American financial history offers many lessons that are relevant to the current financial crisis. Lawmakers should avoid protectionist and antibusiness policies--similar to those imposed during the Great Depression--that would magnify and prolong the current economic downturn.  

Senior Fellow Kevin A. Hassett

It is an open question whether the history books will call this "the Panic of 2008."

A panic occurs when terror replaces thinking and reason, as happened in mythology when Pan frightened the Titans in their epic battle with the gods.

This stampede to the exits certainly looks like a panic. Markets are pricing in catastrophes beyond modern experience. Corporate bonds, for example, are trading at levels consistent with default rates of about 50 percent. If half of U.S. firms default on their debt, we might need to find a word that is worse than "depression."

But the view that these prices have been driven by a panic is really quite hopeful. It suggests the truth can't possibly be so bad, that sooner or later markets will wake up and recover.

Such hope may be misplaced. We should all pray that we are living through a panic. It is far scarier if markets aren't panicked, but rather are functioning well and properly discounting the probability that the economy will be horrific.

Why might markets be right? A look at the academic literature on the causes of the Great Depression suggests a simple answer: If Democrats actually adopt the policies they have advocated on the campaign trail, they will be repeating with eerie precision the mistakes made by both parties that gave us the Depression.

Economists generally have concluded that, in addition to woefully misguided Federal Reserve actions, two policy errors worsened and prolonged the Great Depression.

Two Mistakes

The first was the Smoot-Hawley Tariff Act of 1930, which imposed tariffs on more than 20,000 goods and set off a trade war that cut world commerce by about a third. The second was the rapid expansion of unionization and cartelization that followed the National Industrial Recovery Act (NIRA) and the National Labor Relations Act (NLRA).

While the Smoot-Hawley nonsense has been widely discussed, the impact of NIRA and the NLRA has received less attention. That impact can't be overstated. A 2004 study by UCLA economists Lee Ohanian and Harold Cole found that 60 percent of the difference between actual output and its long-run trend during the Great Depression was attributable to NIRA and NLRA.

Cartelization, or the coordinated raising of prices by businesses that Franklin Roosevelt allowed after unions organized an industry, played a role in deepening the Depression. But perhaps the key negative component was the massive increase in unionization, from 13 percent of the workforce in 1935 to 29 percent in 1939.

On Strike

Greater unionization led to a doubling of the number of strikes and an increase in their effectiveness because new rules let workers use "sit-down" tactics that shut plants.

As we head to the voting booths, two of the centerpieces of the Democratic platform threaten to repeat these policy errors. On trade, there is the Fair Currency Act. This legislation targets the supposed currency manipulation of the Chinese and empowers the president to "proclaim increased duties or other import restrictions" to combat unfair trade.

Senator Barack Obama is a co-sponsor of this protectionist bill, originally sponsored by Republican Jim Bunning, and has argued that it is necessary to level the playing field: "China has competed in ways that tilt the playing field inappropriately in its favor. China has followed the path taken by so many other countries before it--dumping goods into American markets while failing to open its own; violating intellectual property rights; and grossly undervaluing its currency, thereby giving its goods another unfair advantage."

Starting a War

One would guess that a President Obama would happily impose tariffs mentioned in the bill. If he does that, in these troubled times, then a trade war could easily ensue.

The key labor policy parallel to the 1930s is "card- check."

Card-check is a method by which union organizers can forgo standard secret ballot procedures when they receive signed union-authorization cards from a majority of employees. Although card-check procedures for union formation are legal, current law lets employers reject card-check petitions and require secret- ballot elections instead.

The Employee Free Choice Act, which passed the House last year and was defeated only by Republican opposition in the Senate, would require employers to recognize card-check petitions except when fraud or coercion is suspected. Opponents of card-check argue that the new procedures wouldn't protect employees against coercion from union organizers.

"Hard to Believe"

One such opponent is former Democratic presidential nominee George McGovern, who recently said: "It's hard to believe that any politician would agree to a law denying millions of employees the right to a private vote. Quite simply, this proposed law cannot be justified. Working families deserve a voice and a private vote."

According to the U.S. Chamber of Commerce, coercion attempts by union leaders are numerous when card-check procedures are in place, and include "threats of termination, deportation, and loss of 401(k) and health benefits for not signing a card; and promises of green cards, termination of supervisors and free turkeys for employees who did sign cards."

Supporters of card-check are presumably willing to accept the possibility of coercion because they believe the end--a large increase in unionization -- justifies the means. But if that end is achieved, then it likely will lead to a surge in labor costs and reduction in competitiveness for U.S. companies at just the wrong time.

Should Democrats deliver on these promises, we will have a trade war and a reorganization of the workplace on par with that of the 1930s. If that occurs, then financial markets will have been right all along.

Kevin A. Hassett is a senior fellow and the director of economic policy studies at AEI.