In our last post, we explored how the Great Depression didn’t happen because capitalism failed, but because government intervention in monetary markets created distortions that made a necessary correction catastrophic. But the story doesn’t end with the 1929 crash. What followed reveals an even more important lesson about how government solutions can turn a temporary downturn into a decade-long disaster.
Most of us learned in school that Franklin Roosevelt’s New Deal programs softened the Depression’s worst effects, and that World War II’s massive government spending finally ended the economic nightmare. It’s a comforting narrative that positions the government as the hero swooping in to save capitalism from itself.
Unfortunately, it simply isn’t true.
Previous economic downturns in American history typically lasted two to four years. Markets would clear out unsustainable investments, resources would shift to productive uses, and growth would resume. The process wasn’t pleasant, but it worked. The Great Depression became Great not because the initial crash was uniquely severe, but because the government kept interfering with this natural recovery process.
President Hoover gets remembered as a champion of laissez-faire economics who did nothing while the economy burned. That’s almost comically wrong. Within a month of the 1929 crash, Hoover convened conferences with business leaders to strongarm them into keeping wages artificially high even as both profits and prices fell. Between 1929 and 1933, consumer prices plunged 25 percent while nominal wages dropped only 15 percent. That sounds good until you realize it meant a substantial increase in real wages during a period when businesses desperately needed to cut costs. The result was predictable: businesses couldn’t afford to keep workers employed. Unemployment soared.
Hoover also dramatically increased government spending. In just one year, from 1930 to 1931, the federal government’s share of GDP jumped from 16.4 percent to 21.5 percent. His agricultural bureaucracy doled out hundreds of millions to farmers even as new tariffs destroyed their export markets. His Reconstruction Finance Corporation ladled out billions more in business subsidies. Decades later, Rexford Tugwell, one of Roosevelt’s top advisers, admitted that “practically the whole New Deal was extrapolated from programs that Hoover started.”
So Roosevelt didn’t inherit a failed free market. He inherited failed interventionism and decided the solution was more of the same, just louder and faster.
The alphabet soup of New Deal agencies—NRA, AAA, WPA, CCC—were presented as bold experiments to restart the economy. In reality, they represented unprecedented peacetime intrusions into private economic decision-making. The National Recovery Administration fixed prices, mandated production quotas, and told businesses how much they could produce and sell. The Agricultural Adjustment Act paid farmers to destroy crops and livestock while millions went hungry. Federal agents supervised the destruction of perfectly good cotton fields and the slaughter of 6 million baby pigs before they could grow to full size.
These weren’t just inefficient programs. They actively prevented the economy from healing. When the Supreme Court struck down the NRA in 1935 and the AAA in 1936, unemployment actually dropped. Freed from the worst New Deal constraints, the economy showed signs of life—unemployment fell to 18 percent in 1935, then 14 percent in 1936.
But Roosevelt kept piling on new interventions. He ratcheted up the top estate tax rate from 45 percent to 70 percent. He increased the top corporate tax rate and added new surtaxes on top. He even issued an executive order to tax all income over $25,000 at 100 percent. When that failed, he threatened to pack the Supreme Court with additional justices who would rubber-stamp his policies.
Meanwhile, the Federal Reserve seesawed its monetary policy wildly, doubling bank reserve requirements between 1936 and 1937. The result was predictable: by 1938, unemployment had surged back to nearly 20 percent, and the stock market crashed (again) by 50 percent. The economy had achieved something remarkable—a depression within a depression.
Economic historian Robert Higgs identified what he called “regime uncertainty” as the critical factor prolonging the Depression. Roosevelt’s relentless attacks on business, property rights, and free enterprise meant that investors couldn’t predict what policies would come next. Would taxes go higher? Would new regulations destroy their business models? Would profits be confiscated? In that environment, capital either got taxed away or went into hiding. Private investment—the genuine engine of recovery—dried up.
