not surprisingly, those reasons are economic. It is even less surprising that the better plan would be to deploy economic logic rather than boots on the ground. A recent op-ed by the noted Latin American economist and political advisor Hernando De Soto points the way.

DRI-270 for week of 2-9-14: Can We Make Economic Sense of First Wives’ ‘Joining Forces’ Initiative?

An Access Advertising EconBrief:

Can We Make Economic Sense of First Wives’ ‘Joining Forces’ Initiative?

In 2011, the wives of President Obama and Vice-President Biden, Michelle Obama and Dr. Jill Biden, announced formation of a public-service initiative called “Joining Forces.” The action is ostensibly intended to “honor and support our veterans, troops and military families.” What sort of “honor” and “support” is provided? A fair idea can be gleaned from the op-ed appearing under Ms. Obama’s byline in the Monday, February 10, 2014,

Wall Street Journal. It is entitled “Construction Companies Step Up to Hire Veterans.”

It contains the sort of prose that adult Americans have been bombarded with since birth. Still, inquiring economists want to know: What sense can we make of this sort of appeal?

Why Should Construction Companies Hire Veterans?

Ms. Obama uses the lead paragraph of her op-ed to announce an announcement. On publication day, “more than 100 construction companies – many of whom are direct competitors – are coming together to announce that they plan to hire more than 100,000 veterans within the next five years. They made this commitment not just because it’s the patriotic thing to do, and not just because they want to repay our veterans for their service to our country, but because these companies know that it’s the smart thing to do for their businesses.”

“As one construction-industry executive put it, ‘Veterans are invaluable to the construction industry. Men and women who serve in the military often have the traits that are so critical to our success: agility, discipline, integrity and the drive to get the job done right.” Ms. Obama records her approval of this “sentiment” and reiterates the guiding challenge of Joining Forces: “Hire as many of these American heroes as you can.”

Joining Forces originated in 2011. “Since then,” Ms. Obama reports, “we have been overwhelmed by the response… The CEOs we have spoken to have been consistently impressed with their hires…veterans are some of the highest-skilled, hardest-working employees they’ve ever had… resilient, adept at building and leading teams, comfortable with diversity, and able to handle uncertainty.” This is attributable to veterans’ “training and experience,” including “some of the most advanced information, medical and communications technologies in the world.” To bolster her argument, she offers an anecdotal case of an Air Force manpower specialist whose service job was estimating the troop strength and specialties needed for missions. Like many veterans whose “qualifications aren’t always obvious from their resumes,” he would have been “easy to overlook” if not for the Disney Company’s human-resources specialists, who are “trained…to translate military experience into civilian qualifications.” They realized that his military background ideally qualified him to plan meals by specifying exact kinds and quantities of ingredients.

Ms. Obama earnestly implores us to consider the multitude of possible employment conversions. Military medics would make such good paramedics and EMTs. Tank crew members would make dandy truck drivers. The military employs “engineers, welders [and] technicians.” Small wonder, then, that “American businesses have hired nearly 400,000 veterans and military spouses” since Joining Forces opened up.

Why Do Construction Company Managers – or Employers

Generally – Need Advice on Whom to Hire?

The first question that occurs to the inquiring economist is: Why do construction company managers need advice on whom to hire? Indeed, why would any employer need that sort of advice?

Running a business can get complicated. But few decisions are as fundamental as qualifications for new hires. If owners and managers don’t know what they’re looking for in a job applicant, how can they ever hope to succeed?

It is true that we recently underwent a financial crisis, the trigger of which was a housing bubble. Undoubtedly many unwise decisions were made in housing sale and finance, and quite a few in housing construction. But nobody has suggested that the crisis was caused by construction companies hiring the wrong people.

