The economic lessons of World War II

As it has become evident that the financial crisis is comparable, in important ways, to the early stages of the Great Depression, there has been a lot of debate about the lessons to be learned from the responses to the Depression in the US, most notably the various policies that made up the New Deal. There’s a lot to be learned there, but it’s also important to remember that the Depression, in the US and elsewhere, continued throughout the 1930s before being brought to an abrupt end by the outbreak of World War II.[1]

Not only did the slump end when the war began, it did not return when the war ended – a huge difference from previous major wars.[2] Instead the three decades beginning in 1940 were a period of unparalleled prosperity for developed countries, with economic growth higher and unemployment lower than at any time before or since.

What lessons can we learn from this experience?

In the immediate aftermath of the war, the lesson seemed obvious. Planning had succeeded where capitalism had failed, and more planning was needed to maintain that success. As the White Paper on Full Employment (Commonwealth of Australia 1945) put it

Despite the need for more houses, food, equipment and every other type of product, before the war not all those available for work were able to find employment or to feel a sense of security in their future. On the average during the twenty years between 1919 and 1939 more than one-tenth of the men and women desiring work were unemployed. In the worst period of the depression well over 25 per cent were left in unproductive idleness. By contrast, during the war no financial or other obstacles have been allowed to prevent the need for extra production being satisfied to the limit of our resources.

Over time, as the difficulties of planning became apparent, emphasis shifted to the idea that the war had provided a Keynesian stimulus to aggregate demand, and that, with careful management, unemployment (or inflation) due to inadequate (excessive) aggregate demand could be avoided. Thirty years of success seemed to confirm that view.

After the failure of Keynesian economic management in the 1970s, this explanation appeared less adequate, but no adequate alternative was proposed. Given the apparent success of monetary policy in stabilising output and inflation, and reducing unemployment, from 1990 onwards, the issue seemed largely academic, and given the focus of US economists on the New Deal, even academic attention to the question has been limited.

Perhaps stimulatory fiscal policy will produce a rapid and complete recovery from the current crisis, and a restoration of the postwar Keynesian orthodoxy. But given the damage that has already been done to the global financial system, and the prospect of much more to come, this is far from certain. The experience of Japan in the 1990s is not encouraging, and this crisis is far worse in important respects. Perhaps when the collapse of financial intermediation is as near-complete as it was in the Depression, a large element of central direction is needed to restore trade and ensure necessary flows of credit. In the absence of a rapid recovery, questions like this will assume increased urgency over the next year or two.

fn1. In most respects, a continuation of the Great War that began in 1914, but in economic terms a completely different kind of conflict, based on comprehensive planning and mobilisation of economic and labour resources.

fn2. Although I didn’t think it necessary to spell this it out, it appears that I must. I am not suggesting that war is economically beneficial, still less that it would be a good thing to expand the wars in which we are currently involved (and which have, obviously, done the economy no good). The fact that the apparent economic benefits of WWII were more or less unique to that war suggests we need to look at the specific policies of that period, and not at ideas about the supposed economic benefits of war.

75 thoughts on “The economic lessons of World War II

  1. If wars are so good for the economy, why don’t we spend $1 trillion dollars on a bunch of ships, place them in the sea somewhere, and then sink them all? Hey, it’d stimulate aggregate demand!

    The above description is basically what happens during wartime, except lots of people die too. In my scenario, we could take the people off the ships, and still obtain the “economic benefits” of war. How about it John?

    But there are also other problems with the simplistic assertion that WWII ended the Great Depression. For starters, how can you compare statistics (e.g. unemployment) from the pre-war and post-war periods? Obviously, if millions of people are drafted to die for their country, you cannot compare that with peacetime employment. Similarly, the GDP growth in wartime is heavily biased towards the armaments industry, at the expense of the private sector.

    The Iraq war has done a fantastic job stimulating the economy right? 🙂 We should invade Pakistan, Iran, etc. too.

    This is a pernicious myth that provides an intellectual basis for the waging of perpetual war. For those interested, I suggest reading Depression, War and Cold War very closely to understand why.

  2. Great post JQ! I have always thought there are two stupid extremes: capitalism/private market does everything (planning and service delivery) or government does everything (planning and service delivery). Neither approach works in my experience.

    The obvious preference, that worked so well in WWII, is that the government does the planning (decides what we shall do/need) and the private market/capitalism does the delivery (decides how to supply for how much). We should recall that not only did this model provide success in World War II and prosperity afterwards, but it also rebuilt Europe via the Marshall plan. The country that wasn’t rebuilt by it (UK) went into terminal decline as a manufacturing power.

    In my line of work the ability of the private market to do the planning well is abysmal. Consider UK Railtrack, Sydney Cross City Tunnel, Lane Cove Tunnel, and various airport links to name a few. OTOH where government does the planning (with transparency) then private contractors can more efficiently deliver it (eg Gateway & other motorways in Brisbane).

    What I find amazing is that this position (government planning/private provision) is seen as somehow “left-wing”. It isn’t! It is a midway position between two extremes (Karl Marx and Milton Friedman) and it works.

    When I read that Obama is now going to oversee a major US investment expansion in infrastructure and services (i.e. government planned, presumably still delivered by private contractors) I almost cheered. Sanity at last after three decades of waste building gold-plated executive washrooms.

  3. While people are entitled to different views I have to say I saw nothing in JQs post endorsing war?

  4. JQ appears to agree with the standard Keynesian view that WWII ended the Great Depression. My view is that this is precisely not what happened. To the contrary, the opportunity costs of WWII alone more than outweigh whatever meagre benefits accrued to the armaments industry and others who profit from war.

    What WWII did was conceal the effects of the Great Depression. It did not end it, as JQ suggests.

