What Happened to the Components of GDP during the Great Depression?

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Now let us look at how these components of GDP behaved during the 1930s. Table 7.3 "Growth Rates of Key Macroeconomic Variables, 1930–39*" presents these data in the form of growth rates. Remember that a positive growth rate means the variable in question increased from one year to the next, while a negative growth rate means it decreased.

Table 7.3 Growth Rates of Key Macroeconomic Variables, 1930–39*

We see again that real GDP decreased for four years in succession (the growth rates are negative from 1930 to 1933). The decrease in real GDP was accompanied by a decline in consumption and investment: consumption likewise decreased for four successive years, and investment decreased for three successive years. The decline in consumption was not as steep as the decline in real GDP, while the decline in investment was much larger. Were we to drill deeper and look at the components of consumption, we would discover that expenditures on durable goods decreased by 17.6 percent in 1930 and 25.1 percent in 1932, while expenditures on services decreased by only 2.5 percent in 1930 and 6.3 percent in 1932.

Whatever was happening during this period evidently had a much larger influence on firms’ purchases of investment goods, and on households’ spending on cars and other durable goods, than it did on purchases of nondurable goods (such as food) and services (such as haircuts). A similar pattern can be observed in modern economies: consumption is smoother than output, and spending on services is smoother than spending on durables. The reason for this is a phenomenon that economists call consumption smoothing.

Toolkit: Section 16.23 "The Life-Cycle Model of Consumption"

Consumption smoothing is the idea that households like to keep their flow of consumption relatively steady over time. When income is unusually high, the household saves (or pays off existing loans); when income is unusually low, the household borrows (or draws down existing savings). Consumption smoothing is a key ingredient of the life-cycle model of consumption, which is discussed in more detail in the toolkit.

If your company has a good year and you get a big bonus, you will increase consumption spending not only this year but also in future years. To do so, you must save a portion of your bonus to pay for this higher consumption in the future. By the same logic, if your income decreases, your consumption will not decrease as much. People who became unemployed during the Great Depression did not reduce their consumption of services and nondurable goods to zero. Instead, as far as was possible, they drew on their existing savings, borrowed, and postponed purchases of durable goods.

Consumption of durable goods, in other words, resembles investment rather than consumption of nondurable goods and services. This makes sense because durable goods resemble investment goods that are purchased by households. Like investment goods, they yield benefits over some prolonged period of time. As an example, consider automobile purchases during the Great Depression. Although 5.4 million cars were produced in 1929, only 3.4 million were produced in 1930—a reduction of more than 37 percent in a single year. Instead of buying new cars, households simply held onto their existing cars longer. As a consequence of the boom of the 1920s, there were a lot of relatively new cars on the road in 1929: the number of cars less than 3 years old was about 9.5 million. Two years later, this number had fallen to 7.9 million. [*** These figures are from Michael Bernstein, The Great Depression: Delayed Recovery and Economic Change in America, 1929–39 (Cambridge, MA: Cambridge University Press, 1987). ]

This reduction in activity in the automobile industry was matched by a reduction of inputs into the production process. By early 1933, there were only 4 workers for every 10 who had been employed 4 years previously. Equipment purchases for the transportation sector were so low that capital stock for this sector decreased between 1931 and 1935. In the turmoil of the Great Depression, many small car producers went out of business, leaving a few relatively large companies—such as Ford Motor Company and GM—still in business. Similar patterns arose as the economy recovered. Investment, in particular, was astonishingly volatile. It decreased by about one-third in 1930 and again in 1931, and by over two-thirds in 1932, but rebounded at an astoundingly high rate after 1933. Consumption, meanwhile, grew at a slower rate than GDP as the economy recovered.

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