No New Deals

Let entrepreneurs and innovation stimulate the economy

There is one thing that's giving political momentum to the Bush-Obama multi-trillion bailout/stimulus spending spree, and it is not a superior understanding of how to fix the ailing economy. It is fear. "Nameless, unreasoning, unjustified terror," as FDR once said.

The economy is in terrible shape. Financial markets are in a deep freeze. The stock market has lost over 40 percent of its value from the Dow's peak last year and 401(k) portfolios are shrinking. Unemployment is rising to levels not seen in 25 years. Companies—big and small—are downsizing or, worse, shuttering their doors completely. And home foreclosure rates are reaching record highs.

Under such circumstances, the fear is that we might well reach the point of no return—or, as a CNN anchor recently put it, face permanent "economic catastrophe."

But it's as likely that government intervention might well delay the recovery process, just as it did in the 1930s when a combination of spending and regulations unleashed by FDR's New Deal turned a recession into a prolonged depression.

Rather than a time for panicked reactions, this is the time to fully understand a lesson of history: The rubble of every recession contains the seeds of its own regeneration. Physical and human capital of dying economic sectors don't vanish with them. These assets—equipment, property, workers—are re-released into the economy, where entrepreneurs, unless thwarted by taxes and regulations, scoop them up and inevitably find more productive uses for them. In the process, new companies are born and new jobs created—offering, over time, far better returns and wages than before.

This is not idle, theoretical speculation.

On a micro level, consider the Pony Express, which was the UPS of 1860. The company cut down delivery time for coast-to-coast mail from six weeks to 10 days by using horse riders instead of ships going around South America. It was wildly successful, but only for about a year. Then commercial telegraph came along, and the company went belly up. Hundreds of workers lost their jobs at a time when civil war was starting, a major recession was brewing after a European bubble in railroads burst, and unemployment was soaring as immigrants from Ireland and elsewhere were coming in droves. But according to Saddles and Spurs, a rare group biography that traces the fortunes of the laid-off riders, all of them found equal or better jobs, in the burgeoning telegraph industry, rodeos and other shows, and as scouts in the Union Army.

On the macro level, consider the experience of the U.S. steel industry in the 20th century and the tech sector at the start of the 21st century. Both went through brutal downsizings that eventually strengthened the American economy and led to generally higher living standards.

Until about 1945, Big Steel—consisting of companies such as U.S. Steel that produced steel from iron ore in large mills—dominated the world market, producing about half of the global steel output. This hegemony, notes University of Dayton economic historian Larry Schweikart, led the industry to precisely the same vices that are responsible for torpedoing the Detroit-based car makers today: bloated corporate bureaucracies; a pampered, unionized workforce with unsustainable legacy costs; and inefficient production methods.

By the 1960s, Big Steel was facing stiff competition from overseas producers, first from Japan and Europe and then from Third World countries such as Brazil. About a quarter of American steel producers went bankrupt between 1974 and 1987. The industry's global market share shrank to 11 percent and employment dropped from 2.5 million in 1974 to 1 million in 1997. But this fight for survival, spanning decades and several recessions, eventually restored the overall industry to profitability. Led by companies such as Nucor, domestic steel makers discovered new ways to turn scrap into steel in sleeker, smaller factories called "mini-mills," using non-unionized workers and a leaner management team.

The physical and human resources that the steel industry squeezed out in its quest for more efficiency didn't simply go up in smoke. They were utilized by other sectors of the economy. For example, employment in the plastics industry, which replaced steel for some uses, grew over 18 percent between 1980 and 2006.

If American-owned automakers were among the loudest voices demanding a bailout from the Bush administration, American steel makers are among the loudest voices demanding massive stimulus spending (on schools, roads, bridges, rapid transit, and other steel-intensive projects) from the Obama administration right now. But if the industry emerged stronger without artificial measures to boost demand for steel once, there is no reason to believe that it won't do so now.

An arguably more stunning comeback involves the dot-com industry. After the 2000 stock market crash, hundreds of Silicon Valley startups collapsed, throwing thousands of highly paid computer professionals out of work. However, within a few short years the industry began to recover, reabsorbing many of the laid-off workers.

One reason for the industry's quick recovery, according to Todd Zywicki, an economist at the George Mason University, was that it was able to rapidly redeploy its resources away from failing enterprises toward more promising ones. Unlike traditional industries, much of the dot-com sector was financed not by debt from bond holders but venture capitalists with equity stakes. This meant that when these companies started showing signs of trouble, their financiers were able to cut their losses and seed other ventures without getting bogged down in time-consuming bankruptcy proceedings.

What's more, they did so at a time when there was a glut of computer talent, not to mention cheap office space, equipment, and other physical assets—all of which positioned them for future success. "If Washington had appointed itself in charge of saving the industry, it would have declared AOL too big to fail," comments Zywicki. "The net effect would have been to retard the advance of broadband and we would all still be using slow-speed dial up to access the Internet."

These are tough economic times and it is impossible to know in advance where the next telegraphic or broadband revolution will come from to drive us out of recession. But the American economy has demonstrated awesome powers of self-correction when its entrepreneurs are left alone to blaze new trails—without a panicked Washington pushing them off course.

FDR famously proclaimed that we have nothing to fear but fear itself. That, and a government that will get in the way of an economic recovery.

Shikha Dalmia is a senior analyst at Reason Foundation.