Although the conventional wisdom — backed by President Obama and the Democrats — is that government spending must go up in hard times, the 1920s began with a depression, and spending went down. Gross National Product (GNP) fell 23.9 percent from 1920 to 1921, compared with the 23.4 percent drop from 1931 to 1932 — the biggest annual GNP decline of the Great Depression. Unemployment doubled to 11 percent in 1921, compared with 24.9 percent in 1933, the worst unemployment level of the Great Depression.
Because pumping trillions into the economy hasn't worked this time, maybe we ought to reflect on the last time government spending was under control — back in the 1920s.
In every decade except one since then, federal spending has more than doubled. The exception (1980-1990) was a decade when spending nearly doubled. How was federal spending brought under control during the 1920s, and how does that relate to dramatically lowering unemployment?
Warren G. Harding, who won the 1920 presidential election, thought companies that prospered because of the war must find peacetime business or shut down. People had to find peacetime jobs. Harding thought that the faster adjustments were made, the better off everybody would be. He understood that the top priority was the recovery of private-sector employment because government didn't have any money other than what it extracted from taxpayers. Accordingly, Harding was determined to minimize taxpayer burdens. By the time he died in August 1923, he had cut spending almost 50 percent. He cut taxes almost 40 percent, and he began paying down the national debt. There were no big-government programs.
The result? The 1920 depression was over in just 18 months. The Roaring '20s boom began in 1922. The American middle class blossomed. Millions of people acquired their first telephone, first radio and first car. The Great Migration of blacks from the South, seeking better opportunities in Northern industrial cities, gained momentum during the 1920s. As a depression fighter, Harding was much more successful than Franklin D. Roosevelt, whose presidency during the 1930s was plagued by chronic double-digit unemployment.
Vice President Calvin Coolidge succeeded Harding and won a term of his own. He, too, was a strong believer in low spending, low taxes and minimum interference with the private sector. Coolidge further cut spending, down to $2.8 billion in 1927. Altogether, spending and taxes were cut 50 percent during the 1920s, and about 30 percent of the national debt was paid off. There were budget surpluses throughout the 1920s. Unemployment fell to 1.8 percent, the lowest U.S. peacetime level in more than 100 years.
There were three principal reasons why Harding and Coolidge were able to control spending, taxes and debt during the 1920s and achieve historically low unemployment.
First, there were no entitlements. The entitlement era in the United States began with Social Security in 1935. Today, entitlements account for more than half of federal spending, and unfunded entitlement liabilities exceed $100 trillion. Congress determines the qualifications for receiving entitlement payments, and the government is obligated to pay however many people show up with qualifications. Entitlement spending could be reduced by changing qualifications to reduce the number of people in a program, but any member of Congress who supported such changes would risk political suicide.
Second, Harding and Coolidge didn't have to deal with government employee unions. These began expanding rapidly during the 1960s. Now they're perhaps the most aggressive lobbyists for higher spending. Government employee unions have gained above-market compensation and gold-plated benefits — more than $5 trillion in federal liabilities. Unfunded state government employee liabilities are another $1 trillion.
Third, Harding and Coolidge believed the job of the military was to protect the United States. They didn't support anything like the current policy of subsidizing the defense of affluent nations in Europe and Asia that can afford to pay for their own defense, or entering other people's wars — especially civil wars — that don't involve a direct national security threat to the United States. Harding and Coolidge believed the United States could legitimately go to war after Congress debated the issues and voted for a declaration of war.
Because Harding and Coolidge were able to keep government spending low, they were able to minimize taxes, debt and government interference with the economy. The private sector flourished, productive jobs were abundant, and unemployment rates reached a historically low peacetime level that no big-government president has ever matched.