Cause and Effect of Great Depression Term Paper

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Great Depression refers to the serious economic decline that started in the United States towards the end of 1929 and spread to most industrial countries of the world, lasting until the early 1940s. The period saw sharp declines in the production and sale of goods and a sudden, severe rise in unemployment. Numerous businesses and banks closed down or went bankrupt, people lost their jobs, homes, and savings, and large sections of the population in hitherto prosperous countries had to depend on charity to survive. Economists have discussed and dissected the causes of the Depression ever since and its long-term effects have not even been fully overcome even today. In this paper we shall discuss some of the important causes and effects of the Great Depression.


The popular misconception about the Great Depression is that the sudden stock market crash of October 1929 caused it. Although the stock market collapse certainly contributed to the subsequent economic downturn, the crash itself was more a symptom than a cause of the economic disease. Some of the major causes of the Great Depression are discussed below:

Economic Inequality and Easy Credit

The end of the World War I saw the American nation withdraw towards an inward looking policy of heightened individualism and the single-minded pursuit of getting rich. New technological innovations in the modern industry enabled quantum increase in industrial productivity. Unrestrained consumerism was promoted through the newly acquired art of advertising. People were persuaded to buy new, attractive products such as the automobile, the radio and household appliances. The problem was that while the public could be easily seduced into abandoning their habits of saving and frugality, the majority of the American public did not have the required buying capacity due to great inequalities in incomes. For example, during the "roaring" twenties (between 1923 and 1929), manufacturing output per person-hour increased by 32%, while workers' wages grew by only 8%. (McElvaine 38) At the same time, massive tax-cuts were initiated to benefit the rich by the government. As a result, the top 0.1% of the American population in 1929 had a total income equal to that of the bottom 42%. (Brookings Institute Study, qtd. By Gusmorino) This meant that the vast majority did not have the required incomes to consume the surplus production in order to keep the wheels of the industry turning. Not to be deterred, innovative businessmen got around the problem by providing easy "credit" by initiating "buy now and pay later" schemes. Hence, by the end of the 1920's 60% of cars and 80% of radios were bought on credit and the total amount of outstanding installment credit more than doubled from $1.38 billion to around $3 billion between 1925 and 1929. (McElvaine 17) This was clearly an unsustainable economic situation.


The agricultural sector in the United States was encouraged to increase production by the government during the First World War due to the demand for food and farm products in Europe. The U.S. government subsidized the farmers and paid $2 a bushel for wheat during the War, but by 1920, when government subsidies were withdrawn, wheat prices had fallen to 67 cents a bushel. (Gusmorino). Since agriculture represented a quarter of the U.S. economy, downturn in the sector was bound to have an adverse effect on the overall economy -- and it eventually did. To make matters worse, beginning in 1930 (when the Great Depression had already started) a severe drought hit the Great Plains. Parts of Kansas, Oklahoma, Texas, New Mexico, and Colorado became known as the Dust Bowl as the topsoil turned to dust due to the prolonged dry weather.

Adverse International Situation

Most of had been physically and economically devastated during the World War I. After the War, the United States assumed the role of the world's chief creditor just as European countries struggled to pay war debts and reparations. American banks that lent heavily to European borrowers ran up huge defaults as countries such as Germany were unable to service their debts due to devastated economies. The negative fall-out on the banking structure began to be felt by the late 1920s. (Delong)

High Tariffs

To make matters worse, the United States maintained high tariffs on goods imported from other countries, even as it was making foreign loans and trying to export products. These tariffs reached an all-time high in the 1920's and early 1930's. Through special Tariff Acts in 1922 and 1930, the U.S. increased its tariffs by 100% or more. (Gusmorino) The trade barriers were set up to protect American business but the policy resulted in falling U.S. exports and $1.5 billion of foreign sales were lost between 1929 and 1933 alone. When the European nations could not sell their goods in the United States, they could not make enough money to buy American products or repay American loans. As a reaction, the trading partners of United States also imposed similar trade barriers that further worsened the international trade situation, contributing in no small measure to the onset of the Depression.

Stock Market Bubble

Most Americans had little money to spare while buying consumer goods during the 1920s (mostly on credit), but the wealthiest Americans had plenty of money to spare and they fueled the rapid (and ultimately, unsustainable) growth in the stock market between 1927 and 1929 by buying stocks. Soon the inflated prices of stocks had far exceeded the worth of the shares and had no relationship to the profits of the companies or the dividends paid by them. As an example, the RCA Corporation's share price rose from $85 to $420 during 1928, even though it had not yet paid a single dividend! No one cared about dividends as long as the stock prices continued to rise and they could soon sell their stocks at a profit. The "bull-run madness" even brought the less wealthy Americans to the stock market. Shares could be bought "on margin" by paying only a fraction of the share price on the expectation that the stock price would continue to rise and could be sold for a profit at a later stage. For sometime, the stock market rose rapidly with the Dow Jones Industrial Average doubling (from 191 to 381) in less than two years from early 1928 to September 1929. (Temin 62-63)

The stock-market bubble lasted until October 1929 when on a single day of mass panic (October 29-dubbed "Black Tuesday") the stocks lost $10 billion to $15 billion in value. Between October 29 and November 13, over $30 billion disappeared from the American economy, which was more than the American government spent to fight the First World War. (Schultz, para on "The Crash") The Great Depression was now well and truly underway.


Having discussed some of the major causes of the Great Depression, let us now look at the effects of the prolonged economic downturn:

Immediate Effects

The first casualty of the Great Depression was the evaporation of the marked optimism of the 1920s that gave way to despair and a sense of defeat. The feelings were understandable as the stock prices continued to head southwards and by end of 1932 they were only about 20% of the pre-crash days; countless factories closed down, and the output of American manufacturing plants was halved in just 3 years 1929 to 1932 due to a sharp drop in consumer demand,. ("Great Depression in the United States"); unemployment soared from 3.2% to 24.9% in just three years putting more than 15 million Americans out of work. As discussed earlier, banks had given extensive loans during the 1920s to people and businesses which were not able to return the money following the depression. To make matters worse, there was a run on banks that forced more than 5,000 bank closures by 1933, wiping out the savings of millions of people. (Ibid)

Political Fall-out in the United States

President Herbert Hoover had come to power in 1928 amidst great optimism in the American economy. A little over a year later, he found himself faced with the severest economic crisis in the country's history. Initially, the Hoover administration was slow to react believing the crisis to be a temporary business cycle. Hoover also thought that a balanced budget would solve the problem and raised taxes which further worsened the situation. By the time of the next Presidential elections, Hoover's policies were so unpopular that the Democratic candidate, Franklin Roosevelt almost got a walkover.

International Fall-out

The effects of the economic downturn were not confined to the United States and soon spread to other industrial countries. Germany, already struggling with the reparation payments in the wake of World War I, was most severely affected. Hitler exploited the situation to the hilt as he blamed the economic woes of his nation on the Jews, communists and the treaty of Versailles, and swept to power. This was perhaps the most devastating fallout of the Great Depression since it is arguable whether Hitler could have come to power without the…

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