Skip to comments.World War II Did Not End the Great Depression (Let's dispel ourselves of this recurring myth)
Posted on 06/16/2009 9:47:55 AM PDT by SeekAndFind
Whereas before there had been almost no framework to explain what Roosevelt was doing, now a respectable one was forming. Spending promoted growth, if government was big enough to spend enough. ~ Amity Shlaes, The Forgotten Man
Perhaps as a result of all the commentary suggesting that were in the midst of the worst economic downturn since the Great Depression, theres lots of talk about what led us out of same. Its conventional wisdom that the government spending wrought by World War II ultimately sparked our emergence from the 1930s downturn, but the evidence suggests otherwise.
World War II spending did not stimulate economic spirits in the U.S., but congressional pushback on New Deal legislation, a move toward freer trade and increased output on the part of the American citizenry did. To show why government spending is not the economic stimulant that many economists suggest, its first worthwhile to look at one downturn that occurred before economists were aware of the supposed wisdom of John Maynard Keynes.
1921-1923. Ohio University professor Richard Vedder observed at a Council on Foreign Relations symposium in March that The 1920s downturn, although initially more severe than the Great Depression, turned out to be relatively short and weak precisely because the federal government did nothing.
The research of Chase economist Benjamin Anderson supports Vedders conclusion. Indeed, as Anderson pointed out in his classic Economics and the Public Welfare, the federal government actually reduced spending from $6.4 billion in fiscal year 1920 to roughly $3.3 billion in 1923. And while taxes were reduced, it might surprise many who feel tax cuts are the answer to todays ills that they were not reduced by very much. Tax revenues in 1920 were $6.7 billion and in 1923 they came out to $4 billion. In the crisis year of 1921 the federal government reduced public debt by $300 million, and from June of 1920 through June of 1923, public debt by $2 billion.
According to classical economics the governments non-intervention was the proper response. Government spending is a tax, and the pullback by the federal government left more capital in the private sector to fund real economic growth rather than government consumption. Contrary to suggestions today that monetary authorities must devalue in the face of economic decline, authorities back in the early 1920s made sure to protect the dollar. As Anderson noted, the gold standard was unshaken despite the economic crisis.
So while the 1921 downturn was surely severe, Anderson recounted that by 1923 we had a labor shortage. All of this supports the recent arguments made by my H.C. Wainwright colleague David Ranson, who asked whether you make people work harder by making them richeror by making them poorer?
Ransons answer was that greater work output results more from poverty (or fear of poverty) than from wealth, and this explains why recessions are frequently V-shaped if left alone. Fear of unemployment or poverty makes us more productive, and this same dynamic applies to companies forced to be more efficient in the face of reduced profits. And if governments spend and tax less as an added bonus, there exists more capital to fund the resumption of economic growth.
1933-1934. The early 1920s economic decline shows that economies can naturally heal after a recession. To clarify further why pump-priming by governments does not live up to its billing, its important now to look at what happened from 1933 to 1934. The Keynesian approach to economic growth was now much better known and, most telling, Keynes had met with President Roosevelt to make the case for more government spending.
While theres no way of knowing how much or how little the eminent British economist affected the Presidents thinking, its certainly true that Roosevelt chose to go on an impressive spending binge in hopes of lifting the economy out of its doldrums. Indeed, in early January of 1934 Roosevelt announced that the 1934 federal deficit would be $7 billion. Keynesianism would be tested in the United States.
Roosevelt never achieved his deficit of $7 billion, but it did rise to $4 billion by the end of fiscal 1934. Some might say that Roosevelt failed for not spending enough. But to test that assumption, we need merely ask whether the massive, but not massive enough, spending increase resulted in at least slightly greater economic activity. History says no.
By November of 1933, the Federal Reserves index of industrial production had fallen from 100 in July all the way to 72. Notably the index rallied from 72 to 86 by May of 1934, but as Wainwright research has regularly shown, governments can surely reschedule economic growth through spending and interest rate programs more easily than they can sustainably boost it. In this case, heavy spending on the part of the Roosevelt administration drove industrial production up in the near term, but by September of 1934, the Feds index had taken a round trip back to 71, slightly lower than it was when the spending program began.
