Arnold Kling  

The Depression that Wasn't

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Burt Folsom, Jr. and Anita Folsom write,


[President Roosevelt's] key advisers were frantic at the possibility of the Great Depression's return when the war ended and the soldiers came home.

I mentioned this in my post on Roger Farmer's book. If the Great Depression is the most difficult economic event for non-Keynesian economists to explain, then the late 1940's are the most difficult period for Keynesians to explain. From a Keynesian perspective, the government did everything wrong--it slashed spending and reduced spending. Yet, instead of falling into Depression, the economy did fine.


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COMMENTS (33 to date)
Tracy W writes:

Nope, the most difficult period for Keynesians to explain is Margaret Thatcher in 1981 slashing goverment spending, and the UK economy started its recovery at the same time.

And then Ruth Richardson did the same in NZ in 1991, with the same result.

You're far too US-centric.

Daniel Kuehn writes:

The only reason why anyone should expect a reduction in government spending to drop us back into a recession would be if you thought that there wasn't private demand to replace it. It seems eminently obvious that there was private demand to replace it, so what's the big deal? I don't see why non-Keynesians always consider this such an amazing point to make. You had years of rationing of consumer demand and low unemployment.

I've never heard any Keynesian suggest that the economy is always dependent on government spending for growth. In certain circumstances, they say it is. But not in all circumstances. I've heard a lot of non-Keynesians attribute that to Keynesians, but no Keynesians.

Noah Yetter writes:

Perhaps because Keynesians themselves predicted demobilization would plunge the economy back into depression?

Also if there was private demand to replace the public demand, would that not prove that crowding-out exists and is extraordinarily powerful?

JPIrving writes:

@Tracy
The drop in government spending in 1946 has got to be proportionally the biggest in the history of any economy, bigger than the 1980s liberalizations. Anyway those are great examples, I always think free marketers in the U.S. cite Reagan too much and forget Thatcher and the Aussie and NZ reforms.

@Daniel
If I understand the generic New Keynesian model right such a spending drop would cause a short run recession. The "Vulgar Keynesian" story of the 1940s says that we should slip right back into the depression.

Boonton writes:

Gov't spending was not stopped in the late 1940's! First while military spending wound down there was still new gov't programs like the Marshal Plan and GI Bill. But you are right net spending by the gov't did fall, but you forgot to include the 'notes hidden in bottles buried in caves'.

Well actually they weren't in bottles in caves, they were sitting in the hands of consumers. All during the war workers in the home market made excellent money. The problem was they couldn't spend it as the gov't imposed price controls and rations. As these were lifted the pent up funds could finally seek out consumer goods to purchase.

My father-in-law has told me right after WWII used cars could be had for next to nothing. All during the war no new cars were produced. When the war finally ended people snatched at the opportunity to dump their worn out cars and buy new ones.

Boonton writes:

If I understand the generic New Keynesian model right such a spending drop would cause a short run recession. The "Vulgar Keynesian" story of the 1940s says that we should slip right back into the depression.

Well I suggest reviewing the two charts on http://en.wikipedia.org/wiki/Great_Depression_in_the_United_States.

There was a recession in the late 40's where the US retreated from the $2T GDP mark (in 2006 dollars) seen at the peak of the war and didn't recover to that point until 1950 (at which point war spending was ramping up again due to Korea and the Cold War). Likewise unemployment became very low at the peak of the war and did shoot up again spiking over 5% right before 1950.

Granted this is nowhere near the Great Depression but as I pointed out elsewhere it's not exactly like the New Deal was repealed on VJ Day. Also Keynes never argued that recessions were caused by pull backs in gov't spending, although pullbacks could make an existing recession worse.

spencer writes:

Gee, my history tells me FDR dies well before the end of WW II.

Tell me, how were FDR's advisers warning him about another depression when he was dead?

Moreover, it was not just Keynesians that worried about a return of the depression after WWII, essentially every school of economic thought was worried about it. Maybe one of the best examples is the JC Penney department store chain where their CEO though we would return to a depression so the firm did not invest in new stores or try to grow after WW II and consequently lost massive market share to Sears where they had gone on a great expansion program after the war.

The libertarian philosophy has a lot to say for it and and great appeal to many people. Why you believe you have to keep making up stuff like this to justify your belief in libertarianism is beyond me.

