Was Keynes Right...Once? (A Bleg)
Chatting with John Stossel yesterday--we devoted an episode of Uncommon Knowledge to his new book, No They Can't: Why Government Fails But Individuals Succeed--I mentioned a question in economics that had always puzzled me. It puzzled John Stossel, too.
We conservatives and libertarians agree that government intervention in the economy tends to make matters worse, not better. During the 1930s, for example, the New Deal did almost nothing to improve the economy, except, perhaps, contribute to a second dip--a depression within the depression--around 1938.
But--and here's the question John Stossel and I puzzled over--what about the war years? As the nearby chart indicates, from 1941 to 1945, GDP per capita grew dramatically. What was the government doing? Well, it was spending massively, borrowing at levels without any precedent in American history, imposing wage and price controls, targeting certain industries for investment, and generally behaving as if John Maynard Keynes--or even (shudder at the thought) Paul Krugman--had been made dictator.
During the Second World War, in other words, Keynesian economics...actually worked.
I'm sure that can't be right. For the life of me, though, I can't figure out what I'm missing.
Can you?
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Comments:
May '11
Re: Was Keynes Right...Once? (A Bleg)
There are many reasons.
First, you are ignoring the distinction between external spending and internal spending. Much spending was external injections (the UK spending money in the US, essentially undoing the trade war of the 1930's). All economists agree that external injections are highly stimulative.
Second, it is internal transfers that are the subject of debate. However, the internal transfers during the war lacked some of the negative effects peacetime transfers have. Wartime tranfers are limited by the war. People may still invest if they believe that they will be able to make money when the war ends. Peacetime transfers create a downward spiral of discouragement.
Third is that War gives certain non-economic motivations to produce. This does not vindicate either Marx or Mao who believed in non-economic motivations.
Fourth, that growth was measured relative to an artificially depressed baseline productivity.
Enough for now.
Edited on April 24, 2012 at 12:56amDec '11
Re: Was Keynes Right...Once? (A Bleg)
Well, every dollar spent on the war was counted as a dollar of GDP, and every soldier killed in the war meant a lower denominator in that per capita figure. That's a place to start. Also, when war broke out, Roosevelt reversed course on a lot of restrictive labour policies, including appointing more moderate (ie. less vehemently pro-union) people to the National Labour Relations Board.
Jul '10
Re: Was Keynes Right...Once? (A Bleg)
Peter,Certainly if the government decided to spend every dollar this year in constructing battleships, it would raise the US's manufacturing output temporarily. You cant spend that much money without some appreciable rise in GDP, however artificial. The question, answered by history, is what happens when that spending inevitably stops. The US would have likely sunk right back into a depression like in 1919 had Truman and Congress not drastically reduced federal expenditure and lessened the war tax burden.
Jun '10
Re: Was Keynes Right...Once? (A Bleg)
I think Keynesians and conservatives are generally in agreement that tax cuts help the economy and higher taxes hurt it.
Conservatives these days take it as an article of faith that government spending doesn't help the economy. I'm not sure why that is. Government often does a clumsy job and spends money inefficiently, granted. But it seems to me the net effect of government spending should indeed help the economy.
The big problem with Keynesian economics is the part that says when the economy is booming government should raise taxes and cut spending. This should accomplish two things:
The trouble is, there's not a government in the world with the self-discipline to actually follow this prescription.
Mar '11
Re: Was Keynes Right...Once? (A Bleg)
I'm no economist, but I'm guessing that in the war years there was a massive increase in the production of weapons of war - that is, there were shovel-ready jobs and stuff actually being manufactured.
As opposed to Mr Obama's stimulus money that went to Mr Obama's friends, without anything actually being produced.
Oct '11
Re: Was Keynes Right...Once? (A Bleg)
Peter,
I think what's missing from this picture is the capitalism, that is, the competition. Yes, Grumman, North American, and others were both designing and building planes for Uncle Sam, but they weren't actually competing with each other. Rather, they were competing with Hitler. GDP rose during the war, but it was due to massive "investment" by that single customer. The reason you often see recessions after the end of a war is that no nation can sustain this kind of thing for very long. Recall that postwar prosperity rested on pent-up demand at home, and lots of new customers oversees (especially where large-scale rebuilding was necessary) that could soak up the industrial capacity American had built during the war. Yet, there was also continued federal spending through the GI Bill, the Marshall Plan, the interstate highway system, and, significantly, the mother-of-all-stimulus programs, the R&D of the Cold War (and its child, the Space Race). Even so, there were major recessions throughout the rest of the century, despite the sustained federal spending. The bottom line is, Keynes may only work for a time, in the absence of true market forces.
