The Ultimate Stimulus?
World War Two and economic growth
Sep 12, 2011, Vol. 16, No. 48 • By ARTHUR HERMAN
In short, it wasn’t the war that created a strong economy. It was the strong economy that made mobilization for war possible in the first place. All the war did was sacrifice present growth to a massive rearmament to defeat the Axis. Yet “as the war ended,” writes Higgs, “real prosperity returned almost overnight.”
This postwar boom has always posed a problem for Keynesians like Krugman. As government spending plummeted with the coming of peace— military spending alone collapsed from 37.5 percent of GDP in 1945 to just 5.5 percent in 1947—many predicted that, without this prop and with the new burden of millions of returning veterans looking for work, the economy would sink once more into the abyss. Paul Samuelson, later the dean of American Keynesian economists, wrote that unless the government did something drastic, “there would be ushered in the greatest period of unemployment and industrial dislocation which any economy has ever faced.”
Instead, after a brief hiccup in 1946, the economy rebounded, growing from $231 billion GDP in 1947—roughly what it was in 1945—to $258 billion in 1948, and from there to $285 billion in 1950. Unemployment, despite the dire predictions, increased only to 3.9 percent between 1945 and 1947, in spite of the fact that some 10 million new workers came into the civilian labor market.
The only way Keynesians could explain it was that all those saved paychecks from the war translated into a consumer spending spree, as pent-up demand finally found an outlet in consumer goods like new cars and refrigerators and houses people had wanted but couldn’t have. That, it seemed, was enough to compensate for the drop-off in government expenditure, which had put all that money in those workers’ bank accounts in the first place—exactly as a good economic stimulus should.
On only one point is this picture accurate. Although war workers were often forced to move into poor and inadequate housing and work longer hours under dangerous conditions—the war saw a 30 percent rise in the number of workers disabled on the job—they were also being paid a lot. With consumer choices contracting, there was little to do with that extra money but save it. (In fact, economist Mark Skousen argues that those aggregate private savings actually propped up a Federal Reserve wartime monetary policy based on deficit borrowing combined with flat interest rates.)
But long ago Milton Friedman and Anna Schwartz noticed something that undermined the Keynesian explanation. The postwar period saw no fall in savings. People’s liquid assets actually continued to grow after the war, from a record $151 billion at the close of 1945 to $168.5 billion by the start of 1948. If something stimulated the economy, it wasn’t people unwinding their savings accounts.
Instead, the biggest trigger to growth turns out to have been a sharp rise in private capital investment, which the New Deal had slowed—one reason the Great Depression lingered as long as it did, Higgs argues—and the war had all but halted. That investment jumped from $10.6 billion in 1945 to $46 billion in 1948, as plants expanded and retooled for the production of civilian goods. Even though the overall personal savings rate fell, the private investment rate soared from 5 percent to almost 18 percent, with the biggest leap coming in 1946—a leap that would be reflected in GNP numbers only two years later. Meanwhile, business savings almost doubled in the same period, from $15.1 billion to $28 billion—providing a sure way to finance expansion and hiring.
This rebirth of business confidence, indeed, was the one positive contribution World War Two did make to the future of the economy.
The sheer breathtaking volume and diversity of wartime production gave people a new respect for American business, whose image had taken a severe beating during the Depression and from New Deal rhetoric. Businesses, including the most productive sectors like automobiles and steel, had made sizable profits from wartime production (though, again, profits had jumped less than wages), and many had built hefty stocks of government securities. Others had gained valuable experience in the techniques of flexible mass production and had learned to apply managerial and engineering skills to what had seemed insurmountable problems, from building the immensely complicated B-29 to creating the atomic bomb. With the release from wartime restrictions and regulations, all that was needed was one more shove to trigger a real boom and complete the shift back to making things the market, not the Pentagon, wanted.
This time the shove came from Washington, in the form of a tax cut. The Revenue Act of 1945 cut the top marginal tax rate from 94 percent to 86.45 percent, and the lowest marginal rate from 23 percent to 19 percent. It also reduced corporate tax rates and eliminated FDR’s wartime excess profits tax and price controls. At the time, Georgia senator Walter George, chairman of the Senate Finance Committee, predicted the tax cut would “so stimulate the expansion of business as to bring in a greater total revenue.” He was right. Revenues soared even as government expenditure continued to fall, and America’s postwar boom was on. In the two decades after 1948, GNP grew at an average annual rate of 4 percent—while a Republican Congress elected in 1946, followed by a Republican president in 1952, ensured that nothing stood in the way of the renewed flow of prosperity.
Private capital formation and investment, restored business confidence, tax cuts and reduced regulation, and a Republican president—there in a nutshell was a genuine formula for economic stimulus, as opposed to the Keynesian distortions of the economy during World War Two. As for those millions of wartime workers and producers, the Rosie the Riveters and the Barney Rooses (inventor of the Army Jeep) who toiled so hard and sacrificed so much, we can always be grateful for what they did. Together with our men and women in uniform, they won a world war, and in the process they drew Germany and Japan, two of the world’s most highly educated and productive nations, back into a global free-market economy.
But they didn’t save our economy then, and invoking their memory won’t save Obama now—or save our economy from the damage he and his Keynesian friends have already done.