[part of this comment was deleted for rudeness. I don't mind trolls, but I do mind rude trolls.--AK]

Amaturus writes:

We spent $25+ billion in aid and the Marshall plan that bolstered demand for U.S. goods in war-torn countries. That's still seems rather Keynesian to me. Instead of spending to increase domestic consumption, increase foreign consumption. When you're the only industrialized economy still left standing, you can sit back and watch the profits roll in.

Boonton writes:

The WSJ piece is on a par of their usual standards. The author ignores, for example, that while Congress rejected FDR's broad proposal for a 'New Deal revised' with expansive provision for housing and health care, it did pass massive tax cuts. From a Keynesian perspective tax cuts work as well to stimulate demand (I'm noticing a pattern here, are we discussing economics or politics? Is Keynesianism just being used to mean Democratic? If this is an actual discussion of economics shouldn't we be looking at variables like net gov't spending instead of focusing on whether or not Congress passed a particular spending package FDR wanted?)

More interestingly money supply isn't addressed.
http://1.bp.blogspot.com/_nSTO-vZpSgc/SRVLM8Kif0I/AAAAAAAADs8/Ad1Iwf_fPJ0/s1600-h/base-money-yoy-1.png

Shows two things. First money growth becamse negative right at the end of WWII (but there was a lot of positive money growth before that). It then suddenly shot in the positive direction during the minor post war recession. This tells us two things:

1. The Fed was not at the 'zero bound' which we know from our friends like Paul Krugman and Brad De Long is a zone where the Fed can act to stimulate the economy when and if Congress declines.

2. The Keynesian narrative seems to fit. Stimulus was withdrawn, a recession happened (albeit minor), stimulus was added and the economy recovered to normal. Why wasn't the recession as bad as the Great Drepression? Well for one thing look at all the rapid money growth during the war, with only a short period of slightly negative growth. There was still a lot of pent up money itching to get spent, even if the gov't was pulling back its spending soldiers were returning home with their pay, families who spent the war on rations and buying War Bonds were itching to cash in some savings and do some spending.

What I'm not seeing is how horrible a fit this is with the Austrian/recalculation narrative. For a period of time gov't was engaged not only in super-massive stimulus but also massive reallocation of production away from consumer goods and towards war goods. From that narrative there was supposed to have been a massive 'recalculation' recession as all the investment in capital goods to make war items (such as factories to make tanks) suddenly became worthless or in need of serious retooling for private production. From that perspective, WWII should have been a massive gov't produced 'bubble' that should have resulted in a huge collapse. Why didn't it?

baconbacon writes:

"Tell me, how were FDR's advisers warning him about another depression when he was dead?"

Hmmm Spencer,

I never realized that it was impossible to talk about what would happen after the war ended prior to the war ending.

Thanks for "enlightening" us.

Aaron writes:

Spencer,

I'm sure FDR was well aware that the war would eventually end (and by that time it was relatively clear that the allies would win), hence his advisors' concern for what would happen when it did. Perhaps you are reading that sentence incorrectly?

Boonton writes:

And look at how silly the WSJ piece is when it tries to explain the lack of a major recession at the end of WWII. It asserts the massive employment during WWII serving in the armed forces and producing arms was 'unsustainable'. OK so there should have been a massive recession, why wasn't there. Ohhh because Keynesian ideas were rejected! What do you mean? Well instead of adopting FDR's massive housing program, a more modest one was adopted! 'Supply side' tax cuts were passed.

What 'supply side' cuts were those? Hold on to your seats, the top marginal rate under that evil FDR was 94%! Can you believe it! Thankfully the Congress, rejecting evil FDR's massively high rate, slashed to top marginal rate. Get ready, what did they slash it to! Hang on......


Ohhhh hang on this is good.....


Can you bear it?.....


86.45%


Wow.

Fenn writes:

"it slashed spending and reduced spending"

what is the other thing besides spending supposed to be?

baconbacon writes:

Danial Keuhn,

"The only reason why anyone should expect a reduction in government spending to drop us back into a recession would be if you thought that there wasn't private demand to replace it. It seems eminently obvious that there was private demand to replace it, so what's the big deal? I don't see why non-Keynesians always consider this such an amazing point to make. You had years of rationing of consumer demand and low unemployment."

