The Keynesian World War II Myth
The Theory of Interest (2018)
What is particularly
disconcerting about the situation we face today is that in spite of the
differences between the way in which we survived the recent financial crisis
compared to the disaster that followed in the wake of the Crash of 1929 we
do not seem to have learned the lessons that should have been learned from
the Great Depression, World War II, and the prosperity that followed World
War II. Few people seem to realize that, contrary to the conventional
wisdom, the United States economy did not recover from the Great
Depression. What actually happened was the failure of the private sector to
cope with the crisis that began in 1929 led to the New Deal and eventually
to a government takeover of the economic system during World War II. There
were 8.1 million unemployed in the United States in 1940 and the
unemployment rate (Figure 1) did not fall below 14% until 1941.
1: Unemployment Rate, 1929-2017.
Source: Bureau of Labor Statistics (1), Economic Report of
the President, 1966 (D17).
It was not until 1943 that
this rate fell below the level in 1929, and by then we were fully mobilized
for World War II, and employment in the military had increased by over 8.5
million men and women. And by the end of the war Non-federal debt as a
fraction of GDP (Figure 2) had fallen by 50% from what it had been in
1940 as total debt as a percent of GDP was essentially held constant during
and following the war.
Figure 2: Total, Non-Federal, and Federal Debt, 1920-2016.
Source: Federal Reserve (L1), Historical Statistics of the
(Cj870, Cj872, Ca10), Bureau of Economic Analysis Table 1.1.5.
When we look at what actually
happened during this period of history we find that the Great Depression did
not end until after the institutional changes of the New Deal were in
place, wage and price controls were instituted, the top marginal tax rate
was increased to over 90%, consumer goods were rationed, the production of
consumer durables ceased, total government expenditures (Figure 3)
had risen to 48% of GDP, non-federal debt was reduced dramatically relative
to GDP, and the size of the military was increased by more than the
number of unemployed in 1940.
3: Total Government Expenditures, 1929-2016.
Source: Bureau of Economic
Analysis, Table 1.1.5 and Table 3.1.
This is what it took to end
the Great Depression, and it was the institutional changes that occurred
as a result of the New Deal and World War II—the rise of unions,
adoption of a minimum wage, progressive taxation, government regulation of
financial institutions, the capital controls of the Bretton Woods Agreement,
the dramatic reduction of private-sector debt relative to income, and
government investment in capital projects as well as in education,
social-insurance, and other government programs—that led to the
prosperity that followed the war, not an economic recovery as such.
As a result of these
institutional changes, the economic system that emerged from the New Deal
and World War II was not the system of laissez-faire that led us into
the Great Depression. The economic system that emerged from the New Deal
and World War II was a system with a substantially reduced nonfederal debt
relative to income as a result of the rationing, wage and price controls and
the huge government expenditures that had taken place during the war. It
was a system in which the capital control provisions of the Bretton Woods
Agreement made it possible to keep our international balances (Figure 4)
in check and in which financial regulatory institutions made it possible to
achieve relatively full employment in the absence of speculative bubbles.
Figure 4: Net Exports, 1929-2016.
Source: Bureau of Economic Analysis, Table 1.1.5.
It was also a system in which
the progressive tax structure put in place during the war (which remained
largely intact for twenty years after the war) combined with the rise of
unions, an increasing minimum wage, and the expansion of social insurance
made it possible for the income share of the bottom 90% of the income
distribution (Figure 5) to increase from 54% of total income in 1933
to 69% by 1973 as the income share of the top 1% fell from 16% to 9% of
5: Income Share of Top and Bottom of the Income Distribution, 1920-2014.
Source: World Wealth and Income Database.
The result was a dramatic
increase in the size of our domestic mass markets which led to an increase
in productivity as mass-production technologies and the economic system in
general thrived throughout the 1950s and 1960s.