The failure of 1930s Keynesian spending should in no way surprise us. Governments can only spend to the extent that they can borrow or tax from the private sector. In that sense, the economic growth that funded the spending had already occurred. To presume that productivity would multiply thanks to government largess is the equivalent of assuming that a thief could aid a convenience store by first stealing $20 from the store, then returning later in the day to spend it. Logic tells us that no stimulation results from money simply changing hands.
At best, there would be a decline in economic activity for the proverbial store owner spending less time selling products, and more time detaining thievery. In much the same way, if governments seek to tax wealth with simple redistribution in mind, the economically productive would spend less time innovating and more time on tax avoidance.
1938 and before. The 1938 elections represented a positive change in terms of Congresss makeup. While the Great Depression was fathered by legislative mistakes in both parties, the gain of seven Republican seats in the Senate and 81 seats in the House of Representatives was a sign that going forward, FDR would experience a great deal more resistance when it came to legislation. Sure enough, the Wages and Hours Act marked what Anderson termed President Roosevelts last successful effort to override a reluctant Congress.
This is important because as history frequently shows, a divided Washington is often the right kind of environment to make bad legislation far more difficult to pass. But up until 1938, most of what came out of Congress was anti-growth, and that helps explain why unemployment was just as high in the late 1930s as it was earlier in the decade.
Looking back to the early 1930s and Herbert Hoovers presidency, J.P. Morgan head Thomas Lamont remarked that I almost went down on my knees to beg Herbert Hoover to veto the asinine Smoot-Hawley tariff. GMs European head, Graeme K. Howard, sent a telegram to Washington which said passage of Smoot-Hawley would lead to the MOST SEVERE DEPRESSION EVER EXPERIENCED. In one fell swoop, Washington shrank the very division of labor that enhances productivity, while the tariffs themselves greatly reduced the size of markets for U.S. firms to sell to.
With deficits in mind, Hoover raised the top tax rate from 25 to 62 percent, and then FDR eventually one-upped him by raising the top tax rate to 79 percent in concert with a reduction in rate thresholds so that more Americans could be ensnared by higher tax rates. Estate taxes were also increased, which meant that the individuals with capital were forced to become careful tax evaders rather than bold investors.
On the wage front, FDR was able to pass the National Industrial Recovery Act of 1933 which, according to Vedder, raised wages in factory employment about 20 percent, thus stalling recovery. This legislation was thankfully killed by 1935, but the Wagner Act followed, and as Vedder recounts, the resulting wave of unionism led to another double digit rise in money wages, reversing the previous unemployment decline. As a result, unemployment ticked back up to 20 percent by 1938.
Perhaps most economically crippling was the passage of the Undistributed Profits Tax of 1936. For corporations with profits of less than $10,000/yr. the tax ran from 10 to 42.14 percent, while companies earning more than $10,000 faced taxes on undistributed profits of 40 to 74 percent. The plan there was to force the distribution of profits through dividends that could be taxed as income, but what it meant in practice was that savings put aside by corporations for future growth or for future economic uncertainty would have to be handed over to the federal government.
When we consider the impact of small businesses on growth and employment, a more economically enervating tax would be hard to conceive. Large, established firms were already paying out dividends as they frequently do today, but this pernicious tax on profits doubtless strangled a lot of promising companies and jobs before they could truly be created. Thankfully this tax was repealed in the early part of 1938.
So while the Wagner Act still weighed on economic growth in 1938, the tide was turning. FDRs court packing scheme had failed, his undistributed profits tax had been repealed, and a Congress previously eager to pass his initiatives was turning against him. In short, a New Deal that gave the U.S. a rate of unemployment in the late 30s that was similar to the one earlier in the decade was winding down. In that sense it could easily be argued that the economy was set to recover regardless of the major war that was looming.
World War II. Mentioned earlier was the conventional account suggesting World War II ended the Great Depression. The basic argument is that government spending employed a lot of people, and the economy grew. But logic tells us that this assumption puts the cart before the proverbial horse. Once again, governments can only spend if they can tax and borrow against productive work thats already occurred. Instead, it would be more accurate to say that a resumption of work combined with a less economically interventionist Washington did the job.
