The sudden crash of the stock market on October 29, 1929 heralded the beginning of the worst economic crisis in living memory, the Great Depression.

It was a dark time in American history as families struggled simply to put food on the table and pay for other basic necessities. By 1932, one in four people were unemployed and, instead of growing, the economy was still contracting.

The Great Depression is notable not only for the intensity of the initial economic decline, but also for its duration. With a lackluster recovery from the initial crash followed by another economic downturn in 1937, the economic turmoil of the 1930s continued to drag on. What was happening?

There were many factors that helped to prolong the Great Depression, but a central cause was the erosion of economic freedom which destroyed private sector confidence.

 

Take 1: The story of government control

The Roosevelt administration thought that increasing government control over companies would bring stability to the struggling economy. Hoping to reverse the downward trend and incite growth, the new administration rolled-out wage and price controls and dramatic tax increases.

However, far from helping, these new government actions only exacerbated the already dire situation by bringing about “regime uncertainty”. Regime uncertainty refers to the distress businesses experience when they are unsure if more government action will hinder their abilities to operate.

Take, for example, hiring new employees. If a company decides to grow and hire new employees, there will be a financial risk involved. A company has to know that it can afford to invest in new employees before it will move ahead and start hiring.  On the other hand, if new taxes and costly regulations are potentially on the horizon, the company will hold off on taking risks such as new hiring.

During times of uncertainty, businesses will avoid taking other risks as well, like buying facilities or investing in new products—all of which are vital for a healthy and growing economy.

New government regulations and taxes created so much uncertainty in the private sector that they contributed to the Great Depression dragging on for more than a decade.

 

Take 2: The story of the free market

The economy did eventually begin to rebound in 1945 when President Harry Truman took office and curbed the creation of new regulations. Private sector confidence returned as the flood of new regulations subsided and business people began to trust  that their property rights were secure. The incentive to invest increased and, as a result, the amount of private investment grew an average of 21 percent between 1945 and 1955 leading to one of the most prosperous decades of America’s history.

The Great Depression ended when economic freedom in the U.S. increased. Opening up the economy restored investor confidence, let the markets work, and gave power to the individual. As a result, America prospered.

Today, economic freedom in America is once again on the decline. The question remains, have we learned from our past?