Not only was the economic
system that emerged from the New Deal and World War II not the system of
laissez-faire that led us into the Great Depression, it was a system
that embraced the “somewhat comprehensive socialisation of investment”
that Keynes had called for in the final chapter of The General Theory
(p. 378) as the government made unprecedented investments in our defense and
space programs; paved city streets, country roads, and built the U.S. and
interstate highway systems; built and improved water and waste treatment
facilities throughout the land along with ports and dams as it electrified
vast regions of our country; expanded social-insurance, regulatory,
educational, public health, and public safety systems along with many other
government programs. As a result of these government investments,
the capital stock grew and unemployment remained relatively low in defiance
of Keynes’ long-period problem of saving for some twenty-five years
following World War II as the government’s contribution to GDP (Figure 6)
ncreased from 9% of GDP in 1929 to 17% by 1950, and to 24% by 1970.
Figure 6: Government Contribution to GDP 1929-2016.
Source: Bureau of Economic Analysis, Table 1.1.5 and Table
And there were no speculative
bubbles that led to financial crises and government bailouts during this
twenty-five-year period as the concentration of income fell with a
negligible international balance , and total debt relative to income
decreased from 157% of GDP in 1945 to 141% in 1950, and had barely increased
to 149% of GDP by 1970 in defiance of the long-period problem of debt.
In other words,
it was the economics of
Keynes’ long-period problem of saving, not the neoclassical economics of
the Keynesians, that was validated by the New Deal, World War II, and the
economic prosperity that followed the war. And the economics of Keynes
was further validated by the institutional changes that occurred as a result
of the policies adopted during and following the 1970s—suppression of
unions, failure of the minimum wage to keep pace with inflation, regressive
tax policies, financial deregulation, the abandonment of the capital
controls of the Bretton Woods Agreement, failure to enforce antitrust laws,
and government neglect of capital projects as well as education,
social-insurance, and other government programs—that came about in an
attempt to reestablish laissez-faire and that led us to where we find
ourselves today, faced with the fallout from Keynes’ long-period problem of
saving as the contribution of government to GDP fell from 24% of GDP in 1970
to 19% in 2007 and stood at 18% in 2016.
At the same time, the
concentration of income rose to levels not seen since the 1920s and trade
deficits to levels not seen since the beginning of the nineteenth century,
and we became overwhelmed by the long-period problem of debt as total debt
relative to income increased from 149% of GDP in 1970 to 349% by 2007
leading up to the Crash of 2008 and was still at 339% of GDP in 2016.
It should not have been a surprise that in the
wake of the institutional changes that began in the 1970s total debt rose to
the unsustainable levels that led to the Crash of 2008 as the concentration
of income increased to levels comparable to those leading up to the Crash of
1929. Nor should it have been a surprise that the system has failed to
recover to its pre recession trends (Figure 7) as it adjusts
to persistent trade deficits and the increased concentration of income in
the absence of speculative bubbles and the failure of debt to increase
relative to income.
Figure 7: Trends in
Real GDP, 1950-2016.
Source: Bureau of Economic
Analysis, Table 1.1.6.
These are the kinds of
results that should have been expected from the attempt to reverse the
institutional changes and “somewhat comprehensive socialisation of
investment” that led us out of the Great Depression and into the prosperity
that followed World War II. Why should any of this be a surprise? After
all, what we are talking about here is an attempt to reestablish
laissez-faire, a system plagued by the same long-period problems of
saving and debt that not only led to the Crash of 2008 and the economic
stagnation that followed, but to the Crash of 1929 and the Great Depression
as well—a world-wide depression that led to World War II.
Blackford (2014a, Chpts. 4 and 6).
See Amy, Bernanke,
Blackford (2014a, Chaps. 1-4, 10-12), Boyer and Morais, Domhoff,
Eichengreen, Friedman and Schwartz, Kennedy, Kindleberger, Lindert, Meltzer,
Perino, Piketty, Polanyi, Shirer, and Zinn.
It is also worth noting that according to Brynjolfsson and McAfee these
“three decades proved to be the best ones of the twentieth century” with
regard to increases in productivity:
Blackford (2014a, Chaps. 1- 4, 6-8, and 10-12), Eichengreen, Kennedy,
Kindleberger, Piketty, Polanyi, and Shirer.