David R. Henderson  

Paul Samuelson's Prediction for Post World War II

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Arnold Kling and I have been discussing what an incredible counterexample to the Keynesian model the post-WWII years are. It occurred to me to check what Keynesians were predicting would happen after the war ended. Here's one of them:

When this war comes to an end, more than one out of every two workers will depend directly or indirectly upon military orders. We shall have some 10 million service men to throw on the labor market. [DRH comment: he nailed that number.] We shall have to face a difficult reconversion period during which current goods cannot be produced and layoffs may be great. Nor will the technical necessity for reconversion necessarily generate much investment outlay in the critical period under discussion whatever its later potentialities. The final conclusion to be drawn from our experience at the end of the last war is inescapable--were the war to end suddenly within the next 6 months, were we again planning to wind up our war effort in the greatest haste, to demobilize our armed forces, to liquidate price controls, to shift from astronomical deficits to even the large deficits of the thirties--then there would be ushered in the greatest period of unemployment and industrial dislocation which any economy has ever faced. [italics in original]

This is from Paul Samuelson, "Full Employment after the War," in S.E. Harris, ed., Postwar Economic Problems, 1943.
It's true that the war ended about two years after he wrote, rather than six months, but that would probably have made his prediction even more extreme. But pretty much everything else he speculated about policywise happened: the huge drop in the deficit, the end of price controls, and the demobilization.

It's also true that he said "Of course, this is not intended as a picture of what will in fact happen." But look at what he wrote directly after this quoted sentence to explain why things might work out better than he provisionally predicted:

For there is every reason to believe that we shall not be lulled into a feeling of false security by the last war's experience or by the half-truth that the end of the war will witness a boom. No doubt, we shall retain direct controls for a period after the conflict ends. We shall taper off war production gradually. We shall undertake income maintenance in the form of dismissal pay for soldiers, unemployment compensation, direct and work relief expenditure. It is probable, although less certain, that, in addition, the Federal government will initiate employment maintenance measures such as large scale public works, etc. But even these will not be adequate to maintain full employment or any approach to it.

Of course, direct controls were removed relatively quickly, certainly within a year and a half of the end of the war. War production did not taper off gradually but plunged. I don't think there was any dismissal pay for soldiers. You could see the GI Bill as a form of relief expenditure, but if I recall correctly, at any given time only about 500,000 people were taking advantage of the GI Bill to get education. And there were no large scale public works programs.
Here's what I wrote about the post WWII episode in a forthcoming piece on Canada's budget turnaround between 1994 and 2006:
This reinforces the lesson from the far more extreme U.S. experience after World War II: Between FY 1945 and FY 1947, federal government spending was cut by 61 percent. This was a 27-percentage-point drop from 41.9 percent of GDP to 14.7 percent of GDP. Yet the unemployment rate over that same time rose from 1.9 percent to only 3.6 percent. The postwar bust that so many Keynesians expected to happen never did.

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CATEGORIES: Fiscal Policy

COMMENTS (11 to date)
Milton Recht writes:

During WWII, the number of women in the workforce increased by 50% from 12 million to 18 million. At the end of the war, many employers replaced women with returning male GIs.

A part of the 10 million returning GIs were absorb in the job market by substituting for women.

One probably should adjust the number of unemployed upwards to include women who were involuntarily forced out of the labor force.

Arnold Kling writes:

Who forced the women out? My guess is that there were some firms that said to women that now that the war was over they were fired. But I would bet that the overwhelming majority of women who left the labor force did so voluntarily. Do you have evidence to the contrary?

Felix writes:

Another time period to look at would be the late '70's - the time of stagflation. I remember reading articles that concluded that Keynesianism was dead because stagflation couldn't happen in a Keynes world. Or something along those lines.

Anyway, 'bout the time of Reagan's election, a gob of economists took sides about what would happen. Who won the bets?

wd40 writes:

During WWII there was a lot of forced saving as many consumer goods were not available. Given this pent up demand, it is not surprising that the standard Keynesian model did not hold post war.

david writes:

Plus restoration of world trade under Bretton Woods. Lots and lots of demand there.

Daniel Kuehn writes:

"During WWII there was a lot of forced saving as many consumer goods were not available. Given this pent up demand, it is not surprising that the standard Keynesian model did not hold post war."

Wouldn't this suggest that the standard Keynesian model did hold after the war? We can point out individual Keynesians who were wrong all we want - that's fine. We've simply learned that humans make errors and are often wrong. But I just don't see how released pent up demand after the war and no depression after the war equals "the Keynesian model did not hold".

Keynesians failed here, not the Keynesian logic, right?

English Professor writes:

And let's not forget the famous memo from Paul Krugman and Larry Summers (dated September 9, 1982), while both were working in the Reagan White House, which predicted "a significant reacceleration of inflation in the near future." They were completely wrong on what would happen in 1983. Their "rough guess" was that distorted prices "will add five percentage points to future increases in consumer prices and about two percent to the GNP deflator." This they called a "conservative" estimate. If your macro assumptions are faulty, your predictions will inevitably be nonsense.

wd40 writes:

Daniel Kuehn is correct. But I was not criticizing the Keynesian model (or defending it for that matter). What I was criticizing was Henderson's simplistic critique of the Keynesian model. He was implicitly saying that the post WWII boom was evidence against the Keynesian model because a drastic reduction in G did not result in in a big reduction in GDP. Such a result would only happen if other things were equal, but of course other things were not equal because of pent up demand and other factors.

English Professor writes:

I think Daniel Kuehn and wd40 have both missed Henderson's point. It was Samuelson who had made predictions based on a Keynesian model. Those predictions suggested that unless major government intervention was brought to bear, the end of the war would produce "the greatest period of unemployment and industrial dislocation which any economy has ever faced." This clearly did NOT happen. This strikes me as a strong indicator of the dubious value of the Keynesian model as a predictive tool. That's also why I brought up the Krugman and Summers memo: their model simply was wrong.

Lord writes:

The GI Bill also provided unemployment compensation and inexpensive loans as well, and by 47 the Marshall Plan was lending abroad to support exports. No shortage of stimulus then.

John Goodman writes:

Thanks for finding this. It is priceless.

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