    I understand JQ didn’t mean to endose wars as a way of stimulating the economy, but spreading the myth that WWII ended the depression could be taken that way by others with less noble intentions.

  5. Fair enough Sukrit but I thought the point was that government direction of the economy (necessitated by WWII) ended the depression. The war was the motivation but not the cause. Germany continued throughout the war with a largely privately run economy and failed to keep up with the allies. So I agree war alone doesn’t cause economci growth, but purposeful government direction can. We could just as easily have the same result now via government direction of investment to resolve climate change (energy and water infrastrucutre) and homelessness.

  6. I agree that post WWII, prosperity seemingly resumed. But I do not agree with JQ that WWII was the cause of this prosperity, and that therefore we should treat WWII as some sort of special case.

    A better explanation, and one with which I agree, is offered by Robert Higgs, in Ch.1 of the book I referenced above. Higgs argues that during the Great Depression there was much ‘regime uncertainty’ over property rights and in credit markets. After WWII, when a new administration came into power in the US, this uncertainty was reduced and private investment picked up again. But there were no economic benefits from WWII as such (apart from some inconsequential by-products of military research & development), and as I mentioned we could easily simulate the effects of WWII without the loss of life by sinking a bunch of ships.

  7. That is to say, I disagree with JQ over these two sentences in his post, which are flat out inconsistent with the historical evidence:

    Not only did the slump end when the war began, it did not return when the war ended – a huge difference from previous major wars…

    The fact that the apparent economic benefits of WWII were more or less unique to that war suggests we need to look at the specific policies of that period, and not at ideas about the supposed economic benefits of war.

  8. Spratt and Sutton suggested in their book Climate Code Red that what is needed to avert the climate crisis is a “WWII style effort”. Similar suggestions have been made by other commenters such as Joe Romm. What they are suggesting is not that we should militarise our society, but that we should invest a serious percentage of our GDP in climate change mitigation, and approach the issue with a similar urgency that we would if there was a war.

    It does sound like a better option than what seems to be occurring nationally and internationally at the moment, where the amount of investment in mitigation suggested by policymakers is far less than the expected costs of climate change.

  9. I’m mystified as to how the sentence “Not only did the slump end when the war began, it did not return when the war ended – a huge difference from previous major wars…” can be said to be “flat out inconsistent with the historical evidence”. Are you saying that the slump did return after WWII, or that other wars weren’t followed by slump.

    Since you also reject “the apparent benefits of WWII were more or less unique ..” I’d take you to be saying that war is always beneficial, except that you obviously reject this silly claim.

  10. “After WWII, when a new administration came into power in the US, this uncertainty was reduced and private investment picked up again.”

    Except of course that the Democratic Party administration continued until 1952 with substantial continuity between the Roosevelt and Truman administrations in terms of both policy and personnel.

  11. The severe drought of 1936 and 1937 and the associated return to dustbowl conditions in large parts of the American west halted the strong recovery that had started in 1932 and led to a double dip recession.

    The length and severity of the Depression of the 1930’s seems in itself to be one of the best explanation of the strength and durability of the subsequent recovery.

    Put simply, the gap between potential and actual production and the pent-up demand ensured a long-lasting expansion.

  12. “To the contrary, the opportunity costs of WWII alone more than outweigh whatever meagre benefits accrued to the armaments industry and others who profit from war.”

    Sukrit, the main people in the US who “benefited from war” in World War II were the farmers and manufacturers who met the shortfall in exports from both sides in the European conflict.

  13. Looking over the last decade in Australia I would have been happy for the government/private dial to have been pushed either way IF Prudence and small c conservatism had been greater. Similarly for current and future policies. I am for the moment more concerned by a lack of prudence in policies than in the government/private balance. It seems imprudent to hand out $10b so early in the crash when the country is so deeply in debt with appalling chronic current account problems.

  14. Regardless of debates over cause, there is some useful time series data on US GDP here:
    http://www.huppi.com/kangaroo/GDPreal.htm

    US GDP rapidly accelerated for wartime production in 1941 (with Lend Lease but prior to US declaration), then dipped slightly due to absence of manpower, then accelerated rapidly again from 1945. The effect of the stimulus from Lend Lease is very obvious.

  15. Steve Hanke essentially agrees with Sukrit.

    http://www.cato.org/pub_display.php?pub_id=9806

    The purveyors of Great Depression myths—such as this year’s Nobel laureate in Economics Paul Krugman—assert that the fiscal stimulus which accompanied World War II rescued the economy from the Great Depression. In fact, the Great Depression was followed by a spontaneous recovery, with the unemployment rate falling from 24.7% in 1933 to 14.2% in 1937. This recovery was interrupted by a sharp slump in 1938-1939. It was concentrated in the manufacturing sector and was associated with a decline in gross private domestic investment.

    Even though a spontaneous recovery occurred before World War II, it is important to stress that scholarship by Robert Higgs, and other economic historians, shows that—contrary to legend—the New Deal held down the spontaneous recovery and contributed to the 1938-1939 slump. Indeed, Higgs’ evidence demonstrates that investment was depressed by New Deal initiatives because of regime uncertainty—”a pervasive uncertainty among investors about the security of their property rights in their capital and prospective returns.” (Robert Higgs, Depression, War and Cold War: Studies in Political Economy. New York: Oxford University Press, 2006, p.5). In short, investors were afraid to commit funds to new projects because they didn’t know what President Roosevelt and the New Dealers will do next.

    This brings us to the Troubled Asset Relief Program (TARP). This $700 billion bailout program is, among other things, a bureaucratic nightmare that is as confused as it is confusing. Add to that Treasury Secretary Henry Paulson’s major shifts in the TARP’s direction, as well as the circus on Capitol Hill, and we have all the ingredients for a royal case of regime uncertainty. It shouldn’t be surprising, therefore, that each time Secretary Paulson makes a pronouncement or the Congress performs another act, the stock market takes a dive.