There are three major problems.

The first is that the Keynesian predicts a certain order of operations. The argument for 'stimulus' is based upon the idea that the government spending will keep AD high enough UNTIL consumer spending returns at which point. The lack of wages drives a downward spiral- holding those wages up is 'necessary' to prevent the spiral. If real (the key word) wages were high during WW2 why wasn't there growth in the consumer industry then?

Number two is that wages are (among) the most sticky prices. If everyone was earning bank during WW2 their wage demands in a post WW2 world should be to high to clear the market which causes high UE- and the whole downward spiral/pressure on prices things.

Third is the uncomfortable notion that Keynsians claim WW2 ended the depression and there was real economic growth during that period- but it somehow occurred without satisfying consumer wants (see Boonton's father in law). This contradicts the idea that there really was recovery during WW2.

JPIrving writes:

@boonton

What charts am I looking at? The RGDP chart shows a big post war drop in real spending and the unemployment chart shows...low post war unemployment. I'm not sure how historical data gives understanding of a theoretical model. If anything this seems at odds with the new Keynesian model.

@Fenn
I reckon the second spending should be deficit

Boonton writes:

Third is the uncomfortable notion that Keynsians claim WW2 ended the depression and there was real economic growth during that period- but it somehow occurred without satisfying consumer wants (see Boonton's father in law). This contradicts the idea that there really was recovery during WW2.

Again remember Keynes's quip about burying money in caves? What do we have, massive employment in WWII and massive money creation but rationing and price controls and 'forced savings' pushes ('Buy War Bonds for our boys!', 'when you ride alone in your car Hitler is in your passenger seat!'). The war ended and income fell as war industries retooled and GI's returned home but spending was replaced by bringing out all that unspent money.

Let's look at the war another way. During the war 'Sally the rivet girl' took a job making $1,000 a month. But due to all the restrictions she could only really spend $500 a month. The recovery was real. Sally wanted to be able to spend $500 a month and accepted a job that allowed her too. If she wasn't she wouldn't have taken it, she would have demanded more, say $1200 a month if she wanted to spend $600!

Now imagine a slightly alternate universe where the gov't isn't so nice. In this Slightly-Stalinish-FDR pushes Sally to work for $500. There are no rations and no 'buy war bond' rallies but since she only makes $500 she spends all her income. After the war massive unemployment should result but FDR turns on the printing presses and has his secret police bury some $500 bills in Sally's basement. After a brief period of financial panic, Sally finds the money and spends it as she looks for new work. That's a perfectly Keynesian story and it fits the facts (minor post-war recession)

As you can see this is two sides of the same coin. The gov't could have paid everyone less but reassured them that they would keep the economy humming post war. Or, what really happened, was the gov't created the post-war stimulus during the war and entrusted it to the people via all the consumption restrictions. When the war ended all the spending happened by individuals bringing out their stashes of 'stimulus'. Call it a Keynesian militia if you wish ;)

Boonton writes:

JPIrving

What charts am I looking at? The RGDP chart shows a big post war drop in real spending and the unemployment chart shows...low post war unemployment.

I'm looking at 3 charts. One is GDP and the other is the unemployment rate on the wikipedia Great Depression article. Both show a minor recession in the 2nd half of the 1940's. The other chart is money supply and it shows very positive growth during the early 1940's (the war itself), a sharp but short negative period right at the end of the war followed by a return to positive money supply growth at the end of the 40's.

AJ writes:

I asked this question in undergraduate Macro (at Duke University) and was told it was the wealth effect. People had forced savings from rationing and forcing their income into savings bonds during the war and there was "pent up" demand waiting when the war ended. [are the magnitudes big enough to account for this????? I'm not so sure]

Tracy W writes:

JPIrving - the growth after WWII is generally explained away by Keynesians as pent-up demand (quite possibly accurately), as shown here.

In the UK, 391 British economists signed a letter opposing Margaret Thatcher's goverment spending cuts, amongst other reasons stating that it would worsen the recession. In NZ, 15 economists signed a similar letter about Ruth Richardson's spending cuts. The openly wrong predictions is what makes these examples strike me as the most difficult times for Keynesians to explain away, if you get your predictions wrong like that how good are your models?