From a stock-market perspective, theres no evidence supporting the conventional claim. While the Dow Jones Industrial Average reached 155 in October of 1939, it never regained that level until 1945, when the war was ending.
On the labor front, unemployment sat at 18.8 percent in 1938, but by 1939 it had already fallen to 16.7 percent. Amity Shlaes observed in The Forgotten Man that FDR knew a war on business and a war against Europe could not happen at the same time, and as has been shown, New Deal legislation so harmful to employment and capital formation was effectively halted by 1938. In 1942, FDR ordered the liquidation of the Work Projects Administration. The WPA employed 2.4 million Americans in 1939, but by June of 1943 the number was down to 42,000.
What seems to have increased national output during the war was the simple fact that Americans were working a great deal more. In this sense we might say the war was superficially stimulative because patriotic Americans felt it was their duty to work. And work they did judging by the increase in hours worked across all manner of industries. While average hours worked in the food products industry was 40 in 1940, by 1944 it had reached 45. In tobacco the number rose from 36 to 42, and in rubber products 36 to 45. FDR asked for income limits, but Congress refused him.
Not surprisingly, the extra work led to a massive increase in federal revenues. While federal receipts were roughly $6 billion in 1940, by 1945 they had risen all the way to $47 billion, an increase of nearly 700 percent. And with patriotism perhaps in mind, 90 percent of federal receipts came from individuals making less than $15,000 per year. Simplified, the government spending that many claim got us out of the Great Depression was only feasible once the government got out of the way somewhat and allowed Americans to work.
It would be hard to argue against the suggestion that the war and a desire to help the government win it stimulated work effort. But the fact remains that the government was only able to spend to extent that Americans in the private sector chose to work more, and were allowed to do so. To suggest that federal spending was the driver of work effort is to ignore the fact that federal receipts rose only when Americans became more productive. The war likely helped, but unemployment was already falling by 1939, and with FDRs legislative assault effectively over with, productivity was set to resume either way.
To assume war is stimulative is to argue for governments that regularly wage wars or massive employment programs. How death and destruction could help any economy has never been explained, plus when the government bids for workers against the private sector, the latter sags due to a lack of human capital. Also, those who continue to suggest that the war drove the economy in ways that the private sector failed to can never explain why our economy didn't collapse once it ended.
The aftermath of World War II. Wainwright publications have long stressed that passage of the Smoot-Hawley tariff was a significant match that sparked the Great Depression. True enough, but by 1944 the tide was happily turning when it came to trade. Put simply, the very legislation that put us on the path to economic decline was reversed in a very substantial way in 1944.
Smoot-Hawley was on its face a protectionist act, as were the responses around the world. The fact that money was unstable in the 30s served to isolate economic activity even more. With the world effectively off the gold standard in the 1930s, economist Judy Shelton wrote in Money Meltdown that through a series of competitive devaluations, nations sought to undercut each others ability to sell their products in world markets.
In that sense the looming passage of the Bretton Woods monetary agreement was highly stimulative, and is arguably the greatest reason that the world economy recovered after the war. Death and destruction wrought by conflict could in no way grow ours or any economy, but resumption of free trade together with stable currency arrangements serving to expand the worldwide division of labor would. As Bretton Woods architect Harry Dexter White observed in 1942, the task of securing the defeat of the Axis powers would be made easier if the victims of aggression, actual and potential, could have more assurance that a victory by the United Nations will not mean, in the economic sphere, a mere return to the pre-war pattern of every-country-for-itself.
Passage of the Bretton Woods agreement in 1944 was a signal to the Axis countries that the economic isolation of the 1930s was to be reversed such that the Allied powers would combine economic growth with military strength. Better yet, once the war was over, the bloc of freely trading nations would grow as they always do when labor is divided based on comparative advantage.
Conclusion. The governmental response to the 1921 economic downturn shows what happens when ailing economies are allowed to heal free of government help. Conversely, the federal governments 1933 compounding of past legislative mistakes shows how ineffective government spending is when it comes to jumpstarting an economy that is unproductive.