    And the problem with JQs analysis above is that he makes no effort to identify the cause of the Great Depression. Perhaps he might enjoy reading some newspaper articles from 1929.

    http://tinyurl.com/5ufx5w

  16. I’m on record favoring a very grand stimulus, tax cuts, and even printing money. I also love Keynes, but more for his writing style, which means a lot to me.

    Anyway, I feel differently about the knowledge we can gain from the 30s. Abstracting out the economic data can be of some slight use, but not much. The reason I believe this is that the decisions people made in the 30s where made in the context of the 30s, and that was a very different context than ours.

    I’ll give you one example. I once read a bunch of books by Wyndham Lewis. I don’t remember much about them, except that he seemed to truly believe that the only choice available was between Communism or Fascism. In other words, some form of Totalitarianism. This shocked me, but, after reading his books, I was surprised to find that many people writing in the 30s made that same assumption.

    Fortunately, there were wiser and better people around, millions and millions of them it turned out,including Keynes and Hayek, who understood the world better, and so we weren’t left with only those choices. But I continue to believe that the existential situation of the times people live in are more important than other people do. So that, the choices and decisions made in the 30s really can’t help us much.

    Instead, what’s happening is that we’re lurching and veering in a pragmatic way towards a path that leads us out of this mess. It turns out that we’re doing so in a way more reminiscent of Keynes, so, in order to feel like we really know what we’re doing, and since Keynes helped get us out of the 30s, we’re calling upon his spirit for solace and guidance.

    That’s fine with me because, as I’ve said, I love Keynes. But we’re going to get out of this mess in our own way and in our own time, and part of the process will be reading great books that help us get through these kinds of times. But there’s one thing that makes me more hopeful about this crisis, and,maybe I’m different than everybody else, but I really wouldn’t want to have been in the existential crisis of the 30s. I’ll take this one any day.

  17. Sure if you blow up stuff and make a lot of stuff to blow up other stuff you are going to produce a lot of demand, and yes you are going to feel things are going forward as you rebuild the stuff that got blown up in the first place..so in a lot of sense the 40s/50s/60s are just catch up decades…then we come back to the 70s or the problems of the 30s revisited, which we solved by the 80s/90s/00s, but buggered up with soft currency and stupid politics. (the economy being a Hayek mirror off)

    So whats next? my guess the realities will prove that you cannot spend your way to prosperity. History is never learned its just too long a time frame, but smaller government I think will be certainty, eventually.

    We might like the idea of spending big, but the truth will out and when it does I expect Krug to concede and send his pseudo Nobel back, but somehow I expect a clever mind to come up with an excuse, “not enough was spent” being by firm bet, Or “not enough early enough, it was Bush ect” being a close second. Ill give the current thinking 3 years.

  18. Just of the top of my head, Bam is down for central planning of 2.5 million jobs?

    This recession year, the US has still made 900K jobs? still losing 2 million?

    So he has a reasonable chance of claiming victory for the new deal and the golden new era, is that good economics or good politics?

  19. The implication is that Obama’s Green New Deal can repeat the success of Roosevelt’s original New Deal. However a couple of factors are different this time around. Firstly the untapped resources buffer is not as great. A local example is that there are no affordable new Snowy Mountains schemes in the wings. Secondly technological progress may now have reached a plateau when it was all ahead of them post WW2. If the new new deal is mainly about efficient infrastructure then it involves making do with less which is hardly the triumphalism of the past. However I don’t see much alternative.

  20. Wasn’t it the case that Keyenes’ system was implemented just before the war because nothing else had worked? Government going into deficit to stimulate the economy could just have easily been applied to a network of railways or a shipping industry or windfarms but the war came along and the stimulous flowed into agents of destruction.

  21. Question for ProfQ:

    Is the level of private debt in Australia a problem, and if so, how does a large fiscal stimulus help solve this problem?

    There is evidence that households used most of the recent monetary and fiscal stimulus to pay down debt:

    All up, the total fiscal boost to household disposable income in Q3 was about $1.9bn. This was mostly due to $7.1bn in income tax cuts, which equates to $1.8bn a quarter.

    The boost appears to have done little or nothing to stimulate consumer spending in Q3. Indeed, with aggregate household savings rising by $4.4bn in the quarter, the implication is that, in aggregate, households saved all of the windfall and then some.

    Most of the savings appears to have gone towards paying down housing debt. The national accounts figures and RBA credit data imply that households injected an enormous $7.5bn into their housing equity in Q3, most of which would have been via paying down principal. This is only the third net equity injection recorded since June 2001. It is easily the largest ever in dollar terms and is the biggest as a proportion of income since 1998Q3.

    If Q3 is a guide and households remain as deeply concerned about reducing their debt levels in the months ahead, the implication is that there will be little or no boost from policy stimulus in Q4.

    The Westpac paper continues that because of size of the stimulus in the December quarter at least some of it will be spent, but consumer sentiment has also darkened considerably (as the global economic situation worsened) thus increasing households’ propensity to save.

    It seems to me we need to both stimulate demand and reduce private debt, but this requires households increase both their spending and saving.

    How can this be achieved?

  22. Is one implication of carbonsink’s coments that a fiscal stimulus via Government spending (eg Obama’s infrastructure plan) is better targetted than a payment or tax cut to individuals?

  23. If there’s one thing we Austrians can be certain of, there’s never any lack of demand judging by all that money from thin air and the ability to find homes for it all among other socially desirable repositories. Perhaps we should reward that great Keynesian Robert Mugabe with next year’s Nobel for demand creation. Ah Zimbabwe, the ultimate millionaires’ factory.

