Was the Economic Miracle of World War II Fact or Fiction?

In 1932, the economist John Maynard Keynes made a prophecy: the American depression would last and never end until the nation’s leaders could identify “some object which is admitted even by the deadheads to be a legitimate excuse for largely increasing the expenditure of someone on something!”

Only spending on the scale of total war would do the trick.

“In the past,” he observed, “we have not infrequently had to wait for a war to terminate a major depression. I hope that in the future ... we shall be ready to spend on the enterprises of peace what the financial maxims of the past would only allow us to spend on the devastations of war.”

Many people after World War II would conclude that Keynes had been right.

They would also conclude that only war had ended the depression. The New Dealer Thurman Arnold looked back in the 1950s and asserted that “we did not learn the real nature of our economic difficulties until the tremendous spending of the Second World War pulled us out of our static economy and made us the richest nation the world had ever known.” Economist Alvin Hansen agreed; he wrote in 1957 that “the war put the American giant to work, and once fully employed, we found that we were able to raise our standard of living ... beyond any level previously achieved at the very same time we were fighting a total war. This no one would have believed until it actually happened.”

American Keynesians have been saying something similar for years. Paul Krugman recently argued that Obama’s stimulus was insufficient compared to what it took to bring America out of the depression. “From an economic point of view,” he has written,

World War II was, above all, a burst of deficit-financed government spending, on a scale that would never have been approved otherwise .... But [the] deficit spending created an economic boom -- and the boom laid the foundation for long-run prosperity .... After the war, thanks to the improved financial position of the private sector, the economy was able to thrive without continuing deficits.

But conservatives have contended the reverse: that “big government” and deficit spending will worsen depressions, and that market forces are the antidote. They are skeptical about World War II as a model for economic recovery. Some of them -- Thomas E. Woods, Jr., for instance -- have offered the policies of Warren G. Harding as an alternative: he did nothing in response to a recession that lasted through 1921, and the economy recovered.

So what are we to make of these claims and counter-claims about World War II? Can the economic history of World War II teach us anything?

Throughout the nineteenth century, the business cycle’s convulsions -- the “boom-and-bust” cycle, as they called it -- took the public on a roller-coaster ride through the chain reactions that expanded and contracted the economy. Orthodox economists (the “classical” economists) said that nothing could be done about this; the large cycles of the market, they argued, were natural forces.

But unorthodox economists -- long-forgotten American thinkers such as Daniel Raymond and Henry Carey -- called for intervention by the government. And so did some political leaders in the decades before the Civil War.

After the ruinous depression that followed the panic of 1837, the leaders of America’s opposition Whig Party called for federal “internal improvements” -- roads and canals, what today we call “infrastructure” -- to put the unemployed back to work. Such was the position of Henry Clay, John Quincy Adams, and young Abraham Lincoln when he served as Whig floor leader in the Illinois legislature. But their program was defeated at the national level as the hard times continued. By 1843, the depression ran its course after wrecking countless lives.

In the 1890s something similar happened: in response to a depression that began with the financial panic of 1893, people called for public works programs to create new jobs. After listening to a Populist Party organizer named Carl Browne, a maverick Ohio businessman named Jacob Coxey led a protest “army” of the unemployed to Washington in 1894. Their demand: jobs, to be created through a “Good Roads Bill” that would appropriate $500 million to repair existing roads and build new ones. Nothing was done, and the depression began to lift in 1897, after ruining many peoples’ lives.

Meanwhile, the theoretical conception of “contra-cyclical” spending to reverse depressions won adherents among the economists. The British economist John A. Hobson argued that a shortage of “purchasing power” was the problem; where the orthodox spoke about “overproduction,” Hobson said the true problem was “underconsumption,” and that government spending should replace the lost “purchasing power” that depressions had sucked from the economy. He offered this argument in books such as Work and Wealth (1914) and The Economics of Unemployment (1922).