Steve Roth writes:

It's actually really easy to explain from a Keynesian -- or actually freshman textbook economics -- perspective. Boonton and AJ already did so.

People spending their savings in massive quantities. (End of rationing and uncertainty.)

Sparing you a thousand words:

http://www.asymptosis.com/wp-content/uploads/2010/04/savings-2.png

baconbacon writes:

"Again remember Keynes's quip about burying money in caves?"

Yep, sure do. There is no mention of the lag between the time of hiring men or women to dig up the money lasting 4-5 years. The Keynesian narrative is that the hiring of the diggers will lead to lower UE which will lead to spending leading to private investment. The last leg is crucial to Keynes' theory- the whole idea isn't that government sponsored employment IS prosperity, its that gov sponsored employment leads to private employment MORE QUICKLY than letting the recession run its course. Long lags between government spending and real economic activity picking up invalidate the need for government spending.

"Let's look at the war another way. During the war 'Sally the rivet girl' took a job making $1,000 a month. But due to all the restrictions she could only really spend $500 a month. The recovery was real. Sally wanted to be able to spend $500 a month and accepted a job that allowed her too. If she wasn't she wouldn't have taken it, she would have demanded more, say $1200 a month if she wanted to spend $600!"


Historically savings rises during a recession/depression. Keynes contended that the increase in savings lowered AD leading to a downward spiral in prices/wages/spending. If increases in savings works as you describe above then recessions/depressions will end themselves via the increase in savings/pent up demand process. This is THE MAJOR DISAGREEMENT between the Austrian view of the business cycle and Keynes' view- WITH THE AUSTRIANS taking the position that the deferred consumption during the downturn will lead to the renewal of real economic activity. Nothing in your explanation implies that government spending shortened the recession.

"Buy War Bonds for our boys!', 'when you ride alone in your car Hitler is in your passenger seat!'"

Yet another major problem for Keynesians. Remember that that one of the main arguments against G spending is "crowding out" of private investment. Keynesians argue that this doesn't happen due to the "multiplier" effect whereby $1 in spending leads to > $1 in economic activity. If the government is stimulating in a Keynesian way then there should be possible for growth in both government AND private spending to occur (near) simultaneously.

"What 'supply side' cuts were those? Hold on to your seats, the top marginal rate under that evil FDR was 94%! Can you believe it! Thankfully the Congress, rejecting evil FDR's massively high rate, slashed to top marginal rate. Get ready, what did they slash it to! Hang on......"

Top marginal rates are a terrible analysis tool.

baconbacon writes:

"It's actually really easy to explain from a Keynesian -- or actually freshman textbook economics -- perspective. Boonton and AJ already did so.

People spending their savings in massive quantities. (End of rationing and uncertainty.)"

This is not a Keynesian explanation- it is no different from the Austrian explanation.

baconbacon writes:

"What I'm not seeing is how horrible a fit this is with the Austrian/recalculation narrative. For a period of time gov't was engaged not only in super-massive stimulus but also massive reallocation of production away from consumer goods and towards war goods. From that narrative there was supposed to have been a massive 'recalculation' recession as all the investment in capital goods to make war items (such as factories to make tanks) suddenly became worthless or in need of serious retooling for private production. From that perspective, WWII should have been a massive gov't produced 'bubble' that should have resulted in a huge collapse. Why didn't it?"

Briefly- the Austrian position is one that basically states that the US was in either a depression or very anemic growth during WW2 (see Higgs' "DEPRESSION, WAR, AND COLD WAR:
Challenging the Myths of Conflict and Prosperity")

Secondly there was a massive 'bubble'- in the production of arms for the war- and this bubble DID collapse- but the Austrian narrative doesn't describe the end of a recession/depression once ALL of the recalculation work is done- it recognizes that the recovery starts when savings is converted to investment.

Boonton writes:

Historically savings rises during a recession/depression. Keynes contended that the increase in savings lowered AD leading to a downward spiral in prices/wages/spending. If increases in savings works as you describe above then recessions/depressions will end themselves via the increase in savings/pent up demand process.