In her op-ed, Ms. Obama didn’t actually

say that employers are boobs who are incapable of hiring the right candidates without the help of the federal government – more specifically, without the help of the wives of the President and Vice-President of the U.S. (Of course, her actions tacitly encourage this belief on the political Left, where it has always flourished.) In fact, what she actually said was that “CEOs …have been consistently impressed with their hires.” She even quoted “one construction industry executive” to the effect that “veterans are invaluable to the construction industry. Men and women who serve in the military often have the traits that are so critical to our success.” (The executive cannot be speaking from experience gained from working with Joining Forces, since that partnership is only now being announced.) If construction-industry executives

already knew

that veterans are “invaluable” – a plausible conjecture for reasons adduced above – why was the intervention of Joining Forces needed?

The clincher comes from Ms. Obama herself, referring to the commitment made by the consortium of construction companies. “They made this commitment not just because it’s the patriotic thing to do…but because these companies know that it’s the smart thing to do for their businesses.” If they

already knew that it was in their interest, in


of this agreement, why was jawboning by Joining Forces required?

In her op-ed, Ms. Obama offers no hint as to why the employers she is urging need advice on hiring. She actually vitiates her own argument by providing persuasive evidence that they do


need her gratuitous advice.

If Employers Did Need Advice on Hiring, Why Would They Seek it from the First Wives?

When people need advice, they generally seek out experts. The hiring decisions of business owners and managers affect their livelihoods and the wealth of investors – all the more reason to obtain qualified opinions when in doubt. Why would a manager base hiring decisions on advice offered informally by two people whose fame and expertise lie outside the industry – and who have no experience in management or personnel?

Taking the advice of a lawyer and an English professor on hiring because their husbands happen to be the President and Vice-President would be tantamount to acting on the basis of a celebrity endorsement. We might heed a celebrity endorser on a question of taste – a choice of beer, say, or candy bar – but not on a matter demanding specialized or expert knowledge.

In her op-ed, Ms. Obama makes one reference to “current research,” but cites no original research attributable to her, Ms. Biden or Joining Forces. In other words, her initiative adds nothing not already available to employers, who already have the strongest possible incentive to seek out and act upon pertinent information about employment candidates.

It is clear that the First Wives would ordinarily not be people whom executives, managers and business owners would solicit for advice on hiring.

Is Ms. Obama Asking for Charity, Demanding an Entitlement or Offering Advice on Efficient Hiring?

Ms. Obama’s plea for hiring of veterans is a mixture of mutually exclusive messages. In the opening paragraph of her op-ed, she declares that construction companies made the commitment to hire over 100,000 veterans in the next five years “because it’s the patriotic thing to do…because they want to repay our veterans for their service to our country [and] because it’s the smart thing to do for their businesses.” Each of these motives is distinct from, and inconsistent with, the others.

In a free-market economy, the purpose of business is to produce as many goods and services as efficiently as possible. This requires hiring workers solely on the basis of their productivity. While business owners are not barred from having ulterior motives and acting upon them, they will suffer a penalty for indulging any prejudices or whims not consonant with the goal of maximum efficiency and profit. And when businesses depart from the straight and narrow, consumers suffer as well.

If the veteran is indeed the best employee for the job, everybody – the veteran, the company and consumers – wins if the vet is hired. But in that case, the intercession of Ms. Obama, Dr. Biden and Joining Forces is utterly superfluous. If the vet is not the best candidate, then the efforts of some outside agency might well be decisive. But that is hardly a victory for truth, justice and the American way. How is patriotism served by making the company and consumers worse off? For that matter, what is patriotic about sticking a veteran in a job in which he or she is inferior to somebody else?

The notion of “repay[ing] our veterans for their service to their country” is at best an anachronism, a throwback to the days before the all-volunteer military. The draft was viewed – erroneously – as a means of assembling a fighting force without having to pay the full economic costs that would be demanded by willing workers. In that context, it might have made a semblance of sense to provide extra compensation to surviving soldiers after demobilization. But today’s fighting force is composed of volunteers. They are professionals who are paid for their work and equipped with physical, mental and emotional skills that pay dividends after their service ends. It is patronizing and insulting as well as flagrantly inaccurate to treat them as naïve conscripts who need looking after. They are not “our boys.” They are men – and women. Apart from medical treatment for injuries suffered on duty, the only further payment they require is respect.

