David R. Henderson  

A Fiscal History Lesson

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The Hoover Institution's on-line publication, Defining Ideas, has published my article, "A Fiscal History Lesson." In it, I retell the story that I told at longer length in my 2010 Mercatus study, "The U.S. Postwar Miracle."

Two highlight paragraphs:

In a 2010 study for the Mercatus Center at George Mason University, I examined the four years from 1944, the peak of World War II spending, to 1948. Over those years, the U.S. government cut spending from a high of 44 percent of gross national product (GNP) in 1944 to only 8.9 percent in 1948, a drop of over 35 percentage points of GNP. The result was an astonishing boom. The unemployment rate, which was artificially low at the end of the war because many millions of workers had been drafted into the U.S. armed services, did increase. But between 1945 and 1948, it reached its peak at only 3.9 percent in 1946. From September 1945 to December 1948, the average unemployment rate was 3.5 percent.

Most of the policies that Samuelson had feared actually happened, and in spades. Price controls were eliminated. Not only was the federal budget deficit decreased, but also, in 1947, the budget surplus was over 5 percent of GNP. Demobilization happened big-time. Between 1945 and 1947, when the postwar transition was complete, the number of people in the armed forces fell by 10.5 million. Civilian employment by the armed forces fell by 1.8 million, and military-related employment in industry fell off the cliff from 11.0 million to 0.8 million. As demobilization proceeded, optimistic employers in the private sector scooped up millions of the soldiers, sailors, and others who had been displaced from the armed forces and from military industries.

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CATEGORIES: Fiscal Policy

COMMENTS (9 to date)
Daniel Kuehn writes:

Thanks David.

I don't understand this passage, though: "The second part of the explanation is that people drew down the savings that they had accumulated during the war. But if people were drawing down their savings after the war, their rate of saving would have been negative. It wasn’t. While the personal saving rate did fall substantially from a wartime peak of 25.5 percent in 1944 to 9.5 percent in 1946 and 4.3 percent in 1947, it remained positive."

So as I think you know, I made a big purchase recently. I spent down tens of thousands of dollars of my savings in order to make that purchase, but every month I'm still managing to save a portion of my income.

Why would you have expected my savings rate to go negative? Am I missing some basic fallacy of composition here? I don't think I am.

From my readings, Samuelson seems highly atypical of wartime Keynesian opinion (and he even says he knows he's out of step with everyone in the Harris volume chapter), but I do need to do a little more legwork in putting together an actual case on this.

David R. Henderson writes:

@Daniel Kuehn,
Thanks. I don’t know enough details about your income, and, believe me, I’m not trying to pry. (That’s rare for me, by the way, because I love knowing people’s incomes. I often say that being an economist gives me an excuse to be nosy. :-)) But I strongly suspect that unless it’s much higher than I think, your saving for the year will be negative. “Tens of thousands” means at least $20,000. So unless your monthly saving is greater than $1,667, you will have a net negative saving rate for the year.

Daniel Kuehn writes:

So this is potentially my personal ignorance on savings rates calculations... so spending down wealth counts as negative savings? I was always under the impression that "the personal savings rate" was income less consumption less taxes over income (and that clearly can stay positive even if a lot of past savings are being spent on consumer goods).

David R. Henderson writes:

@Daniel Kuehn,
Not quite: spending down wealth counts as negative saving. (Notice that it’s saving, a flow, not savings, a stock). It’s symmetric with building up wealth (other than through capital gains), which counts as positive saving.
At least that’s what I wrote in the study and when other anonymous referees had the same objection you did, I justified it with the stock/flow point and it passed the referees. Of course, I’m willing to be shown to be wrong, but in this case, I think there’s a high probability that I’m right.

It's amazing how little attention the post WWII period gets from professional economists. Surely there are lessons there about how robustly the private sector made the transition from war to peace.

It's even evident in movies made at the time. Remember the Dana Andrews character in The Best Years of our Lives finally finding an opportunity in a bomber graveyard that's being salvaged for pre-fabricated housing.

I'm old enough to remember all the Army and Navy surplus stores that abounded.

Greg G writes:

Was Keynes a "Keynesian economist" in this analysis? The man was known to speak his mind occasionally. Are there any quotes at all where Keynes predicts we will require big fiscal stimulus after the war?

Daniel Kuehn writes:

Thanks David. That makes sense. I had always thought of the numerator as the flow, but income minus outlays is not the flow of savings even though its composed of flows. This is, of course, household consumption. Makes you wonder what businesses were doing. I suppose you could also conceive of a paradox of thrift in reverse, although I'm not sure how much sense that makes.

Greg G -
According to Collander and Landreth's book on The Coming of Keynesianism to America he adamantly rejected the idea of a post-war depression in a meeting at the Federal Reserve in 1943. At one point I tracked down a lot of these sources when I was posting on it, but I didn't keep a good enough record. Beveridge in Full Employment in a Free Society, the CDF, some Brookings Keynesians, and several others rejected the idea too if I recall (I really should dig that stuff up again). But the Collander and Landreth book definitely has the note about Keynes. The thing is, in the Harris volume where Samuelson makes this statement, he even makes a point of saying that he is in the minority on this view!

I, for one, don't understand why a Keynesian perspective means that you'd expect a post-war depression. It depends entirely on how the other components of demand respond to the decline in government spending.

Mike Rulle writes:

I also have thought that the post WWII example is appropriate for any time. In real terms, it is hard to believe we did not grow poorer during WWII. Anecdotally, my parents and grandparents all spoke of living within a rationed world. Europe certainly got poorer as it was destroyed. War is never an economic plus (although it may be a necessity). So the US Government negatively saved and we got poorer.

When the war ended people forgot Bastiat and instead remembered Keynes (who unfortunately was too dead to weigh in with his real opinion). Samuelson style fears, which was called Keynesianism, assumed that if the Government did not create demand, no one would.

Talk about ironic. WWII was one big broken window economy and Samuelson feared its end would lead to recession/depression. He forgot his Bastiat----when we stop getting our windows broken we can build other things.

Same is true today----inefficient wealth transference is Government policy.

David writes:

Wasn't the war period a massive eminent domain seizure of supply (raw materials and labor) to enable production of non-durable goods like bombs and bullets? When supply was freed to satisfy new post-war demands, the demand for tools and labor could have increased.
And even if some women remained in the workforce, many of them also started families, with attendant demand for new housing and consumer goods. New families and new housing required new roads, schools and other public infrastructure, largely supplied by state and local government. While federal spending decreased dramatically, what happened to spending at the local and state level, setting aside the interstate highway system?
Pent up war-period demand was the baseline for a new post-war demand curve. We have a different kind of pent up demand now similar to the late 30's, when unemployed individuals didn't have savings or income to bring their demand to the marketplace. Now the most traumatic government budget cuts occur at the state and local level, resulting in decaying infrastructure and reduced education, public safety, and other services, despite no decrease in demand.
The failure of businesses and rent-seekers to use their capital seems to be the real cause of our current problems. What did Keynes or anyone else say about the effect of accumulated, unused capital that is equal to the federal deficit? Isn't it time for a brave business to follow the example of Henry Ford and move some money back into the economy by declaring sizable wage increases for its workforce?

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