I think what you're missing here is the savings in WWII was forced. Sally the Rivet Girl wanted to spend more like $900 a month but was 'forced' to save only $500. (Don't confuse this with Sally's decision to take work if it provides her with at least $500 of consumption per month, that is the point where she is willing to trade off not doing a job with doing a job) The rise in savings rates during recessions is a different animal, caused by uncertainty and fear. During the war, though, unemployment was almost nothing. Whether or not the jobs were sponsored by the gov't doesn't really matter to Sally. She can pay her rent each month with her pay she receives.

[Speaking of which, my mother-in-law had a story which may illustrate such a time. She once held 30 jobs in 30 days. Each day going to a new diner or factory and working a different job. That was long after WWII ended but I suspect that was what it was like working in an environment of next to no unemployment]

You're right that recessions could be self correcting if gov't could 'bottle the stimulus' during booms into private hands. WWII was an exceptional moment because the war provided both gov't controls to ration consumption as well as the peer pressure to reinforce it. A similiar time might have been the Civil War in the South, but there since the Confederacy lost the war there was massive economic destruction.....and also a generation that stuffed their worthless Confederate dollars in the attic rather than spending them in the post war years.

The US didn't loose the war, US Dollars didn't become worthless as the currency was replaced by Japanese Yen or German Nazi Marks. The positive 'animal spirits' of the 1945-1950 era were probably an amazing thing to witness and live through. It's quite believable IMO that could have swamped a natural tendancy towards sinking back into Depression resulting in only a minor 'recalculation recession'.

Keynes was very aware that psychology was highly unpredictable....and its fair to point out that the more scientific orientated Keynesians often forget this important point. If the US didn't have a world with Nazi Germany and Japan to contend with, a massive infrastructure program probably could have done the same good in getting us out of Depression BUT providing us with useful capital goods and avoiding the cost of hundreds of thousands of young men. While growth was rapid post WWII, the fact is we probably could have had 1970 in 1955 if the rest of the world had been a little more civilized. But again a 'Rebuild America' campaign in place of WWII could very well have lacked the sense of psychological victory that recentered the American economy in the post-war years. [Although this is something I wonder about, if WWII hadn't happened how long would major things like the space program, atomic energy, large commercial airflight, computers have taken? What contributions would those millions of victims had made to offset that?]


Yet another major problem for Keynesians. Remember that that one of the main arguments against G spending is "crowding out" of private investment. Keynesians argue that this doesn't happen due to the "multiplier" effect whereby $1 in spending leads to > $1 in economic activity. If the government is stimulating in a Keynesian way then there should be possible for growth in both government AND private spending to occur (near) simultaneously.

I think you're a bit off here. G only crowds out private investment in a full employment economy. In an economy below full employment G soaks up otherwise unemployed recourses. The multplier being >1 happens in an economy below full employment, as the economy reaches full capacity the multiplier falls until it becomes 0 at which point G becomes purely inflationary. That has historically been a chronic problem for economies in 'full war mode' whether you're talking about WWI, II, the Civil War or numerous other ones. The US in WWII had a relatively good inflation experience because the US had a huge productive capacity to produce both war and consumer goods (plus a lot of it unemployed) AND a major effort was made to limit consumer consumption. The 'price' that consumers like Sally extracted for this was the 'right' to consume beyond their means after the war when they could start cashing in their savings, war bonds etc. and hit the 'mall' without worrying about the ration book.


Top marginal rates are a terrible analysis tool.

True but the WSJ analysis is, I think you have to admit, absurd. Tax cuts are stimulative from a Keynesian POV. OK cutting spending is a favorite policy of Austrians but let's get real. Post-WWII America was one where Keynesism was vindicated, not rejected! OK Congress didn't follow the prescriptions of economists to the letter and there was some cutting back but there was no return to 'normalcy' meaning the pre-Great Depression paradign. The New Deal was left mostly in place. Unionization was moderately challenged in the 50's but certainly not rolled back. Spending on the military was cut briefly but social spending was expanded (again not as much as FDR advocated). The Austrians have a post-war period that is a closer fit to their policy recommendations, that is the post-WWI recession but that track record is nowhere near as good as the post-WWII record!

baconbacon writes:

"I think what you're missing here is the savings in WWII was forced."


Keynes contended that the downward spiral in wages/prices was due in large part to the increase in savings which aren't transformed into investment and it doesn't matter to the theory if the savings are forced or not.


