How the American economy worked

As it is at the heart of three major aspects to this Depth Study it seems sensible to have some idea of how the American economy worked. Now I am no economist but I think I can explain the basics for you and so provide a platform for your studies of this economy as it boomed and as it went bust.

The American economy was, of course, based on capitalist principles. That is businesses were privately owned and profit was the motive. That much is pretty straight forward. Capitalist economies are also very much consumer-driven. If we don’t want the things that are grown, or the things that are made, we simply don’t buy them. So, to be successful, to make a profit, the goods have to be in demand, and sold at the right price.

That the American economy was very much a capitalist economy also meant that government policy was one of what we call laissez-faire or leave well alone. American governments, whether Republican or Democrats, would tend to leave the economy to run itself. Democrats less so, but they would still be reluctant to get too involved. This involves the relationships between employers and workers as well as things like banking regulations and stock market regulations too.

But governments (in America, both state and federal) still have a role to play. They can keep taxes low or increase them. If they are low, people have more money to spend and businesses have more profits to re-invest. But if they increase them they can provide more services: schools, health care and so on (though America has always had minimal state health care). They can often influence interest rates too: increase them and borrowing becomes mpore expensive and so there is usually less economic growth, reduce them and the opposite should happen but it might lead to inflation.

Governments also help to provide what we call the infrastructure of an economy: the physical things that help make economies work: roads, railways (privately built but often subsidised by government), ports and airports are all examples. But so too is the provision of things like electricity and water.

Another area that government can make a difference is the degree to which they adopt a free trade policy or a protectionist policy, i.e. the degree to which they allow goods into their country without imposing tariffs, or at least high tariffs. This is important to home manufacturers who might face competition from overseas or not, and it is important to farmers or manufacturers who rely on exporting their produce or goods. It is very difficult for governments to please both but in the early twentieth century Democrat governments reduced tariffs and when the Republicans regained power in 1920 they increased them again.

And another policy area that is important is the degree to which governments protect the trade union movement. Trade Unions in America were not as established and protected by law as they were in America. This led to the owners of companies having more power over their workers. Whether that is fair or not, good or bad, I leave up to you. But it does change the dynamics of an economy when it comes to wage rates, working conditions, whilst all of the above affects the prices of things in the shops.

This brings me to another important factor about the American economy. Though America was a highly industrialised nation, half of Americans lived in rural America and worked as farmers or for farmers, or else in businesses linked to farming. So agriculture was a very important sector of the economy. But many farmers were in fact very poor, barely scratching a living, whilst farm workers tend to be paid less than industrial workers.

In total in 1928 the number of Americans living below the poverty line, i.e. those without the means to provide basic shelter, food or clothing, had actually risen and was at an amazingly high 42% of Americans and if we add those on or just above the poverty line, the total is 60%. For an economy built on the basis of consumerism, this would prove to be a major problem.

Overseeing a capitalist economy is a tricky thing. It is often a matter of balance: the level of taxation or interest rates, the level of regulation, the level of tariffs, and so on. It is also a matter of balancing the degree in which a government might try to direct the economy: to grow or to slow down the growth (and economies can grow too fast leading to its own problems, like inflation) or changing the balance between different sectors of the economy, for example agriculture or manufacturing. Or the degree to which the government feels it has to respond to outside or world-wide factors, like a major recession or a war.