Aug '11
Re: Was Keynes Right...Once? (A Bleg)
The industrial surge begun with WWII did not really diminish beyond the war. Korea, Vietnam, the cold War kept the military industrial complex largely intact, so the spending during WWII created jobs that were both essentially permanent and private. Women temporarily filled the workplace void left by soldiers and post WWII, as the soldiers returned, women returned to former roles as wives and mothers. This made the re-absorption of men returning to the workforce less economically disruptive. War spending is pragmatic business – not political. Politically inspired Keynesian spending generally does not create a permanent industrial production, but targets temporary infrastructure – at best an acceleration of necessary projects and a displacement of local funding. At worst, these Keynesian projects target infrastructure that is unnecessary and which require significant future subsidies – light rail, Amtrack, etc. or which is not otherwise economically viable – green energy. These kinds of spending have no future economic value – they either require subsidy or they die. In either case, they are a drain on future economic growth.
Edited on April 24, 2012 at 1:00amAug '10
Re: Was Keynes Right...Once? (A Bleg)
Ah, "bleg"--a handy neologism coined by John Derbyshire. Reminds me how sad I am that he's threatened to cease writing.
Dec '11
Re: Was Keynes Right...Once? (A Bleg)
This kind of like saying that its sound economics to get a dozen credit cards and max them running up a huge debt, and hoping to win the lottery, because once someone won the lottery after running up a huge debt? Thus running up debt = winning the lottery.
overnment spending is like a credit card in that it can cover sudden needs, and it can make the GDP look better than it really is. The problem is and always has been that this needs to be paid back, and if the spending doesnt get you that new job that makes the debt managable you are undone and your GDP is going to be worse than before while you pay it back. We just got really lucky and the entire world blew itself up, aka winning the lottery.
So, if you can predict a worldwide war in which the entire industrialized world will blow itself to smithereens and we can finance half of it to buy our stuff, and then finance a reconstruction that uses our construction and manufacturing gear, sure keynesian economics will work wonderfully for a short term problem.
The words you are looking for are: "In spite of"
May '10
Re: Was Keynes Right...Once? (A Bleg)
One major issue is with the reliability of the data from that period. When you have a command economy responsible for more than fifty percent of the economy, consumer demand is crowded out by government dictates. This leads to metrics that are completely unreliable and do not reflect actual effeciency or the growth of wealth.
For instance, by the end of the war the United States was producing at more than 100% of its capacity. That is, by definition, impossible and rendered even more absurd when you consider millions of abled-bodied men left industry to fight in a war and were replaced by unskilled women and less able-bodied men (whether old or not able to serve in the military).
The metric problem helps explain why we had a drop in GDP after the war ended as well. How did returning millions of men from war, all with saved income and pent up demand, lead to an economic recession? The better answer is what actually happened was consumer demand returned and the weakened bureaucratic command of the economy led to more honest and reflective data. The economy was not in recession; the data was just regaining accuracy.
Oct '10
Re: Was Keynes Right...Once? (A Bleg)
You prepare for war with the economics you have, not the economics you want. Pethokoukis hit the nail on the head the last podcast when he said unless your economic platform includes world war, it doesn't work. When you are fighting for your very existence, what alternative is there but to deserve victory by being the outlying exception to the rule? Or how about this: only in America, and only in a time of sovereign crisis, could such theories be made to work.
Edited on April 24, 2012 at 2:44amFeb '12
Re: Was Keynes Right...Once? (A Bleg)
In short, the money was better spent. Saving the country and the free world, not just pissing it up against the wall to create jobs for the sake of creating jobs. When the war broke out across the globe the answer was clear; real work was needed to be done and all pitched in for the betterment of the country. Actual need rather created need.
Jun '10
Re: Was Keynes Right...Once? (A Bleg)
To be fair to Keynes he never expected never-ending stimulus spending. His idea, at least as I've always understood it, was to use deficit spending to jump-start the economy during a recession/depression. You're supposed to cut spending after the economy recovers, though politicians often conveniently forget this part of the prescription.
It basically the same thing the Fed now tries to do with interest rates: use low rates during recessions to jump-start the economy, then use high rates during booms to keep the economy from overheating. Hit the gas, hit the brakes, repeat.
Nov '11
Re: Was Keynes Right...Once? (A Bleg)
Peter, don't forget that the U.S. had pretty much the only functioning modern industrial sector not under direct attack by a hostile power throughout WWII: our factories could produce at a fever pitch, especially compared to our Allies. The rest of the Western world was consuming more wholly-American produced products than at any time before or since.
Also I'm willing to bet that if you looked at migration patterns you'd see a corresponding move to urban areas from rural areas to meet factory demand in a way that has not occurred in the U.S. since, but has happened in the "rising" economic powers of India and East Asia
This is also a not-insignificant factor in the prevalence of the American industrial machine that gradually went in decline due to the fact that other countries devastated by war began to produce their own products.