In the 1920s, the idea began to have appeal. Commerce Secretary Herbert Hoover urged government construction to take up the slack in the recession that Harding inherited. Even after prosperity returned, some observers argued that a shortage of purchasing power -- paychecks were not keeping pace with productivity -- might stultify America’s economy. This was the argument of co-authors William Trufant Foster (the former president of Reed College) and Waddill Catchings (a financier) in their two books Business Without A Buyer (1927) and The Road to Plenty (1928). The latter book promoted public works to supplement the earning power that the private sector created.

At the National Governors Conference in 1928, Ralph Owen Brewster of Maine proposed creating a $3 billion federal-state-municipal “reserve fund” that would serve as a “balance wheel” to propel a contracting economy back into expansion.

Then came the Great Depression. It was true that all previous depressions had run their course, but this one seemed different in its sheer destructive magnitude. The output of durable goods fell from an index level of approximately 100 in 1929 to 24 by 1933. By 1933, one half of America’s commercial banks had failed. Unemployment rose from approximately 1.5 million to 13 million -- roughly a fourth to a third of the full-time workforce -- and nothing seemed to stop the chain reaction. Never before had a depression reached such proportions.

Panic gripped the business community to such an extent that the earliest New Deal measures (especially the Emergency Banking Act of 1933) were shouted through Congress. Conservatives were in full support. Arch-conservative Republican Hamilton Fish told FDR that Congress would provide “any power that you may need.” Alfred Landon (the future Republican presidential nominee of 1936) said that “even the iron hand of a national dictator is in preference to a paralytic stroke.”

The public works projects of the early New Deal kept the Great Depression contained. But the job-creating potential of New Deal agencies like the Public Works Administration (PWA), the Tennessee Valley Authority (TVA), and the Civilian Conservation Corps (CCC) alleviated only a third of America’s unemployment.

The situation was roughly comparable to our “jobless recovery” today. Dim sales expectations kept businessmen cautious: why should they take the risk of borrowing when manufactured goods would gather dust in warehouses? As economic historians Lester S. Levy and Roy J. Sampson observed, “so severe was the depression that sound business people were reluctant to borrow and banks were hesitant about lending to the daring entrepreneurs who solicited loans.”

In 1935, FDR made a second attempt to jump-start the economy. He proposed a significant new public works project that Congress approved: the Works Progress Administration (WPA). Things began to pick up, and so Roosevelt -- hopeful that the private sector could start to take over -- slashed funding for the program in 1937. The economy took a huge plunge that was called the “Roosevelt Recession.” By 1939, things were almost as bad as they had been back in 1933, when the New Deal was launched.

All of this changed during World War II: full employment was finally achieved. And it happened due to government spending that soared from the level of $13.3 billion in 1941 to $34 billion in 1942 to $79.4 billion in 1943 to $95.1 billion in 1944 to $98.4 billion in 1945. New Deal job-creation spending had never exceeded $5 billion in any given year. But the spending that was used to defeat the Axis was immense.

The before-and-after comparison was obvious. Historian David M. Kennedy has written that “the war did not merely banish the decade-long scourge of unemployment. It also provided jobs for the 3.25 million new job-seekers who reached employment age during the conflict, as well as to another 7.3 million workers, half of them women, who would not normally have sought work even in a full-employment peacetime economy.”

Kennedy quoted the reminiscences of Americans who could speak from first-hand experience. A shipyard worker in Portsmouth, Virginia, said that

going to work in the navy yard, I felt like something had come down from heaven. I went from forty cents an hour to a dollar an hour .... At the end of the war I was making two seventy an hour .... I was able to buy some working clothes for a change, buy a suit ... It just made a different man out of me.

A native of Portland, Oregon recalled how the war changed his family’s existence:

For the first time we began to have money .... You started to think you could do things. We used to go out to a restaurant now and then, where we would never do that before the war. We hardly ever went to the picture shows during the Depression; now I did all the time .... My mother saved enough money to buy a modest home. That was the first home we ever bought.