    If believing that there can exist shortages of demand,(tell that to politicians for a laugh) such side spliting humour is only matched by the notion that shortages of work can likewise occur from time to time. Whilst jovial fellows from Stalin to Pol Pot had simple remedies for that by marching intellectual afficionados of such humour off to the Gulags and rural countryside, the ultimate Keynesians failed to explain how such humour is usually at someone’s expense. The moral to the tale is there is never any shortage of work just a shortage of rewarding work. Unfortunately for Stalin, Pol Pot, Mugabe, et al it was the lack of capital here that made their big joke backfire. Alas for more capital you need real savings and investment to increase reward for work, albeit in times of war we note many may be prepared to work for less butter and more guns than normal. If not there’s always ‘moral suasion’ or conscription of course.

    If real capital accumulation per capita can be waylaid from time to time by false price signals (ie the printing press), then it’s also axiomatic that demography will affect the capital to labour ratio and reward for work. It somehow seems to have escaped the attention of Keynesians how useless demand management was in the 70s with a surge of available labour being added to the existing capital base. Despite their well intentioned bumblings, those economies have done a remarkable job in absorbing such an unprecedented supply of workers, particularly the female variety.

    As successful as that process has been it would appear that a large part of the recent success has been due to too much credit and the inevitable need for more prudent savings and investment now. Apparently that means guaranteeing banks, bailing out childcare centres and $6.2 bill handouts to car firms to produce cars people are buying 22% less of at last count. Well if they won’t buy the cars and the guaranteed banks aren’t interested in helping out, then what’s another $2bill to help the car dealers buy them and fund the trade-ins on the floor they can’t sell likewise. Hopefully the $10.4 bill stimulus and $11mill advertising campaign to spend it by Xmas, will keep all who demand it in such interesting and rewarding work.

  24. There’s another point of view. In the Great Depression and before the war there was a lot of excess industrial capacity that had been built up in the 20s.

    World War II destroyed this capaciity.

    Imagine if the US went to war and all that excess housing stock was destroyed. A floor is put under asset prices, and banks feel confident to lend again.

  25. The government is doing the right thing by targeting the fiscal stimulus at pensioners and low income families, who are far more likely to spend the money (because they have to). The monetary stimulus is likely to have less impact on demand because indebted households are using every last cent to pay down debt at the moment.

    Infrastructure spending is great (in theory) as long as its not spent on building “bridges to nowhere” etc. Ideally the government would use this opportunity to spend up big on green infrastructure (and kill two birds with one stone) but there is very little sign of this happening in Australia.

    But hey, Kev did ratify Kyoto, and he’s produced both a white paper and a green paper on climate change policy.

  26. “It seems to me we need to both stimulate demand and reduce private debt, but this requires households increase both their spending and saving. How can this be achieved?”

    As soon as you allow for 2 individuals, Carbonsink, the apparent contradiction becomes less daunting because their personal circumstances may differ (eg young-income earning-taxpaying person with a relatively large mortgage versus a retired low income person with no mortgage but high unmet demand for consumer goods).

  27. Ernestine Gross @ 25: Sure, interest rate cuts are helping the heavily indebted young person pay down debt, but they are almost certainly cutting back on spending as well. The retired older person with no debt will benefit from the fiscal stimulus, but at the same time interest rate cuts are reducing any income they might have received from savings.

    The real contradiction at the moment is households are very concerned about debt, while governments are very concerned about demand.

    BTW, Ross Gittins seems to have had an epiphany today:
    It’s not inflation that did us in, it’s the borrowing

  28. Re # 27, Carbonsink,

    A small point to clarify: My #25 followed from your #21. In your #21, it was the tax cut part of the stimulus package (fiscal policy) which was the issue rather than monetary policy.

    Yes, as you said in #27, monetary policy in the form of declining cash rates, tends to lower fixed interest incomes for pensioners while mortgagees have more spending money (including repaying debt). However, there are now signs that consumer prices have stabilised and some are declining (eg petrol), hence the purchasing power of fixed interest incomes may not fall correspondingly to nominal interest rates (and mortgagees benefit too).

    You say “The real contradiction at the moment is households are very concerned about debt, while governments are very concerned about demand.”

    I appreciate that one may perceive the above mentioned contradiction if one listens to various market economists and opinion authors. In my mind, the concern about demand is not confined to governments. Most people know that if businesses can’t sell goods and services they will lay off staff and reduce new orders (ie a decline in aggregate demand). Most people know if this happens then those among them who have more than a one period credit card debt of modest amounts face an increased risk of bankruptcy. They don’t like this prospect.

    With respect to your data in #21 and daily observations, I reach the tentative conclusion that I am witnessing an extraordinary coincidence of governments and borrowers (who use tax cuts to repay debt) and the RBA acting sensible. It is not only the type of policy which matters but also the sequence and so far things are working out quite well in Oz.

    Generating more ‘aggregate demand’ in the near future by means of working toward solving actual problems (environment, health, education, infrastructure) seems sensible to me.

    Perhaps the economic lessons JQ is talking about have been absorbed by all but the reactionary (going back to the 19th century) group which dominated policy discussions for about 20 – 25 years in the more recent past.

    PS: I quite like Ross Gittin’s articles, read over time and in context.

  29. In my mind, the concern about demand is not confined to governments. Most people know that if businesses can’t sell goods and services they will lay off staff and reduce new orders (ie a decline in aggregate demand).

    Of course, its not just governments that are concerned about demand. Most people realise that if we all sit on our wallets we’re all screwed, but most people also realise that tough times are ahead, and they have to get on top of their debts in a period of declining asset values, so they save and/or pay down debt.

