Keynesian stimulation, natural regeneration or increased capacity as reasons for WWII recovery

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).

 

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15 Responses to Keynesian stimulation, natural regeneration or increased capacity as reasons for WWII recovery

  1. Rodney

    I do not believe that any modelling of western economies 70 years ago is of much use.
    I poke around in the real economy and talk to people similarly engaged. The ever increasing cost, delays and uncertainties of Govt regulation bear no comparison with that period.
    Labour market regulation and green regulation are well known, but I suspect town planning is even more important. Delay plus uncertainty adds greatly to the risk of investment

  2. Steve of Glasshouse

    I’ve always wondered what the smashing of the old boy’s networks had to do with post WWII recovery ..

  3. BIEN Home
    http://www.basicincome.org/Serves as a link between individuals and groups committed to, or interested in, basic income. Features essays, links and newsletter.

    If such a system could be refined and implemented, there would be no need of wars to sustain “economies”.

  4. .

    A basic income won’t “sustain” the economy either.

    War doesn’t “sustain” the economy anyway.

    The economy is ephemeral but it doesn’t need “scare quotes”.

    It would just be more efficient than Newstart, and a zillion other different types of benefit one can live on, especially if we reform the tax system to a flat income tax or mostly the GST and a land tax.

  5. Skuter

    An interesting take on the Keynesian explanation of the post-WW2 story. If this nuanced story is correct, then it means all of the uncritical calls for the US to increase the debt ceiling because a drop in spending levels will cause famine and pestilence, the end of the world, hellfire and damnation for all eternity, etc., are just plain WRONG.
    This adds an interesting aspect to Alesina’s research on expansionary fiscal contractions…

  6. Dan

    Is it not fundamentally wrong to compare The War Effort to conditions today? After all, productivity was all that mattered. Also, there was very little red tape, green tape and if union members went on strike over pay and conditions they would likely have been hung drawn and quartered.

    The War Effort produced labour saving machines like the CNC and MiG welder, modern day stimulus just exists to produce jobs for the boys.

  7. mct

    … they would likely have been hung drawn and quartered.

    Well, no actually.

  8. Dan

    Well FMD. Australians stand proud.

  9. Rafe

    How hard is it to explain the postwar recovery when millions of workers went home to civilian work instead of doing their best to kill each other and destroy the infrastructure on the other side of the front line?

  10. brc

    This makes no mention of the increase in energy production that must have coincided with the war effort? Surely a comparison of pre-war gas, coal and petrol prices with post war would show a drop as (presumably) expanded supply lowered energy costs once the ships, tanks and planes were no longer being used day and night.

    There would be little argument that a drop in energy prices likely leads to increased production and generally lower prices, which is the sort of thing that can kick start investment better than anything else?

  11. Tel

    Is it not fundamentally wrong to compare The War Effort to conditions today? After all, productivity was all that mattered. Also, there was very little red tape, green tape and if union members went on strike over pay and conditions they would likely have been hung drawn and quartered.

    Herbert Hoover stood by the unions, insisted that business should not use wage cuts to improve their profitability and tried to keep prices high wherever he could. The great American railways were built with private money in the 19th Century, and then got borrowed by the government (using war powers) during World War I, the government encouraged unionisation before handing the railways back to private owners.

    Hoover also encouraged “voluntary” cartel formation in various industries, to deliberately throttle production and keep commodity prices high.

    It’s all documented in detail in Rothbard’s book, “America’s Great Depression”.

  12. Tel

    http://www.usgovernmentdebt.us/spending_chart_1920_1940USp_13s1li011mcn_G0f

    If you check the graph, see the deficit kicked in about 1932, during the end of the Hoover presidency. Roosevelt just continued where Hoover left off stimulus wise and they kept running a big deficit all through the depression years.

  13. Jim Rose

    rafe, Remember unbalanced growth. After wars and disasters, the destruction is not uniform. Jack Hirshleifer specialised in post-war and post-disaster recovery.

    The repair of a few missing key production inputs (power, water, rail & roads) will make the rest of the economy highly productive and will grow quickly.

    Hirshleifer found that recovery hinges on governments maintaining or restoring property rights and a market system that supports the economic division of labor. The survival of a functioning competitive market system was the key to recovery.

    See http://www.econlib.org/library/Enc/DisasterandRecovery.html

    what has so often excited wonder, the great rapidity with which countries recover from a state of devastation; the disappearance, in a short time, of all traces of the mischiefs done by earthquakes, floods, hurricanes, and the ravages of war.

    An enemy lays waste a country by fire and sword, and destroys or carries away nearly all the moveable wealth existing in it: all the inhabitants are ruined, and yet in a few years after, everything is much as it was before.

    JS Mill

  14. Pyrmonter

    All interesting stuff, but consider the following:

    WWII was the first war not followed by substantial deflation. Can the wartime economy be considered to be in equilibrium? Were those who subscribed for war loans paying trivial interest rates tricked into the biggest “time consistency” fraud?

    However it is measured, the war seems to have been a time at which the capacity to yield economic services grew. Happily, much of that capacity was consumed in ensuring the defeat of fascists (albeit at the price of surrendering half of Europe and half of Asia to communism). We can’t directly measure the “value” of winning; but does that mean it has no value, as Higgs seems to think?

    Picking up on the De Long, Summers and C Romer pieces referred to in the article: while it may not have been fiscal stimulus that dragged the US out of recession (one might have thought this put paid to that argument over 50 years ago – Brown, E. C. (1956), ‘Fiscal Policy in the ’Thirties: A Reappraisal’, American Economic Review, 46(December), 857–77.) that leaves plenty of scope for monetary expansion, spontaneous or Fed initiated. In the current context, that lends plenty of support to QE3 (and 4?) .

    This seems a fairly good summary: http://www.colorado.edu/ibs/EB/alston/econ8534/SectionX/Fishback,_US_monetary_and_fiscal_policy_in_the_1930s.pdf

  15. Simon

    The rehousing of skilled soldiers and refugees in more economically strategic and advantageous areas helped quite a bit too. The knowledge gained through sudden and massive war time industrial and administrative expansion was second only to learning the critical understanding communication plays in the modern world. The second world war didn’t really end it just changed into a trade war. One from which our veterans are now disappearing leaving a legacy of dogooders and squanderers.

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