Saturday, 22 November 2008

What do the new deal and world war II tell us about the prospects for a stimulus package?

This is the title of a guest post by economic historian Price Fishback at Freakonomics. Fishback looks at the issue of whether the New Deal and World War II are good examples of Keynesian stimuli. He makes a simple and compelling case that they are not.

With regard to the New Deal, Fishback writes
Federal spending rose from 4 percent to 8 percent of G.D.P. during the New Deal in the largest peacetime expansion in federal outlays in U.S. history. Yet this was not an example of Keynesian stimulus to the economy. Economists and economic historians have known this for the past 70 years, yet the myth lives on.
Once you take into account the level of taxation, it becomes obvious that the budget deficits of the 1930's were tiny relative to the size of the problems in the 1930s. In fact John Maynard Keynes published an open letter to Franklin Roosevelt arguing that more spending was not enough; the government needed to run larger deficits.

Fishback continues
If not Keynesian policy, what was the New Deal? It was a broad-ranging mix of spending, regulation, lending, taxation, and monetary policies that can best be described as “See a problem and try to fix it.” In many situations the fix for one problem exacerbated other problems. The programs to raise farm prices hurt work relief recipients, while attempts to raise wages and prices contributed to more unemployment, and thus a greater need for relief spending.
Fishback argues that the main New Deal spending programs that might be described as stimulus programs are the relief and public works during the New Deal. With regard to these programs he writes,
How successful were they at stimulating the economy? As yet, the only estimates we have are for the combined effects of the public works and relief programs. Studies that examine their success at the county level suggest that an additional grant dollar per person distributed to a county for public works and relief during the period of 1933 to 1939 contributed to a rise in in-migration and an increase in income per person in the county of about 80 cents in 1939. We should remember, however, that this was during a period when there were huge numbers of unemployed workers available for work. Even during this period, some studies find evidence of crowding out of private employment.
The lesson for today?
Today, with unemployment rates below 7 percent, it is likely that such public-works spending would crowd out a significant amount of private construction.
What about World War II?
It is widely held that World War II was a huge Keynesian stimulus that finally brought us out of the Great Depression. On the surface, the facts seem to fit. The federal government devoted 44 percent of G.D.P. to fighting the war and ran very large deficits. Unemployment rates fell below 2 percent even as large numbers of women entered the work force.

In a series of academic papers, Robert Higgs of the Independent Institute has raised doubts about this rosy picture of Keynesian stimulus. The war economy was a very unusual setting. While running large deficits, the federal government took command over large segments of the economy, allocated a large part of the resources to the war effort, put 15 percent of the working-age population in the military, and established wage and price controls.
He goes on,
One sign that Keynesian budget deficits were not the key to bringing the U.S. out of the Great Depression is what happened after the war. Every Keynesian predicted that the private economy would go into a recession because the large government budget deficits would be eliminated and so many men would be returning from the war jobless. Instead, as government deficits receded, private consumption and investment boomed. Resources were no longer allocated to producing munitions and instead were devoted to production of typical consumer goods and services.
During the 1940s the vast budget deficits that were run by the US government were not a stimulus in the normal sense of the word simply because the US was a command economy devoted to an all-out war effort.

The whole Fishback piece is worth reading.


Unknown said...

The modern U.S. has been shirking its commitment to R & D, as well as infrastructure modernization. As for World War II. The extraordinary insensitivity of economists to basic human values never ceases to amaze me. WWII lowered consumption and increased employment and investment - all those auto plants could produce cars after they stopped producing tanks.
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