    One solution is to ignore the high level of indebtedness, pump-prime the economy, get the banks lending again, and ratchet up to an even higher level of indebtedness.

    Another solution is to engineer rapid inflation and inflate away the debt.

    Neither seems like a good solution to me. Can someone describe an ideal outcome and how it might be achieved?

  30. I cannot entirely agree with those pushing the Higgs thesis. Irving Fisher despite his earlier euphoria over the golden age which cost him his own fortune later thought it was a psychological state of fear of debt that kept people from going out and spending and borrowing although the liquidity issue was resolved early – so more money is not going to work until this version of Tulip mania works its way out of the system.

    WW2 allowed for a great deal of goods replacement for destroyed property and infrastructure but it significantly unleashed a wave of technological innovation the likes of which had not been seen at the conclusion of any other war. The succesful isolation of the US also provided a once in a generation production capacity already at the leading edge of technological innovation. Civil engineering projects world wide took off, air transportation took off, automobiles took off and reproductive capacity was satiated with a baby boom with all the consumer demand that generated and peoples anxiety about depression and then war was alieviated by a period of relative peace and unparralled opportunities to make the productive most of that peace. Granted their were some hiccups but even those crises spurred on even more technological innovation and the economies of scale model came into its own. It was all done with cheap and abundant energy and a green science revolution boosted by the age of electronics.So we now have no cheap or abundant energy the world baby boom is now severe world wide overpopulation and the green revolution reached an end point.Freidman’s theory removed the constraints of burecratic Keynesiasm both had yet to consider economic life at and past the PP curve which is where I think we are now.

  31. “Can someone describe an ideal outcome and how it might be achieved?”

    Yes.

    Oh, you meant “give a description”. That’s tricky, in the time and space available, but without giving my reasons here are some (not exhaustive) possible options under the general pattern of “buy time and use it constructively”:-

    – Implement the virtual wage subsidy part of the Kim Swales scheme, without raising the GST rate to compensate;

    – Still allowing the Aussie dollar to float, apply export taxes based on bulk and weight rather than value, at levels estimated to be roughly sufficient to balance reductions in GST revenues;

    – Reduce taxes on necessary imported inputs (mostly petrochemicals), perhaps to a third of current levels;

    – For new or reorganised companies, commute corporation tax pro rata (or perhaps lower) for shares to go into the Future Fund that already exists;

    – Use money market operations judiciously, with a view to balancing them over a financial year and adjusting taxes and spending over longer time scales to compensate to the extent that this balancing is not possible;

    – Initiate a SAYE scheme at 10% or so of income (over and above income tax), with withdrawals allowed on holdings above an age related target (say, A$500,000 for persons under a cut off age, and zero for older people, with the cut off age initially 60 and gradually reducing until the fund self eliminates);

    – Apply interest from the SAYE fund partly to health and education, but mainly to age pensions, also raising the entitlement age by one year every two calendar years;

    – Draw on the SAYE fund capital for zero interest loans for infrastructure needs, including Defence expansion but not things like education or health unless the spending genuinely does go on things of a tangibly enduring nature that contribute to operations (e.g. output of credentialled young people is not that sort);

    – Assess other needs periodically to see if the residual budget imbalance calls for tax increases, but unless in emergency do not implement them in full until matters are clearer (probably two or more years later).

    And don’t pick and choose from the list unless the result, along with any other measures you can think of, is a coherent strategy in time and space.

  32. I thought the economic effect of WWII was that it was politically acceptable to reduce household consumption. In other words, governments could tax but not provide anything in return on the grounds that the tax revenue went towards defending against the enemy. The tax revenues could then be invested in new plant.

  33. No Godwin’s Law accusations please. Stimulated by this blog, I asked myself: “How did that 1929 basket-case of an economy Germany dig itself out of a ditch to the extent that it was able to threaten the world militarily in 1939?”

    From the Wikipedia entry http://en.wikipedia.org/wiki/Economy_of_Nazi_Germany you get snippets like the following:

    “Nazis came to power in the aftermath of the Great Depression. When the Nazis came to power the most pressing issue was an unemployment rate of close to 30%. Before World War II, the Nazis placed non-Nazi professionals in charge of economic policy. Hitler appointed Hjalmar Schacht, a former member of the German Democratic Party, as Chairman of the Reichsbank in 1933 and Minister of Economics in 1934.
    “At first, Schacht continued the economic policies introduced by the government of Kurt von Schleicher in 1932 to combat the effects of the Great Depression. These policies were mostly Keynesian, relying on large public works programs supported by deficit spending – such as the construction of the Autobahn – to stimulate the economy and reduce unemployment (which stood at 30% in early 1933). There was major reduction in unemployment over the following years, while price controls prevented the recurrence of inflation. The economic policies of the Third Reich were in the beginning the brainchildren of Schacht, who assumed office as president of the central bank under Hitler in 1933, and became finance minister in the following year. Schacht was one of the few finance ministers to take advantage of the freedom provided by the end of the gold standard to keep interest rates low and government budget deficits high, with massive public works funded by large budget deficits. The consequence was an extremely rapid decline in unemployment-the most rapid decline in unemployment in any country during the Great Depression. Eventually this Keynesian economic policy was supplemented by the boost to demand provided by rearmament and swelling military spending.”

    End of quote. I’m not an economist and, since I hadn’t taken any interest in German economic history of the 1930s until half-an-hour ago, I have no idea whether Wikipedia’s entry is a good history or whether the whole recovery depended, say between 1934 and 1937, on some degree of totalitarian nastiness that wouldn’t be acceptable in a democracy.

    Two things though intrigue me: (1) How on earth did they finance this? and (2) The sentence: “Eventually this Keynesian economic policy was supplemented by the boost to demand provided by rearmament and swelling military spending.”