When pollsters asked Americans in 1939 whether Roosevelt’s attitude toward business was delaying recovery, they said yes by more than 2-to-1. The business community felt even more strongly. Hardly “soften the blow” that it gets so much credit for these days.
But what about World War II? Didn’t all that government spending finally end the Depression?
This is where we need to talk about the Broken Window Fallacy—one of the most important concepts in economics, first explained by French economist Frédéric Bastiat in 1850.
Imagine a shopkeeper’s son breaks a window. Some onlookers might say this is actually good for the economy because now the shopkeeper has to pay a glazier to replace it. The glazier will have money to spend elsewhere, creating a ripple of economic activity. Destruction creates jobs!
But Bastiat pointed out what we don’t see: the shopkeeper would have spent that money on something else—new shoes from the shoemaker or inventory for his shop or maybe hiring another clerk. Because he has to replace the window, those other purchases don’t happen so we’ll never know. The glazier has work, but the shoemaker loses a sale. No new wealth has been created; we’ve simply redirected existing wealth from productive uses to repairing destruction.
The same logic applies to war spending, except on a massive scale. Yes, the government spent enormous sums producing tanks, planes, and munitions. Yes, unemployment dropped as millions entered the military and defense industries. But where did those resources come from?
They came from consumer goods that weren’t produced. From factories that couldn’t expand. From businesses that couldn’t invest in better equipment. From all the civilian prosperity that didn’t happen because resources got diverted into blowing things up overseas. The war didn’t create new wealth. It consumed existing wealth at a staggering rate while redirecting what remained toward destruction rather than creation. The materials used to supply armies cannot also be used to build private consumer goods.
Real recovery didn’t come until after both Roosevelt and the war ended. When FDR died in 1945, and the war concluded, the government finally eased up on its anti-business agenda. Tax rates came down. Regulatory uncertainty decreased. Most importantly, investors felt confident enough to start deploying capital again. The postwar investment boom—not government spending—powered the return to sustained prosperity.
Think about it this way: if government spending during wartime actually creates prosperity, we should be able to achieve the same result by having the government spend massively during peacetime. We could build weapons and immediately destroy them, or pay people to dig holes and fill them back in. The spending would be the same, right? But obviously, that wouldn’t make anyone wealthier. The wartime production that looks like prosperity is really just a frantic mobilization of resources away from improving people’s lives and toward destroying things and killing people.
The broken window fallacy applies to modern policy debates, too. When politicians promise “shovel-ready jobs,” they’re repeating the same error. The money comes from somewhere—either taxes that reduce private spending or borrowing that crowds out private investment. The jobs created in the favored industries come at the expense of jobs that would have existed elsewhere if people had been free to spend their own money on what they actually wanted.
The lesson of the Great Depression isn’t that capitalism is unstable and requires constant government management. It’s that government intervention itself creates instability. The boom was caused by the Federal Reserve’s manipulation of credit. The bust became a prolonged depression because Hoover and Roosevelt kept preventing markets from clearing and resources from reallocating to productive uses. The recovery didn’t come from war spending. It came when the government finally stepped back and let private capital work again.
When markets fail, they fail quickly and correct themselves. When the government fails, it tends to double down, creating new interventions to fix problems caused by previous interventions. The Great Depression is a textbook case of how that dynamic can turn a normal business cycle into a lost decade.
Understanding this matters because the myths persist. Every recession brings calls for massive government stimulus. Every economic challenge prompts demands for new regulations and controls. The ghost of FDR still haunts policy discussions, with his interventions held up as proof that government activism works.
But the real evidence tells a different story. The Great Depression lasted as long as it did precisely because the government kept interfering with the adjustment process that market economies need to recover. The tragedy wasn’t capitalism’s failure. It was the triumph of the belief that political management could outperform voluntary exchange, private property, and free markets.
Markets don’t need the government to save them from themselves. More often, they need the government to stop preventing them from working.
Learn more about capitalism here.