"I think you're a bit off here. G only crowds out private investment in a full employment economy."

That is the Keynesian theory- the issue here is that the economy clearly wasn't at full employment in 1940- so the stimulus should have provided boosts both public and private spending IF THE MULTIPLIER IS > 1. If private consumption doesn't increase, or decreases (per capita) then the multiplier is considered to be

"The Austrians have a post-war period that is a closer fit to their policy recommendations, that is the post-WWI recession but that track record is nowhere near as good as the post-WWII record!"

No- the Austrians prefer a free market approach to the money supply and the non war periods during the 1800s is much closer to the Austrian preference than the post WW1 era (the Austrians only argue that the handling of the post WW1 depression was better than the post 1929 handling)- and the economic growth of the 1800s >>> the post WW2 growth in the US.

Boonton writes:

Briefly- the Austrian position is one that basically states that the US was in either a depression or very anemic growth during WW2

Yet we see decreased GDP and increased unemployment following WWII. Likewise we see lower GDP and higher unemployment before WWII. WWII did not solve unemployment by drafting everyone. Unemployment is measured by those looking for work as a percentage of the labor force. Drafted soldiers may remove some unemployed but it also removes them from the labor force. There's no reason that those left behind wouldn't continue to experience unemployment in the home economy. Yet they didn't. They not only were able to consume with the earnings they made during the war (see again Sally the Riverter example) but able to consume the savings they were forced to make after the war.

The argument that this wasn't all real because it was about producing gov't war goods rather than consumer goods strikes me as very unsientific....almost akin to the Marxist claims that capitalist economies were really poorer because the consumption taking place isn't what people really want to do but what capitalists are fooling them into doing! Are you telling me after Pearl Harbor Americans didn't want bombs dropping on Japan but instead wanted rock'n'roll records produced? For a school that says it thinks a lot about social institutions this is a very odd way to look at the gov't, like some alien entity that landed on our backs from Mars! The gov't is an organic entity that is, essentially, all of us.

To claim that the production of war goods in WWII wasn't really production because the orders were being placed by the Department of War rather than Wal-Mart's purchasing department is absurd IMO. Likewise the residents of Dresden and Hiroshima didn't meet illusionary bubbles during the war.

Boonton writes:

Keynes contended that the downward spiral in wages/prices was due in large part to the increase in savings which aren't transformed into investment and it doesn't matter to the theory if the savings are forced or not.

True, if the US had simply 'forced savings' in WWII without any serious gov't spending there'd be a massive recession. But as Sally the Riviter was saving $500 a month the US gov't was spending $1000 a month which is why there was both zero unemployment and inflationary pressure.

No- the Austrians prefer a free market approach to the money supply and the non war periods during the 1800s is much closer to the Austrian preference than the post WW1 era (the Austrians only argue that the handling of the post WW1 depression was better than the post 1929 handling)- and the economic growth of the 1800s >>> the post WW2 growth in the US.

I don't think the 1800's are better than the 2nd half of the 1900's in terms of economic growth but regardless the problem here is that post-WWII is even less Austrian in terms of gov't policy than post-WWI (unless you're going to play games like the WSJ piece which cherry picks facts). Hence post-WWII should be much worse than post-WWI. It was only a minor blip at best. Considering the gov't intervention in the economy in WWII was much larger than anything that came in the New Deal, Great Depression or anything else, this shouldn't be the case unless there's something wrong with their theory.

baconbacon writes:

"There's no reason that those left behind wouldn't continue to experience unemployment in the home economy."

Yes there is. Jobs (in the post industrial world) require capital investment, because the capital investment still exists after Johnny America leaves his job to enlist/get drafted into the military there is EVERY reason (ie the profit motive) for that employer to attempt to hire someone to take his place.

"The argument that this wasn't all real because it was about producing gov't war goods rather than consumer goods strikes me as very unsientific...."

Lets say you spend $100 on groceries a week. One week you are to ill to shop and you call up your local government agency who agrees to purchase your groceries for you and drop them off at your house. If you do not provide the agency with a list of brands you like, prices you are willing to buy goods at, dietary preferences/restrictions- do you expect to gain the same utility out of a random strangers decisions for your $100 as you would on your own weekly trip to store?