    And, arising from (2) above, then question (1) above needs to be asked again.

    So, If President Obama chooses to wage “war” on climate change, can we dare hope that this will be the “war” that could end the US downturn? Autobahn-scale investments in renewable energy infrastructure anyone?

  34. Paul Hodgson, James Buchan covers some of that in passing in his book Frozen Desire. Roughly speaking, there were lots of savings schemes and the funds were redirected to current spending. High tax and balanced spending still provides some Keynesian stimulus, and savings schemes were more politically acceptable than taxes – at least until people started asking for the Volkswagens they’d been saving up for, and so on. But by that time Germany would have won big or lost big in other respects (we now know which it was), and either way it would have been a non-problem. (It’s not a coincidence that I suggested using a SAYE scheme as one technique, by the way.)

  35. Pr Q says:

    In the immediate aftermath of the war, the lesson seemed obvious. Planning had succeeded where capitalism had failed, and more planning was needed to maintain that success.

    The mischief maker inside me cannot resist quoting Keynes’s in the foreword to the General Theory, published in 1936. He explicitly addressed the proto-Kenysian economists in Herr Hitler’s newly minted regime who were at that moment successfully tackling Germany’s gigantic unemployment problem along the lines suggested in Pr Q’s quote above:

    The theory of aggregated production, which is the point of the following book, nevertheless can be much easier adapted to the conditions of a totalitarian state than the theory of production and distribution of a given production put forth under conditions of free competition and a large degree of laissez-faire. This is one of the reasons that justifies the fact that I call my theory a general theory.

    Of course Hitler (and Lenin) were only following in the footsteps of the 20th Century’s most original socialist policy maker: Walther Rathenau. His program of “war socialism”, together with Bismark’s welfare state, were the corner stone ideas in statist planning over the next century. Funny that the Left’s practical policy inspiration comes from German militarists!

    Its not surprising that Hitler’s administration anticipated much Keynsian economic thinking. As Joan Robinson remarked, in a lecture to the American Economic Association in 1971:

    Hitler had already found how to cure unemployment before Keynes had finished explaining why it occurred.

    But of course that does not prove that Keynes was a proto-Nazi. Keynes was a member of the “educated bourgeoisie” (on whose side he said he would be in the heat of the class war). He was a classical liberal at heart. In his review of Hayek’s Road to Serfdom he let his true political feelings show:

    In my opinion it is a grand book…Morally and philosophically I find myself in agreement with virtually the whole of it: and not only in agreement with it, but in deeply moved agreement.

    Keynes also had no patience for naive intellectuals who fantasize that social democracy can be reconciled with unbridled cultural diversity. Although perhaps his own resolution of Arrow’s impossibility paradox was a little far-fetched. He reassured Hayek that planning would work so long as everyone adopted the mind-set of a nineteenth century liberal gentleman!:

    I should say that what we want is not no planning, or even less planning, indeed I should say we almost certainly want more. But the planning should take place in a community in which as many people as possible, both leaders and followers wholly share your own moral position.

    I wonder what Pr Q would make of his intellectual heroes rather old-fashioned notions of cultural acceptability and dalliance with the Austrian devil?

    Keynes’ theory was paradoxical in both economic and political applications. Economically he advocated govt spendthriftness just when finances were heading south.

    Politically he suggested that some statism was necessary to save capitalism from its worst excesses.

    It is worth quoting Keynes end-note on the social philosophy suggested by the General Theory to get a full perspective on his devious brand of reformatory conservatism:

    In some other respects the foregoing theory is moderately conservative in its implications. For whilst it indicates the vital importance of establishing certain central controls in matters which are now left in the main to individual initiative, there are wide fields of activity which are unaffected.

    [economic] individualism, if it can be purged of its defects and its abuses, is the best safeguard of personal liberty in the sense that, compared with any other system, it greatly widens the field for the exercise of personal choice…For this variety preserves the traditions which embody the most secure and successful choices of former generations;

    Whilst, therefore, the enlargement of the functions of government, involved in the task of adjusting to one another the propensity to consume and the inducement to invest, would seem to a nineteenth-century publicist or to a contemporary American financier to be a terrific encroachment on individualism. I defend it, on the contrary, both as the only practicable means of avoiding the destruction of existing economic forms in their entirety and as the condition of the successful functioning of individual initiative.

    One might say, adopting Strocchi-speak, he advocated corporal means to pursue liberal ends. In that sense Keynes work sits in the grand tradition of Machiavellian social science.

  36. I think MH at 30 has the core of the WW2 effect. Adding to that WW2 marked a turning point in the availability of social services, particularly higher education. Perhaps not generally known is that the US government paid for returning servicemen to further their education after the war. My dad, who was at Hickham Field in a towel with a gun that did not work, obtained his Architecture degree at Sydney Uni after the war, paid for by the US government. Most importantly, along with good social services, the improved degree of global automation that was triggered by this first high technology war was the key to funding the rapid recovery from the effects of the war.

    This current economic crisis is about debt, surplus wealth and overvalued assets, from what I can see. And it highlights the failure of a market based economy to responsibly utilise wealth accumulated for the funding of retirement, which comes back to issues of planning and regulation.

    The single largest driver of this crash is the issue of property deposits. By allowing 100% borrowings on property, unhealthy competition has pushed property values to unnatural levels globally. The only people who should be able to obtain 100% finance on property should be first property buyers. First home, first business premisis, etc. Deposit levels are the best mechanism to manage property affordability versus the first home buyer grant shamozle. The only snag with this is that if it is not a global standard then richer countries prey on poorer country’s property markets to the disadvantage of the local populace.