The mistakes of the 1930s reveal for us how very unequal government is to the challenge of coping with economic declinerather than being a facilitator of economic growth. Governments are the instigators of most recessions. Its the height of folly to presume that they have the answers to dig us out of them.
By the late 1930s it was already apparent that the New Deal had not worked, and more legislation of its kind ceased. The war years gave us a less economically intrusive government whose relative absence made possible a great deal of productivity once the Bretton Woods monetary agreement was passed. In short, World War II and spending more generally did nothing to end the Great Depression.
John Tamny is editor of RealClearMarkets, a senior economic advisor for H.C. Wainwright Economics, and a senior economic advisor to Toreador Research and Trading (www.trtadvisors.com). He can be reached at email@example.com.
Well, unemployment disappeared overnight and we were at full production.
What a wonderfully apt analogy--Congresscritters and theives.
Thanks for posting this article.
BTTT. Good read
I know the depression was felt by my family until some time during the Korean War. We didn’t have electric lights or running water until 1951.
WW II did end the depression. No matter what this guy says.
Government spending during the War and the War itself did not create a recovery. The War was a holding pattern that took care of the issue of unemployment be removing millions from the job market.
That said, rationing during the War created pent-up demand and the end of the War and re-allocation of resources to the private sector allowed the fulfillment of that demand to create economic growth and recovery.
So, the War IS tangentially responsible for ending the Depression. I understand the author’s point, that GOVERNMENT SPENDING didn’t end the Depression. It’s too simplistic to try to divorce the cause and effect of WWII from the recovery that corresponds with its beginning. That correlation exists for good reason.
Much better to directly attack the premise that government spending ended the Depression than to rail that people don’t “get it” that the recovery had nothing to do with WWII. It did, but not because of government spending.
I can't tell if you are being serious.
Millions of men in uniform are not "employed". Not in the sense that their employment is economically productive. No goods and services are being produced.
More important would be to absolutely dispel the Leftist mythology, the accepted explanation by most, that the heroic FDR’s socialism ended the Great Depression.
You can’t dispel yourself, although you can learn, yourself, to spell.
I was just going to say that. WWII put everyone to work. And I guess in that sense it ended the Depression. The New Deal did not end it. If anything it made it worse.
I was being serious. The military men were not the only people “working”. America broke all production and productivity records. There was no downturn until after the war.
My point was that the bad times were over
In that sense, I'll give WWII credit.
Harry Dexter White? that commie p.o.s.
If you didn’t have electric lights or running water then you lived in what we now call rural America. The TVA and other programs to bring electricity to communities and farms out side of the urban centers had its largest year in 1956.
Even though I live in a city we spent summers in the mountains and there was not electricity in that small town until the early 1960s.
The electrification or lack thereof was NOT due to the Depression
My contention has always been, that WWII ended the depression, not because of Government spending, but because of the men taken out of unemployement and put into service. That level of government employment is not sustainable however.
In that sense, I'll give WWII credit.war on business and a war against Europe could not happen at the same time,
WWII did throttle back the New Deal.
World War 2 was accompanied by full employment under conditions of impoverishment. This was due to a combination of inflation and wage and price controls. These control prevented the increase in prices of wages and products that would normally occur under inflation. This, then, allowed for larger volumes of spending for labor and products, and the purchase of larger quantities of labor and products.
Full employment under conditions of prosperity was made possible only by the return of peace. The restoration of peace made possible a radical reduction in government spending and thus in the portion of the output of the economic system absorbed by the government. It also put and end to the governments massive printing of money.
“WW II did end the depression. No matter what this guy says.”
The main reason the Depression ended with WWII was that Roosevelt and his band of elves were too busy dealing with the war to tinker with the economy. Absent the constant tinkering and intermittent wars on capital waged by the White House the economy recovered on its own.
Economically, the major winners of WWII were Japan, Germany, and America.
Only in the sense that the twenty percent unemployment that had endured through the first eight years of Roosevelt's administration was mathmatically ended by enlistee and drafted military came off the roles -- the economy didn't rebound until full war production was underway.
Roosevelt's personal friend and cabinet Secretary of the Treasury testified (yes testified as in sworn) before the House Ways and Means Committee: "I say after eight years of this Administration we have just as much unemployment as when we started And an enormous debt to boot".