Why is it Desirable for Construction Companies to Collude in Hiring Veterans?

Ms. Obama went to great pains to announce that over 100 construction companies were “coming together” to “plan” their hiring of veterans. To alleviate potential ambiguity on the point, she noted that “many of [them] are direct competitors.” The term economists and lawyers use to characterize collective hiring decisions made by direct competitors is “collusion.” It is presumptively illegal, on the theory that it allows firms to set wages lower than would be the case were the companies to compete independently in the same labor market. Collusion allows the firms to replicate, or at least approach, the outcome attained by a single

monopsony buyer of labor – just as collusion by a cartel of sellers in a market for output strives to replicate the


result attained by a single seller.

When owners of major-league baseball teams were adjudged guilty of collusion in bargaining with players, they were subject to legal penalties. Why is it wrong for baseball-team owners to collude in hiring players but praiseworthy for construction companies to collude in hiring veterans? Does the approval of Madams Obama and Biden sanctify the practice?

It seems axiomatic that when two people whose primary basis for association is political cooperate to achieve an outcome, their motives are presumed to be political. A political motivation does not sanctify collusion – just the opposite, in fact. A political motivation suggests that the collusion will benefit one political interest or party at the expense of the other or others. Moreover, it also suggests that the gains of the gainers will be less than the losses felt by the losers. That is one way of defining the difference between economic change and political change.

Will Madams Obama and Biden personally supervise the hiring to prevent the monopsony outcome described above? Ms. Obama made no mention of it. There is no reason to expect that, since we have no reason to think that either Ms Obama or Ms. Biden have advanced training in economic theory and no reason to think they could effectively supervise the hiring of thousands of people even if they did. It is competition that precludes the possibility of monopoly, not minute scrutiny of each economic transaction by government authorities.

How Do We Explain the History of Joining Forces?

We have cast overwhelming doubt on the public rationale behind Joining Forces, the initiative promoted by the First Wives. What, then, is its likely purpose? The late Milton Friedman likened the actions of politicians to those of the lead duck in a flying V-formation. Periodically, the leader glances back, only to discover that the formation has deserted him and is flying off in a different direction. The leader must scramble to find the formation and resume his place at the head. The point is that this form of leadership is purely ceremonial; the formation leads and the apparent leader is really following.

It was clear even in 2011 that the Obama administration’s economic stimulus package had failed to stimulate. The Federal Reserve had embarked on an unprecedented program of monetary expansion that was being sold as stimulus but was really designed to prop up the financial system. The Obama administration needed something it could point to as a success and claim credit for.

Presidential spouses since Mamie Eisenhower have been publicly active. Mostly their activities have been innocuous; i.e., non-political. The most conspicuous exception was Hillary Clinton’s leadership of her husband’s health-care program – a choice that turned out to be notably unsuccessful. This time, Mrs. Obama’s involvement was shrewdly chosen.

Politically, her support for veterans was designed to appeal to both friend and foe. It would satisfy Democrats who had become accustomed to a party line of supporting soldiers but not war and whose nostrils quivered at the scent of a victimized interest group. The President

was thought to be particularly unpopular with the military community and pro-military Republicans, so Ms. Obama’s stand couldn’t help but improve matters there.

Economically, Ms. Obama would be betting on a sure thing. The President’s wind-down of wars in Iraq and Afghanistan, coupled with Defense Department budget cuts, would gradually feed veterans into the civilian work force. Mrs. Obama’s strategy would portray them as if they were draftees coping with a painful readjustment amidst civilian indifference or even hostility,

a la the World War II vets in the movie

The Best Years of Our Life or the Vietnam vets of

Coming Home


Of course, nothing could be further from the truth than this pretense. The volunteer military has been working well for decades. In order to attract recruits, the military has had to offer not only wages and salaries sufficient to compensate soldiers for the opportunity costs of service, but also training in the skills and technological savvy necessary to run a modern military. To employers starved for job applicants with just those skills and training and the emotional maturity gained from military service, skilled vets are like raw meat to hungry lions. And even unskilled vets offer physically trained bodies coupled with mental self-discipline – two more attributes that are highly attractive to sectors like the construction industry.