  37. “Eventually this Keynesian economic policy was supplemented by the boost to demand provided by rearmament and swelling military spending.”

    Government spending on roads or wars is still Keynesian economics, if you accept this ( and I do) then the Iraq war has been a stimulus to an overheated economy. It all would have worked out if the US has won the war, but they didn’t.

  38. My personal belief, based on nothing but gut feel, is that Higgs is only partially correct. Uncertainty about property right was the problem. But, it would not have sorted itself out. An all out war of the World War I and II type removes the excess of property rights that collects in a western style capitalist system and which tends to stifle innovation. A classic example that is always raised to this end is the American aircraft industry during WWI. There where that many different patent holders for different aspects of aircraft manufacture in the USA that is was impossible of anyone in the USA to assemble licences for enough patents to manufacture a plane that was competitive with those flying over France. In the end the USA government forced the patents holder to surrender their patents to a commission and paid each patent holder a small fee for each plane manufactured.

    I got thinking about this issue last Saturday while I was listening to Andrew Ford’s interview Rodney Bennet.

    http://www.abc.net.au/rn/intothemusic/stories/2008/2413516.htm

    Apparently, Rodney Bennett was successfully sued for breach of copyright by some obscure French composer because Bennett’s theme to Four Wedding and a Funeral commenced with the same four notes as a composition by this French composer. The composition had only been played once publically on a late night French TV channel and Bennett could prove he was nowhere near France at the time. If this isn’t property rights getting out of hand, what is?

    It seems to me that there is a touch of Nicomachean Ethics about property rights. There is a Golden Mean that is the correct level of property protection which is effective. Too little or too many rights and society as a whole suffers. At the moment there are industries such as Pharmaceuticals that seem to have creased to innovate because of the excess in property rights they have been granted. It is all becoming out of hand and is having a serious negative impact on innovation in our economy.

    This may have been the situation in the 1920s and 1930s. I know Henry Ford spent considerable resources fighting patents that came from left ring and centre on different aspects of car design and manufacture. WWII certainly cleared the patent log jam. For example, as a result of the North Atlantic Treaty, a whole swag of technologies were put into the public domain. (From synchromesh gear boxes to solid state devices.) Some of these technologies formed the basis of the electronics industry that has been the source of much post war economic growth. The book “The Invention That Changed the world: How a Small Group of Radar Pioneers Won the Second World War and Launched a Technical Revolution” by Robert Buderi from the excellent Sloan Technology series of publications is a very readable account of how this happened.

    It would be nice if tens of millions of people didn’t have to die to clean up the mess that is current intellectual property mess and allow the economy to grow. However, I can not see any thing else that will do the job.

  39. Once upon a time in economic history when the limitations of land,labour,capital and ideas were reached we either engaged in violent conflict to ensure our continuation OR we moved and started again always abundance of opportunity, resources and cooperative will allowed this to happen. Economic history shows that when known limits are finally reached that city-state edifices always collapse and the ensuing eras of conflict and change are lost to the histories gaze. Fukayama coined a phrase the end of history and merely fell into the same hubric embrace of circumstanial triumphalism that Fisher offered at the beginning of the Great Depression, so are we at the end of history? The collapse of the ‘city-states’ evidenced by the Great Depression gave rise instead to the world struggling through the most destructive conflicts the planet has yet witnessed. I am not calling this end game yet but the global evidence of collapse of the world city states are ominous and this time there is no where to go.

  40. It all would have worked out if the US has won the war, but they didn’t.

    Charles – I’m no fan of the Iraq invasion but given that it was essentially a war between the USA and Iraq could you please tell me who won the war if it wasn’t the USA?

    I would contend that they easily won the war. They occupied the country, they controlled the streets (mostly), they installed a new government. If that isn’t winning a war I don’t know what is. Of more concern is whether winning the war achieve any meaningful objectives at a reasonable cost.

  41. TerjeP

    You win the war if you get an economic benefit, if you get a return on your investment.

  42. Winning the a war involves achieving one’s initial objectives for the war.

    The US objectives for the Iraq war were to establish a stable democratic state in Iraq, promote democracy in the region and reduce support for Islamist terrorism.

    Of the three, you can make a highly qualified claim for the first – a claim I’d contest.

    1 out of 3 is at best a “D”, more like an “F”.

    Of course, the original antagonist – Saddam Hussein – lost even more since his objective was to remain in power.

    If anyone has “won” it’s either Moqtada Al Sadr or Iran.

  43. Socrates said
    “The obvious preference, that worked so well in WWII, is that the government does the planning (decides what we shall do/need) and the private market/capitalism does the delivery (decides how to supply for how much).”

    Well exactly. Couldnt agree more except planning and fiscal expenditure as illustrated by the 2nd world war worked to raise the economy in the aftermath of the depression but we are ignoring something else.

    It can equally effectively spent on socially beneficial peace industries – oh where are you Keynes? How soon they forget!

    Now with globalisation we have an IMF hell bent on stripping every notion of public service, public spending and public planning and reversing the good intentions behind those loans, wrecking the infrastructure, making it an entirely user pays world (how do users pay for public infrastructure that is privatised and then fails or becomes degraded due to the short term profit motive)? They pay twice or three times plus over – once with tax and again when the private sector takes a piece of it and raises prices and again to renationalise it when it fails in private hands). Thus plunging poor countries into growing debt. Then where do the taxes of the working go if not to pay for public infrastructure? Back to the IMF in burgeoning interest bills. The interest acting the same way as imports do – making it a bigger debtor. Keynes would be turning in his grave.

  44. Alanna

    Yes, I never intended my remarks to imply support for military spending, or indeed any particular category of spending, just the idea that government is the best body to select the planning targets, not the market.

