David R. Henderson  

The U.S. Postwar Miracle

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Co-blogger Scott Sumner posted yesterday some interesting facts and figures about the post World War II economic boom in the United States that came after the U.S. government cut government spending massively.

I wrote a study on this for Mercatus in 2010 and highlighted some of the findings in this post in November 2010.

Two things I want to highlight.

First, as I wrote then, "federal government spending on goods and services fell, in a period of two to three years, by over one third of GDP." That puts in perspective Gary Johnson's proposal to cut government spending by 20 percent. A 20 percent cut in federal government spending, when government spending is about 20 percent of GDP, is a 4-percentage-point cut in government spending as a percent of GDP. In other words, Johnson proposes to cut government spending as a percent of GDP by about one eighth of the percent by which Truman and Congress cut it in 2 to 3 years.

Second, I want to answer the question raised by one of the commenters who said:

Real GDP declined an unprecedented 12.7% from 1944 to 1946. Hardly "fine".

I answered this point at length in my Mercatus study. Here's an excerpt from my answer:
According to official government data, the U.S. economy suffered its worst one-year recession in history in 1946. The official data show a 12-percent decline in real GNP after the war. A 12-percent decline in one year would fit anyone's idea of not just a recession, but an outright depression. So, is the story about a postwar boom pure myth?

If you ask most people who were young adults in those years (a steadily diminishing number of people, so talk to them soon) about economic conditions after the war, they will talk about "the postwar boom." They saw it as a time of prosperity.


The same commenter, Ben, wrote:
Sure, unemployment didn't increase substantially at all which was likely due to a high demand for workers as women returned home and left the workforce again.

I answered this in some detail in my Mercatus study also. I called this the "Rosie the Riveter Goes Home" explanation. It turns out that half of the additional women who entered the work force during WWII did not go home.

Here's what I wrote in the study:

"There was no surge in unemployment," goes the first explanation, "because women left the defense plants and went back to being housewives and raising families."

This explanation is half true and totally misleading. First, approximately half of the women who entered the labor force in the early 1940s stayed. The number of women in the labor force rose from 14.5 million in 1941 to a peak of 19.4 million in 1944, declining to 16.9 million in 1947. In other words, of the 4.9 million women who entered the labor force between 1941 and 1944, 2.4 million stayed in the labor force. Thus, there was still a need for millions of jobs to open up for newly demobilized male soldiers. The fact that the unemployment rate stayed in the low single digits is an outstanding success story.

Second, what defense plants? Almost all of them shut down or reconverted to peacetime uses after the war. Women who wanted to stay employed had to find other private work. As [Robert] Higgs points out, "[T]he real miracle was to reallocate a third of the total labor force to serving private consumers and investors in just two years."


UPDATE: Scott Sumner posts further on the employment numbers.


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COMMENTS (9 to date)
Bill Conerly writes:

So GNP went down when we didn't need to build as many guns. I think building fewer military guns is good. Look at consumer spending, throw in private investment as a provision for the future, add in non-defense government on the theory that some of it is useful, and what do you get? The welfare of the people improved even if GNP went down. Oh, and maybe consider that freedom improved by fewer people being drafted and killed.

Is this reproducible? A 20% budget cut centered on defense cuts from reduced war in the Middle East sounds good to me.

David R. Henderson writes:

@Bill Conerly,
Is this reproducible? A 20% budget cut centered on defense cuts from reduced war in the Middle East sounds good to me.
It is reproducible, but not the same way as after WWII. The government had few forced transfer programs then. Social Security was small; Medicare and Medicaid were non-existent. If you got the U.S. government out of the Middle East, you might be able to cut spending by about 0.4 percent of GDP.
So to get to a 20% budget cut now would mean cutting Social Security, Medicare, and Medicaid by, say, 10%, which would be politically shocking, cutting defense by 30 or 40%, and cutting a lot of other programs by 50 to 100 percent.
The good news, as Dan Mitchell of Cato has pointed out a number of times, is that you could get to a balanced budget with no tax increases if you cut federal spending in nominal dollars by about 1 percent a year for about 8 years.