That BFF plaintively told FDR we have been doing all this stuff and made no difference in our country's misery. Henry J. Morgenthau Jr was always an FDR man, but FDR shrugged it off as the true believers in socialism always do.
For some real good economic history read Burton Folsom, Jr.'s book New Deal or Raw Deal which is an economic and policy history of that era.
Smoot-Hawley set the stage and yes it was introduced under Harding and adopted by both parties, but that could have been reformed by fdr at any time and he made that 12% inflation worse and present for a whole generation at near 20% by countless other destructive programs.
War production, both before and during WWII played a part in reenergizing the economy. FDR’s spending did zip to make that happen before we started to support the Brits in the war effort.
A holding pattern was created during the war but after the end of the war and the return of the GIs the tail-end of the depression droned on until the early 50s for many people.
Producing a dead Nazi is both a good and a service.
And while I agree that a man under arms was not directly producing economic goods any more than the policeman on the corner; like the policeman on the corner - his work ensures that economic activity CAN take place.
The economic productivity of Germany went down precipitously once our fighting men prevailed over their fighting men and our planes were dropping bombs on their production facilities.
Mark for later reading.
mark for later.
Explanation: fear of being destroyed motivates a nation to divert welfare spending into massive investment in technology. WWII was not the source of America's new wealth, the resulting new technologies were. How can anyone study the effects of WWII without mentioning the huge amount of new technology that came out of it: computers, jet travel, atomic energy, radar, rockets. That, along with technology investments during the Cold War, is the origin of our modern wealth and lifestyle.
“increased output on the part of the American citizen’ was directly connected to the war and it had stimulating effect for years after the war. That is diffferent from the Keynesian view.
We had 25 cycle electricity at least. Where were you in 51.
We merely moved our unemployed over seas in the form of soldiers.
Nope but they gave up jobs, that other people had to fill. We just moved our unemployed over seas.
We could do that today by sending the millions of H-1B guest workers and illegal aliens home. The airlines have plenty of empty seats.
Northern Maine, two miles from Canada.
We sure could, but unfortunately, we won't, not even if we get attacked. Unless you want to count the four detainees we moved to Bermuda, and put up in a beach hotel on the taxpayer dime.
North East Corner of Oklahoma, Depression didn't end, really got worse after the lead and Zinc mines closed, boomed for a while but everything was rationed, except booze and parties.
...David Ranson, who asked whether you make people work harder by making them richeror by making them poorer?
Ransons answer was that greater work output results more from poverty (or fear of poverty) than from wealth, and this explains why recessions are frequently V-shaped if left alone. Fear of unemployment or poverty makes us more productive, and this same dynamic applies to companies forced to be more efficient in the face of reduced profits.
And if governments spend and tax less as an added bonus, there exists more capital to fund the resumption of economic growth.
The modern state is an engine of death - it kills what it touches.
Great reply by RJS, FDR and his "Stimulus" basically was hiring people to dig holes and ditches. The war distracted them from messing anything else up. Instead of Government bailing out the economy and creating worthless jobs, Government became a customer.
If 0bama wants to help then spend as a customer not as a new owner with investment capital. I have no problem with repairing roads, bridges, etc.. It needs to be done and that kind of spending puts people to work and helps businesses grow. But 0bama wants to take over the road repairing business and be both the customer and the supplier, that doesn't work.
If they wanted to help GM, they should have bought cars, or better yet, have the car companies come up with a replacement for light armor transports and turn some of those plants into making military equipment.
That's what ended the depression.
No, this was the type of recession that always happens after a war.
Is this guy demented? His arguments all point to the conclusion that the war ended the depression, then he ends with a whiplash-inducing denial of that fact.
I have long been amazed that people could become so deluded as to believe that a war could save an economy. Why does no one try to claim that the American Civil War boosted our standard of living? Is it because the answer to that is far too obvious because it occurred on American soil?
Did it help that WWII destroyed a large majority of the worlds manufacturing and the US happened to have a massive and untouched capacity built up during prior to WWII? Didn’t FDR’s building of the TVA power plants and dams allow the US to expand its manufacturing base and help win the war?