Such comparisons led to a decisive policy verdict. It took the form of the Employment Act of 1946, which vested the federal government with permanent responsibility for guaranteeing high levels of employment. As early as 1944, Republican presidential candidate Thomas Dewey declared that “if at any time there are not sufficient jobs in private employment to go around, then government can and must create additional job opportunities because there must be jobs for all in this country of ours.”

This was the economic lesson of World War II -- a lesson in conceptualization that was based upon direct experience -- a lesson that is now so distant that only dwindling numbers of elderly Americans can haltingly recall its details (if anyone will listen).

This lesson was applied through the decades following the war. As John Kenneth Galbraith observed, much discussion in economic circles was focused in the forties and fifties on the issue of how “wartime employment, output and achievement could be made to last into the peace.” The most significant result was the Interstate Highway System of Dwight D. Eisenhower, set up in response to a recession in 1954. Two years later, journalist Robert J. Donovan recounted in Eisenhower: the Inside Story the instructions Ike gave to his cabinet:

The President informed the Cabinet that he had asked [Arthur F.] Burns to co-ordinate reports from the various departments and agencies on their plans for public works projects. It would be essential, he said, to have planning advanced sufficiently to insure that men would be put to work quickly. Too often, he said, preliminary planning, testing, and surveys delay start on work .... Projects actually under way, he noted, gave the government flexibility in speeding them up or stretching them out, as conditions required.

Ike -- who in 1944 had been supreme commander of the largest invasion force in all of recorded history, the invasion armada of D-Day -- understood by his presidential years the economics of abundance and the role of government in fostering abundance. He too had been affected by the back-to-back experiences of the depression decade and the wartime super-mobilization.

The earlier proponents of job creation by government seemed vindicated at long last by the 1950s. But the man who got the credit at the time was John Maynard Keynes, whose teachings became broadly institutionalized under the rubric of the “New Economics.” The middle class was prospering, unemployment was down, and the profits of corporate America were highly satisfactory.

Today, of course, this historical lesson is contested. As early as the 1970s, Keynes was displaced by conservative economists such as Milton Friedman and Arthur Laffer. In 1978, a Laffer acolyte named Jude Wanniski argued in The Way The World Works that “the supply of goods creates a demand for goods” (hence “Supply-Side” economic theory). Wanniski denounced as false the “alternative idea that has dominated Western economic thought for forty years, the notion that demand for goods creates its own supply and that demand for goods can be increased through the purchasing power of individuals.”

Simultaneously, the role of World War II in creating the postwar boom was contested by people like historian Robert Higgs, who wrote that

the war had taught the American people many lessons, some true, some false. Of the latter sort, a leading example was the Keynesian illusion .... The notion that wartime “full employment” had resulted from the huge federal deficits was false. Quite simply, unemployment fell mainly because of the buildup of the armed forces .... Any government that can conscript prime workers by the millions can eliminate unemployment.

But this reasoning is rather hard to follow. Though Higgs acknowledged the obvious achievement of full employment in World War II, the financial method that was widely believed to have created this result -- the Keynesian method of deficit spending -- was, according to Higgs, an “illusion,” since employment resulted from the sovereign power of the state to conscript prime workers. But unless these workers were to serve without pay, some method of paying for the war -- whether deficit spending or revenue from taxes or another alternative method, such as Civil War-style money-creation via “Greenbacks” -- would have to be used.

As it was, our financial method during World War II was a mixture of taxes and deficit spending. According to economic historian Allen H. Meltzer, FDR’s treasury secretary Henry Morgenthau “wanted to finance 50 percent of the war through direct taxation” and “came close” to achieving that goal. The rest was financed through deficit spending: bonds that were sold by the Treasury Department through eight successive bond drives.

There is no way around the proposition that World War II brought full employment to America.

But the issue to consider at the moment is the question of whether Americans will ever find a way to “spend on the enterprises of peace what the financial maxims of the past would only allow us to spend on the devastations of war.” Upon that question the fate of our nation may depend in the immediate future.