Lessons not learned from World War II

Policymakers today draw what they consider obvious conclusions from the Good War.   The New Deal had been chipping away at unemployment and the economy was recovering, but then Japan’s surprise attack provided the political means for allowing the government to shift gears.  Over the next four years the American economy got a heavy dose of Keynesianism, and the results prove the Keynesian case: GDP soared and unemployment all but disappeared.  Only in 1946 did official GDP take a beating, though surprisingly, given that the government fired roughly 20% of the labor force, the unemployment rate rose to only 3.8%.  (Five percent is considered normal for a healthy economy.)

Since Keynesianism has been validated under fire in the real world, its advocates tell us, it is altogether appropriate that government spend and inflate the economy back to prosperity today or any other time.

This is why Obama in 2009 came charging into office touting a big spending plan.  Mark Zandi, one of the architects of Obama’s stimulus package (officially, the American Recovery and Reinvestment Plan of 2009), projected in November, 2008 that “even with the [$300 billion] stimulus [in 2009], some 1.8 million jobs will be lost, with unemployment peaking near 8%.”  Without the stimulus, God forbid, unemployment would reach 8.94% by October, 2009.

What actually happened?  By October, 2009, with a $250 billion stimulus (according to the CBO), unemployment reached 10.1%.  How did it happen that the cure made matters worse by more than a full point?  Always spin-ready, the administration’s post-facto claim was they had misjudged the degree to which Bush had ruined the economy.  Without the stimulus, you see, unemployment would’ve risen even further. 

They can say this with a straight face because they know big deficits and inflation did the trick in World War II.  They know because they’ve seen the data.  Even conservatives readily agree - “World War II got us out of the Depression.”

Conscription to the rescue

During the 1930s and up until Pearl Harbor, there were many deteriorating measures of economic health, but none worse than unemployment.  All the controls and regulations, all the taxes and inflation, all the fireside chats and damnations of the rich, all the privileges to the unions, all the deficits, were not restoring employment to anything close to pre-Crash levels.

Then the Japanese finally struck, giving Roosevelt the back door he had been looking for. 

Finally, the government was in a position to provide millions of men with a paying job - conscript them and send them overseas to fight a war.  Government’s pitch was we had tried minding our own business but the forces of evil spread to our shores - not our shores, exactly, but the shores of an island some 2,500 miles from the mainland where the U.S. Navy had been hanging out since the 19th century.

There was a sudden rush to kill a lot of people, and the government would pay men to do the killing.  Low pay, of course, but nonetheless something.  Since government was doing the “hiring,” the 10 million or so men who were drafted could either take the job or stay home in the comfort of prison.  In a display of patriotic fervor, most of them took the job.  The draftees had no way of knowing their beloved FDR had set them up by provoking an attack that killed over 2,400 people, including civilians.

Was the economy booming as a result of the war?  No.  People stateside were working, but they were building things for the military rather than private citizens.  People were getting paychecks but price ceilings, rationing, and other government controls made life anything but prosperous.

Let’s ask that question again: Was the economy booming?  Absolutely.  The GDP figures tell the story.  During the war years, GDP exploded.  The government component of GDP went wild while private investment shrank, but so what?  To most analysts, GDP is GDP.

Ignoring the market’s signals

From the beginning of the depression in 1930, the free market had been willing to put people to work, but government wouldn’t let it.  Allowing wages to fall along with other prices was deemed cruel and unfair.  Almost 12 years later wages did fall for the men sent overseas, over a million of whom came back dead or wounded.   

Americans had a choice - the market’s way or the government’s way.  Unfortunately, they let government decide for them.

Politicians know that workers don’t take kindly to seeing their nominal income decrease, even if other prices are falling, and are likely to register their displeasure at the polls.  But there has to be more to it than political expediency, so officials announce that if wages fall, workers can’t buy as much and the economy goes downhill.   So they keep wages up to protect the workers, without whose spending they put themselves out of a job.

Keeping wages from falling did protect them - the ones who managed to hold onto their jobs.  Given the falling prices prior to Roosevelt’s gold heist, people with jobs found the dollars in their paychecks were buying more.  Predictably, high wages led to high unemployment, but Keynes considered this evidence of market failure, that Say’s Law no longer worked - there was a glut of labor but no one was hiring.  As Rothbard explains, however,

There is never any genuine unsold surplus, or "glut," whether specific or general over the whole economy, if prices are free to fall to clear the market and eliminate the surplus.

Keynes’s recommended policy - deficit spending and inflation - was far more politically palatable than leaving wage rates to the market.  With above-market wages, especially after passage of the Wagner Act in 1935, not only were people out of work, but those with jobs frequently worked reduced work weeks and lived in constant fear of getting fired.  By contrast, if you were stateside during the war you had no trouble at all finding a military contractor willing to hire you.

Government deficits and inflation didn’t cure unemployment in the 1930s, and they didn’t cure it during the war, either.  

When did prosperity return?  After Roosevelt died and the war ended, a new attitude prevailed in Washington that gave investors enough confidence to begin investing again.  Most of the wartime controls were removed, and consequently private investment soared even though official GDP plummeted.

As Robert Higgs tells us,

A minimum estimate of [economic] growth in 1946 was 30%.  There was never a year like that in our history.  Ever.  Not even half that good.  Ever.  Thirty percent in one year.  This was real growth. 

What looks like the second-worse year in history from the standard GDP data was, in reality, the best year ever in year to year performance of all time.  This was the real peace dividend.

Conclusion

Keynesianism instills the conviction that some combination of deficits and inflation will set things right again, that when one QE or stimulus package doesn’t do the job, another will, then another, then another.  We need to remember that it wasn’t more government that restored prosperity in 1946, but rather the release of productive energy made possible by significantly less government.