Anytime you see something like this, use Occam's razor: is it more likely that Keynesian economics worked just this once, or that other factors masked or counteracted Keynesian economics typical effects?
Mar '11
Re: Was Keynes Right...Once? (A Bleg)
Peter Robinson: During the Second World War, in other words, Keynesian economics...actually worked.
I'msurethat can't be right. For the life of me, though, I can't figure out what I'm missing.
Can you? · · 29 minutes ago
Define "worked". The Federal Government borrowed massive amounts to fuel your GDP "growth" which it repaid by looting taxpayer savings:
This is nothing more than financial repression. If your goal is to maximize extraction of wealth from citizens to the government it "works". If your goal is prosperity for citizens, not so much.
Edited on April 24, 2012 at 1:13amNov '11
Re: Was Keynes Right...Once? (A Bleg)
Joseph Stanko:
...
The big problem with Keynesian economics is the part that says when the economy is booming government should raise taxes and cut spending. This should accomplish two things:
The trouble is, there's not a government in the world with the self-discipline to actually follow this prescription. · 0 minutes ago
Precisely.
Krugman, et al, don't seem believe in Keynesianism as Keynes described it (at least as I understand it), because they don't preach spending cuts during the good times, nor do I remember a big push for tax cuts during bad times (except maybe the SS payroll tax). (Neo-)Keynsianism is just a justification for more taxes and more spending "all the way down," to support their statist impulses.
May '10
Re: Was Keynes Right...Once? (A Bleg)
Peter, Russ Roberts did an EconTalk episode with Valerie Ramey of UCSD, the subject was Keynesian multipliers, and it turns out that the only good dataset available to allow measurement of spending multipliers where you can adequately separate the factors was WWII. The audio, and the transcript summary, are both here. Highly recommended.
The "multiplier" is between .8 and 1.2- in other words, on average, 1, or, translated, "zero net effect". The war years created serious private consumption austerity, GDP per capita was high because everybody was working- we exported all 6 million unemployed men overseas and paid them almost nothing to carry rifles. If you were in the US, you were working and producing, under a wage-controlled regime, so output per dollar of labor could peak as well.
It would be pretty hard not to show a positive GDP effect under such circumstances. Then after the war, pent-up demand caused an explosion in production to serve consumers, as the only industrial country in the world that wasn't virtually destroyed by the war.
Pretty unique situation.
Oct '10
Re: Was Keynes Right...Once? (A Bleg)
I don't doubt that all four of the reasons ctlaw gives are valid, I just don't know enough economics to comment. But what occurred to me is the motivation of the workforce. Judging from the old newsreels, public emotion was keyed pretty high and the results of your labor could save a relative or brother. I don't imagine that that level could be sustained indefinitely, but I'll bet it was a huge factor spurring production.
Jul '11
Re: Was Keynes Right...Once? (A Bleg)
Duane Oyen brings up a good point, regarding multipliers. The other piece touched on here but is part and parcel of the multiplier is that wartime spending is on real, tangible goods - raw materials are purchased, shipped, transformed into final finished goods, and shipped to the nearest military depot for wartime use. This is Keynesian spending in its most pure form - the actual buying of goods. It's not buying a pension bailout for a state that has underfunded its benefits programs to union workers. It's actually buying something. This has a ripple effect (the multiplier) in the economy, as a dollar spent by the USG on procurement is re-spent by the contractors as they themselves subcontract work out (a gun manufacturer buys raw steel, for example).
Paradoxically, for those who think all gov't spending is stimulative, those who would support policies of larger federal spending look aghast at the idea of more federal spending...on defense. If there is an industry that's well-equipped to start building things right now the gov't needs, it's the defense industry - yet no "progressive" ever calls for more tanks, or more jobs for tank-builders.
Jun '10
Re: Was Keynes Right...Once? (A Bleg)
Severely Ltd.
But what occurred to me is the motivation of the workforce. Judging from the old newsreels, public emotion was keyed pretty high and the results of your labor could save a relative or brother. I don't imagine that that level could be sustained indefinitely, but I'll bet it was a huge factor spurring production.
I agree. I think mass psychology is the major factor in the business cycle. When people see on TV every night that there's a financial crisis, or the stock market is down, or we're in a recession, they react. They take fewer risks, save more, spend less, and put off large purchases. Consumer demand plummets. Business executives see this and they get conservative, too: they cut costs, lay off workers, postpone opening new plants and new stores, etc. All of this causes a downward spiral that creates and sustains a recession.
Conversely, when times are good people think they will last forever and take more risks, run up their credit cards, and spend like there's no tomorrow. Eventually they succumb to irrational exuberance, and that leads to a bubble that eventually bursts and starts the next recession.