You claim it is unscientific to count gov spent dollars differently from consumer dollars- but it is the opposite that is true. The concept of aggregating GDP for the purposes of understanding growth is based on the idea that consumers face opportunity costs with their decisions and that the expected utility of spending is > than the amount spent. Consumer dollars are inherently different from government dollars because consumer dollars are spent by individuals who reap the vast majority of the rewards/benefits of their purchases. Treating two unlike things as the same is unscientific.

Now return to the grocery analogy above- instead of you being sick and needing someone to shop from you your friendly government agency calls you up and simply tells you that they are going to do all your shopping for you and count that $100 toward GDP in exactly the same way- how is your dissatisfaction in your new food selection captured in GDP?

"almost akin to the Marxist claims that capitalist economies were really poorer because the consumption taking place isn't what people really want to do but what capitalists are fooling them into doing!"

Marx was wrong because he assumed that his own ideas/preferences were better/more valuable than individual choices. Government spending is much more akin to Marx telling people what they should or shouldn't do with their money than it is to free market enterprise.

"Are you telling me after Pearl Harbor Americans didn't want bombs dropping on Japan but instead wanted rock'n'roll records produced?"

You don't understand the purpose behind calculating GDP. When the government buys a bomb that costs $1,000 they say "this adds $1,000 to gdp because that is how much it costs"- when a consumer buys 200 records for $5 each the consumer is saying "I would prefer to have these 200 records than the $1,000 dollars."

"To claim that the production of war goods in WWII wasn't really production because the orders were being placed by the Department of War rather than Wal-Mart's purchasing department is absurd IMO. Likewise the residents of Dresden and Hiroshima didn't meet illusionary bubbles during the war."

No one says the bombs are illusory, only that the prices are.

Next time you think about this argument consider what the Soviet Union did to achieve "growth". They ordered X tons of nails produced and slapped a value of $y per ton on the nail. The next year they ordered 1.1*X number of tons produced, slapped price Y on it and claimed a 10% growth in the number of nails. The tonnage of nails may well have gone up by 10%- but frequently the nails simply sat in a yard somewhere and rusted because there was little to no use for them. The nails were real but their production did not equal the prices slapped on them by the government.

Boonton writes:

Yes there is. Jobs (in the post industrial world) require capital investment, because the capital investment still exists after Johnny America leaves his job to enlist/get drafted into the military there is EVERY reason (ie the profit motive) for that employer to attempt to hire someone to take his place.

I think you have cause and effect backwards. You seem to be saying that given some capital, you need X number of workers to use it. Take a garbage truck. It takes a driver and two men in back. Your logic seems to be if we killed those 3 men (or shipped them off to the front line), then 3 men will be pulled from the unemployment lines to fill work that truck.

That's fine but if you ship 3 men overseas that's 3 mens worth less garbage being tossed out here. Whose to say the garbage truck, while still a perfectly good piece of capital, will only have 2/3 the garbage to pick up resulting in a net 2 FTE (full time equilivant) jobs to be filled?

Lets say you spend $100 on groceries a week. One week you are to ill to shop and you call up your local government agency who agrees to purchase your groceries for you and drop them off at your house. If you do not provide the agency with a list of brands you like, prices you are willing to buy goods at, dietary preferences/restrictions- do you expect to gain the same utility out of a random strangers decisions for your $100 as you would on your own weekly trip to store?

Probably not. So why would you spend $100? Why not let the agency (or your kid) spend $70 so you have just enough to get by on and you can then use $130 next week to make up for your loss of utility?

The point is, though, that production is still production. Let's say that after Pearl Harbor 1 million people put $1,000 into a special fund that would pay out the bounty to any capitalist who destroyed a Japanese city. Steve Job's grandfather borrows $1B from Henry Ford and other industrialists and perfects the atomic bomb, destroys Hiroshima and collects $1B in revenue minus whatever the R&D and production costs were. This would clearly be counted as $1B of GDP produced that year. Pretending that $1B of GDP didn't happen that year because the dollars were spent in an accounting bucket we call G rather than I or C makes little sense.