genauer writes:

when I look at US and UK GDP data,
there are no miracles, just getting back to normal after a negative shock in 1930, and a "positive shock" with WWII output, second shifts, more women than trend in the workforce for a time

GDP history
http://de.slideshare.net/genauer/sampler-2-of-imf-2014-weo-data-plots
page 8 US and 9 UK

and US economists and Bank of England sources cited there

Pajser writes:

Acccording to Maddison's data, US GDP (PPP) per capita was 11709 (1990) Intl.$. in 1945, Then 9197 in 1946., that's that big drop you talk about. However, in 1949, it was 8944 Intl.$., -3% compared to 1946, it is not miracle. What's your data for 1946-49 GDP (PPP) per capita, David Henderson?

Assuming that Maddison is right, only unemployment part is left. But it is not mystery either - most of soldiers returned on jobs they had before the war. When soldier goes to war, he is typically not fired. It is psychologically bad for soldiers to be under this kind of pressure, beside risking their lives.

And those who replaced them during war? Partly no one, partly women, partly elderly prolonged their retirement. When soldiers came back on their jobs, old people retired, half of women went home, and other half was kept at job, perhaps with some temporary loss for employer, but they were sort of war heroes too and they were not fired either. Employers saw that will happen from the first days of war, and they were prepared.

Philip George writes:

The reason there was only a "technical recession" was that the saving rate fell by half after the war.

The mechanism has been described in my book "Macroeconomics Redefined" http://www.amazon.com/dp/B00ZX9O5XQ and touched upon in passing in http://www.philipji.com/item/2016-01-16/did-japan-really-lose-its-lost-decade

Thaomas writes:

You seem to leave out the point that what the government cut spending on was useless (to consumers) military spending and the Fed did not have a 2% inflation ceiling. Under such conditions, the results were hardly miraculous.

Thaomas writes:

The good news, as Dan Mitchell of Cato has pointed out a number of times, is that you could get to a balanced budget with no tax increases if you cut federal spending in nominal dollars by about 1 percent a year for about 8 years.

Why is a zero budget deficit or no tax increases good things? I think that good cases can be made for lower expenditures on some things -- farm subsidies, the military -- and higher expenditures on other things -- national parks, NASA. Different people will have different lists.

Other good arguments can be made for lowering some kinds of taxes -- business and personal income taxes and wage taxes that finance Medicare and Social Security -- and increasing others -- progressive consumption tax and taxes on CO2 emissions and other externalities.

Will all these reordered taxing and spending decisions add up to a zero deficit in any particular year? I do not see why.

The deficit (federal state and local) comes into this scheme, as I see it, because expenditures that have future benefits and present costs have to pass a NPV test and when, for business cycle reasons, (I do not assume that monetary policy can totally avoid macroeconomic fluctuations) interest rates are low and many inputs into investment projects will have marginal costs below their market prices, this will push investment up and vice versa. (I suspect there ought to be a discount rate in at least some tax optimization functions, too, but I do not have a clear idea exactly how that works.)

I’m pretty sure that this framework would not lead to ever higher or lower deficits, but I doubt that it would lead to zero as the long term path, either.


Jon Murphy writes:

@Thaomas

Different people will have different lists.

And here we have the perfect explanation on why cost-benefit analysis cannot be done at the macro level. And why it's easy to grow government, but not to shrink it. And why finding government programs that benefit no one is impossible to do.

Phil writes:
Is this reproducible? A 20% budget cut centered on defense cuts from reduced war in the Middle East sounds good to me
.

Sounds impossible if you look at the facts. The FY2016 federal budget estimated that in 2017, federal expenditures would be $4,147 billion. 20% of that is $830 billion. Estimated outlays for national defense: $617 billion.

Contrast that to 1945 when defense was $83 billion of a federal budget of $93 billion.

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