    I am all in favour of a government stimulus to overcome the current economic downturn being allocated towards socially beneficial ends such as health, education, public transport and (green) energy and water infrastructure.

  45. Ian

    If you look behind the curtain are the objectives ever anything greater than a return on investment, especially when it comes to global politics.

  46. John, some might argue Obama’s ‘modernisation’ program is very similar to what Australia had undertaken during the late 1970s and early eighties when our economy was in the doldrums and rust belts existed everywhere.

  47. Pr Q says:

    Perhaps stimulatory fiscal policy will produce a rapid and complete recovery from the current crisis, and a restoration of the postwar Keynesian orthodoxy. But given the damage that has already been done to the global financial system, and the prospect of much more to come, this is far from certain. The experience of Japan in the 1990s is not encouraging, and this crisis is far worse in important respects.

    Perhaps when the collapse of financial intermediation is as near-complete as it was in the Depression, a large element of central direction is needed to restore trade and ensure necessary flows of credit. In the absence of a rapid recovery, questions like this will assume increased urgency over the next year or two.

    Re-reading this one notes Pr Q uncharacteristic reticence in coming to the ideological point. “A large element of central direction” is certainly not consistent with “a restoration of the post-war Keynsian orthodoxy”. See the slabs of Keynes conservative “thoughts on social philosophy” that I quoted above.

    I take this as an oblique suggestion that Depression and War present the need and opportunity for a strong dose of Socialism. In an age of plutological ruin, ecological crisis and technological boom it is once again time to pose the Schumpeter question: “Can Socialism Work?”

    Pr Q is not the only democratic Left wing economist who expected socialist progress in the aftermath of war and financial crisis. Hilferding believed that the financial industry led to socialism by:

    – destabilising industrial capitalism through reckless credit expansion;
    – concentrating itself though “too big to fail” bail-outs and buy-outs;
    – centralising industrial capital ownership through vast funds.

    Hilferding thought that the financial capitalist super-structure would effectively socialise the industrial capitalist structure:

    Once finance capital has brought the most important branches of production under its control, it is enough for society, through its conscious executive organ — the state conquered by the working class — to seize financial capital in order to gain immediate control of those branches of production.”

    This would obviate the need to expropriate “peasant farms and small businesses” because they would be indirectly socialized, through the socialization of institutions upon which finance capital had already made them dependent.

    Thus, because a narrow class dominated the economy, socialist revolution could gain wider support by directly expropriating only from that narrow class.

    Things have panned out more or less as Hilferding (and Minsky) expected. In fact the largely liberal Bush administrations nationalisation of entrepreneurial financial firms is the strongest test possible test of the efficacy of socialist program.

    It is an open question how much entrepreneurial “animal spirits” will remain in the capitalist economy once all the debt is wrung out of the system through prolonged liquidation. There is a fair bit of creative dynamism out there, what with all the back-yard inventors, agency workers, night-schoolers, sub-contractors, self-employed, self-funded retirees etc.

    OTOH there is probably a somewhat higher degree of industrial concentration in the Australian economy these days. What with a small market, toothless regulator and all the little fish getting eaten by big fish.

    MY own take over the past decade, FWIW, is that the financial capitalist industry in its contemporary form is doomed. Also that there is a massive requirement for state investment in public goods, primarily for repair of the damaged ecology and their aging biology.

    On the ideological level, middle class political sentiment has shifted away from liberal individualism and towards “corporal” institutionalism. From youth autonomianism to geezer authoritarianism, one might say. At least where the middle class needs to regulate the dysfunctional behaviour by unter- and uber-classes to conserve hard won accumulations of residential and intellectual capital.

    The middle classes have also, through exposure to economic rationalism, learned much about institutional and instrumental accountability. This is critical for the effective execution of socialist programs. The sheer size of a the medical economy (15%+ of GDP) is likely to require a gigantic health bureuacracy which needs to be made accountable.

    So it is entirely possible that more conservative middle classes, in trying to preserve their health, wealth and earth, may unconsciously embrace a more socialist economy. The only problem is that politicians are more or less all whores now. So I dont see much political agency out there.

  48. # agree socrates. The market doesnt organise collective benefits well. Even if we consider previous governments such as colonial governments such as the British – they had enough sense to understand that markets need organisation and they were good at it – organisation. They hanged the captain of the privatised 2nd Fleet when he starved an excessive number of convicts to make more profit. They probably needed those female convicts. An early lesson in leaving it to the market.

  49. Charles, wars are fought for all sorts of reasons. Many of those reasons have to do with personal aggrandisation or political benefit rather than direct financial benefit.

    Britain certainly didn’t profit from the Falklands War – but Thatcher’s political career beenfited immensely.

    Trying ot reduce all the various motives for war to purely financial ones makes otherwise sensible people concoct bizarre theories about the vital geopolitical position of Kososvo (for example).

  50. Ian Gould, wars are no doubt fought for all manner of reasons, that being self evident.

    More importantly, they are more often promoted by the instigating governments, towards their sedated electorate, under many and varied veils of convenience.

    The establishment of a substantial U.S. military bases (camp bondsteel) used in projecting military power into the Balkans, whilst securing a U.S. sponsored oil pipeline from Burgas on the Black Sea coast to Vlore on the Adriatic Sea as a means of ensuring the spoils from the Caspian Sea reach the West via this newly established U.S. protectorate, and simultaneously weakening the Russian bears monopoly on this energy rich region, to say nothing of supporting the ever arching eastward expansion of NATO (read U.S. neo-con fanaticism) to achieve their goal of the encirclement of Russia are just a few reasons for Kosovo’s vital geopolitical position.

    Of equal importance to this U.S. initiated stratagem to force a Russian zugzwang is Georgia, Ukraine, Poland and the Baltic States.

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