A recent article by Horwitz and McPhillips adds colour to theanalysis by Higgs of the US recovery post 1945.
The natural proclivities of those choosing to ply their economics training in the public sector with activism has been given huge fillips by the apparent success of Keynesian stimulus measures – going to war rather than the less life-threatening pyramid building that Keynes himself applauded. As the story goes this soaked up unemployed labour and capital and created a resumption of the virtuous circle. That circle, as in any economic analysis must be sustained by increased productivity which means more, or more market friendly, investments and better skills more appropriately directed on the part of the workforce.
It is clear that making goods that are bads cannot increase wealth and that sending 10 million (mainly) young men into forced low income servitude cannot increase wealth. The case put by Higgs and by Romer is that the economy was recovering anyway, the latter argues because of monetary stimulus. Perhaps but unemployment remained at 17 per cent in 1939 notwithstanding US benefitting from war spending in Europe.
Moreover, it is less clear that the shock of spending had no effect at all. Higgs uses well respected analyses to demonstrate that real consumption in theUSdipped in 1942-44 and suggests that the economy was recovering prior toPearl Harbor. But war and its prospects was affecting the US economy from 1937 and earlier in Europe, so demand stimulus was in place and increasingly it was demand stimulus with unbalanced budgets.
While war spending is a clear waste, it does have some effects that increase potential output. War spending clearly squeezes consumption expenditure (including capital spending on homes) and directs that into different forms of capital spending. It also smashed the labour monopolies with inefficient work practices.
This allowed massive increases in certain sorts of capital equipment. Much of this was destroyed in fighting and a good deal – tanks, rifles and gun emplacements – was of no economic worth. But some had a great deal of use in increasing productivity post the hostilities. The massive construction of trucks, shipping and aircraft found ready employment after 1945. Similarly, although many European factories were destroyed (and the Russians took much ofGermany’s surviving plant) many had been rebuilt and were ready to be converted from aircraft production to motor cars and refrigerators, tanks to construction equipment. Factories built to make bricks and factory frames could be converted to be used in house construction.
So World War II contained three factors that encouraged post war growth. The first was a dramatic fall in real wages (and a vast increase in real profits) that allowed and encouraged a redirection of gross spending from consumption into investment that is vital to underpin higher living standards. The second was an over-production of certain capital goods – trucks, trains, shipping, aircraft – that itself allowed higher levels of production and real consumption. And thirdly, although real private investment fell dramatically (64% 1941-43 in theUS) one component of this was housing (not really “productive” investment) and it was massively outbalanced by the increase in public investment. Even though much of this was not ideally suited to civilian demand, it could readily be converted to produce the different products required.
In this respect, Keynesian stimulus can be said to have jolted the world from a depression that many consider was not facing an autonomous recovery in 1939.
This jolted quasi-psychological impact on the growth cycle can also be seen elsewhere. The Chinese economy embarked on a remarkable growth path post 1988. Greater individual certainty allowed a shift to lower levels of consumption and higher savings for investments that were increasingly geared to producing things that were demanded (overseas and domestically). In China’s case this was greatly facilitated by a production shift to private agriculture that the government tolerated and that peasants expected them to continue tolerating.
In both cases expectations brought a virtuous circle of expanded demand and growth. Keynesians have dined out on the World War II story for 70 years but have failed to recognize that it was a particularly dramatic imposition of government spending and that the key to growth resuming was the abandonment of restrictive labour practices, and a massive redirection of national expenditure from consumption to investment and to goods that could be converted into capital items.
The various stimulus packages applied globally have not drawn on this experience, even though the prevalence of phrases like “shovel ready” investments is recognition that the stimulus process must increase productivity. But the inability to replicate the vast reductions in living standards and workforce interactions that contributed to economic recovery post 1945 mean that the modern stimulus measures are bound to fail. They are geared to increasing consumption, reducing the incentive to work and cannibalizing savings that would otherwise go to producing investment goods. As such they do the opposite of what is required.
For the pharaohs’ Pyramids to perform the economic stimulus job that Keynes thought they did, they would have had to have increased the skills of the workforce and reduced immediate levels of consumption while creating capital that has a productive life after their immediate use was no longer necessary (something that the tourist industry achieved for Egypt but some thousands of years later).