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World War II Did Not End the Great Depression: Lessons for Today

Friday September 9th, 2011   •   Posted by David Theroux at 5:58pm PDT   •  

In a very timely new article in The Weekly Standard, “The Ultimate Stimulus? World War Two and Economic Growth,” Arthur Herman refutes the Keynesian economics myth that Big Government spending during World War II ended the Great Depression. In so doing, he bases his analysis on the path-breaking work of Independent Institute Senior Fellow Robert Higgs, author of the book, Depression, War, and Cold War: Challenging the Myths of Conflict and Prosperity.

This understanding overturns the hyper-spending views of Paul Krugman and calls into question the basis for the myriad Big Government measures coming out of Washington.

As Washington waits for President Obama’s plan on how to revive the economy and pull us out of our 9 percent unemployment rut, a growing chorus on the left is calling for us to go to war—or at least the economic equivalent of war.

Leading the chants is ultra-Keynesian Nobel Prize-winning economist Paul Krugman, who argues that the only thing that will save the economy now is “a burst of deficit-financed government spending” on a scale like that launched in World War Two. In fact, “if we discovered that space aliens were planning to attack and we needed a massive [military] build-up,” he said on a recent television show, “this slump would be over in 18 months.”

Krugman says this not because he’s a great fan of our military (he’s not) but because he’s a fan of big deficits as a form of economic stimulus. During World War Two, that involved government borrowing to the tune of $30 trillion in today’s dollars—a sum that makes Obama’s 2009 $800 billion stimulus look like pocket change. But since that’s what turned around the economy in World War Two, wiped out 9 percent unemployment, and finally ended the Great Depression, goes the argument, then that’s the scale of spending that is required now.

But did World War Two really end the Great Depression? A growing body of evidence from economists and historians suggests the opposite. Far from turning around the numbers in a burst of government-financed economic activity, the massive mobilization for war may actually have prolonged the Depression, and even deepened aspects of it. And far from setting the stage for the boom of the fifties and afterward, as the textbooks suggest, the economic policies of the war had to be reversed to make way for the postwar boom—yet some of those very policies are being pressed on Obama and the country today.

This flies in the face of conventional wisdom, the evidence for which at first seems overwhelming. The explosive growth in defense spending from 1941-45—from $1.5 billion in 1940 to $20 billion in 1942 and $42 billion in 1944 (or in current dollars, a defense budget roughly eight times larger than the one today)—was accompanied by a similar explosion in GNP, which more than doubled. As America’s factories turned out planes and tanks and other munitions in unheard-of numbers, unemployment plummeted from 9.5 percent to about 1.2 percent even as wages soared far faster than business profits, thanks to a wartime excess profits tax. “Pyramid-building, earthquakes, even wars may serve to increase wealth” by multiplying economic demand across the board, John Maynard Keynes had written in 1936. To generations of Keynesian economists and their students, America’s experience in World War Two seemed to prove it.

Yet those amazing numbers are softer than they look at first glance.

To quote one of the leading skeptics of the Keynesian “multiplier effect,” economist Robert J. Barro, “the data show that output expanded during World War Two by less than the increase in military purchases.” Other measures of economic output in the form of private consumption, private investment, nonmilitary government purchases, and net exports actually fell so that resources could go to military production.

In fact, when you take the government share out of the GNP growth numbers, a very different picture emerges. Economist Robert Higgs has shown that nongovernment GNP growth, which was moving ahead in 1940, actually slowed down in 1942 and then slowed still further in 1943. Far from getting stimulated by the frenzy of government spending, the nongovernment share of GNP recovered its earlier pace of growth only once the war was over.

In short, the war may have killed off a recovery already under way. All evidence suggests that the crucial turnaround from the Great Depression came before U.S. entry into the war: GNP jumped from $90.5 billion in 1939 to $124.5 billion just before Pearl Harbor, when government spending was still at relatively low levels. Then with mobilization, private consumption and investment slowed and headed south—while government deficit spending headed sharply north, rising from $6 billion in 1940 to $89 billion in 1944. . . .

For the full article, please click here.

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September 2011