I accept that an economy of $1B GDP of only G is not the same of $1B GDP of only C. But GDP is still a good measure of production and we see how when the accounting gimmicks are removed planned economies like the USSR in the 1980's and 90's do a bad job at producing goods. Nonetheless they do produce goods, some more than others. To say that we are going to pretend a planned economy like the USSR or the US in WWII produced nothing because its G is nonsense. The US faced a very real set of products in the Cold War, thousand of tanks and missiles, that didn't spring out of an accounting fiction but represented the result of putting real capital together with real labor to make very real output. So did the victims of WWII. And on the flip side, 'Sally the Riviter' made real income during WWII which she used to enjoy consumption both during the war and after unlike her mother who did not during the Great Depression.

I think you're confusing GDP with a measure of ideal individual happiness. Its fine to say a 20 year old kid getting shot at on the front lines in WWII was less happy than a 20 year old kid chatting with his friends on a bread line in 1934. But figure out your metric and stick with it. Create your 'happiness index' and figure out what its been for the past 80 years or so and we can talk about it. But its silly to measure results with GDP when it produces the results you like but suddenly switch to unmeasurable metrics when it doesn't.

No one says the bombs are illusory, only that the prices are.

Ok but when a bomb was made for $1000 various people ended up with a total of $1000 in their pocket. That $1000 brought them things they wanted (either during the war or after). If producing the bomb was an accounting illusion then where's the correct number? Is the G portion of GDP reduced by, say, 20%? Why not 25%? Or 15%? If so then restate all the historical GDP numbers and less evaluate economic performance at all points in history.

baconbacon writes:

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Dyer1829 writes:

I think the easiest way to explain the cut in spending is that the government did not want the economy to rely on government spending entirely. If the government had simply increased spending, what would have happened when they finally cut spending? The answer is a simple one, the economy would have plummeted. If the government used massive amounts of spending to keep the economy alive, when they stop spending, the economy takes a huge hit. Instead of using all government spending to keep the economy going, the government decided that it would be better to let the populace do the spending, and miraculously, going completely against Keynesian economic theory, it worked and the economy recovered.

Boonton writes:

Well except it doesn't 'go completely against Keynesian economic theory'. If you had to boil Keynes down to one word is isn't government but spending. If spending is high enough, the economy is good. If not its bad.

You can have a sector of the economy suddenly cut its spending and nothing too bad will happen provided other sector(s) increase spending. The fact seems very clear that gov't cuts in spending were being offset by dramatic increases in consumer spending. The Austrian argument seems to be this happened because Americans spent WWII fuming at FDR as they read their Hayek and when theh old man was finally dead they wanted to party in order to prove Keynes was wrong. The Keynesian argument is that the gov't spent WWII having people build up cash but not letting them spend it. When the war ended not only were the living happy to be alive but the US was the winner! And to boot with a brand new superweapon that no one else had, we were the champions!! Why not start enjoying life again?

Weren't Keynesians worried about the Depression returning after the war ended?

Sure and it was a reasonable fear. Yes people had cash and they were being held back from spending it but how do you measure how much people want to spend their piggy bank funds?

Try to imagine an alternative world. Say the atomic bomb was never invented and say Stalin did a two face suddenly leaping to Japan's side after Hitler was dead. In that world the policy of demanding 'uncontitional surrender' suddenly starts costing the US even more lives and after two horrible D-Day like attempts at invading Japan fail with 75,000 dead Americans each a negotiated end of the war is done. To make it even more gloomy, pretend that Stalin perfects the atomic bomb first, demonstrates it in Europe and announces that he will use it to help Japan if the US tries another invasion.

With the war ending in this gloomy way, the prospect of going immediately into the Cold War with the USSR and while not technically losing not being a great winner. IN this gloomy end to WWII would people be eager to spend up their funds? Maybe not, maybe there would have been a return to the Depression as gov't cut back and individuals hoarded their savings for fear of more bad news...

harald writes:

England did well while reducing spending because about that time they also reduced foreign purchases of oil via' their big oil discovery in the North Sea, no.

Amercia's recovery should abort due to Washington holding bank interst rates below true inflation via' the Federal Reserve forcing rates way to low. Greedy of them thinking corrspondingly lower borrowing rates will in the end lead to anything other then having the capital base of America fund spending via' the banks taking that cheap money and buying Teasury bills at a 2 or 2.5% spread.......So why Lend??

Similar to the 1950's......Remember those those years guys!

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