What about the publicity given to returning vets suffering from forms of emotional trauma such as delayed stress? Could this have given rise to a bias adversely affecting the employment prospects of all returning veterans? Could Joining Forces play a role in overcoming this bias?

We will never know because Ms. Obama’s op-ed says nothing on the subject. We cannot very well grant Joining Forces the credit for overcoming a bias that may or may not exist and that the initiative has ignored. It is easy to understand why the First Wives might skirt the issue. They have no expertise in this area either and do not want to introduce an issue that can only detract from their otherwise favorable publicity.

So what role have the First Wives and Joining Forces played in the absorption of vets into the civilian work force? None whatsoever. They are the leader ducks scrambling to get in front of the formation. They are desperate to take credit for veterans’ inevitable success. No wonder, since this has been the only bona-fide economic success that the Obama administration has rubbed up against in recent years.

Why Has Business Cooperated in this Sham Initiative?

Ms. Obama’s op-ed makes it clear that businesses throughout the country have cooperated with the First Wives in professing solidarity with their initiative and making sympathetic noises toward veterans in general.

Our analysis shows that Joining Forces is a sham. Its motives are purely political. In economic terms, it is superfluous. The internal logic behind the project is so contradictory that the more contemplation it receives, the more ludicrous is becomes.

Why, then, have businesses been so cooperative with the First Wives? The obvious answers would seem to be: fear and prudence. Businesses have watched the conduct of the Obama administration. They have seen auto-company shareholders expropriated for the benefit of unionized employees. They have seen one regulatory agency after another launch assaults on industries in the form of new rules, regulations and policies. They have observed an entire Presidential campaign built around attacks on business success and a candidate who epitomized it. They saw the President’s approval rating remain consistently high throughout, suggesting that his actions resonated with a majority of the general public – not just the proverbial 47% that are supposedly dependent on government. Thus, they have every reason to fear the wrath of this administration and to avoid displeasing it if possible.

In this case, business leaders almost certainly reason that playing along with the sham of Joining Forces is a form of cheap insurance. They can make effusive public statements supporting the goals of the First Wives – talk is the cheapest form of political payoff. And they don’t even have to lie – at least not much. They can sign declarations of support and even make public “plans,” “announcements” and “commitments” – none of which contractually obligate them to anything and which the public will have forgotten about within days. The Obama administration has no intention of later holding their feet to the fire and checking to see if they follow through on that “commitment” to hire 100,000 veterans. (Follow-through would have everything to lose and nothing to gain, since the administration only cares about

seeming to cause veterans to be hired, not about actually


it.) Businesses will certainly hire veterans, who constitute an attractive employment option. No economic archaeologist is going to later paw through the data to calculate whether veteran hires reached the promised total. As political blackmail goes, this is probably the cheapest form of protection these businesses will ever pay.

What’s the Harm?

Readers might wonder where the harm lies in allowing the First Wives their little deception. They aren’t altering the course of economic activity much by their actions. Perhaps this forestalls them from pursuing some more destructive pastime.

Willful deception practiced by government cannot be beneficial. Its effects will harm us both directly and indirectly. Waste and misdirection of resources are bad enough. But the misleading impression of an omniscient and confident government compensating for the ham-handed, ineffectual efforts of a short-sighted private sector establishes a precedent for future interventions. Each new intervention sets the stage for the one that follows. The success of a protection racket like this one emboldens and empowers politicians to attempt bigger and more expensive scams.

There is no conceivable rationale or defense for Joining Forces, the job-placement initiative for veterans begun by Madams Obama and Biden. Its economic benefits are entirely illusory. Its aims are purely political. It is big-government bunkum at its most cynical and demagogic. And this conclusion derives not from political animus, but rather from the straightforward logical implications of Ms. Obama’s own words.