Sunday, 1 July 2012

The reality of the wartime economy

A common story told about the U.S. economy, and many other economies, is that World War II got the U.S. out of the Great Depression and thus a war like effort should act as a model for getting the U.S. out of the Great Recession. Economic historian Robert Higgs is one author who has for many years challenged this view. In a paper published in 1992 Higgs wrote
Relying on standard measures of macroeconomic performance, historians and economists believe that “war prosperity” prevailed in the United States during World War II. This belief is ill-founded, because it does not recognize that the United States had a command economy during the war. From 1942 to 1946 some macroeconomic performance measures are statistically inaccurate; others are conceptually inappropriate. A better grounded interpretation is that during the war the economy was a huge arsenal in which the well-being of consumers deteriorated. After the war genuine prosperity returned for the first time since 1929.
Higgs end his paper by saying
To sum up, World War II got the economy out of the Great Depression, but not in the manner described by the orthodox story. The war itself did not get the economy out of the Depression. The economy produced neither a “carnival of consumption” nor an investment boom, however successfully it overwhelmed the nation’s enemies with bombs, shells, and bullets. But certain events of the war years—the buildup of financial wealth and especially the transformation of expectations—justify an interpretation that views the war as an event that recreated the possibility of genuine economic recovery. As the war ended, real prosperity returned.
Now Steven Horwitz and Michael J. McPhillips join the club of those arguing against such a narrative. They have a paper forthcoming in the "Independent Review" on The Reality of the Wartime Economy: More Historical Evidence on Whether World War Il Ended the Great Depression The abstract reads,
In response to contemporary arguments that the expenditures associated with World War II were a major factor in ending the Great Depression and should therefore be imitated today, we offer historical evidence to suggest that the wartime economy was hardly a model of success in the eyes of most Americans. Expanding on Robert Higgs’ criticisms of the ability of conventional macroeconomic data to tell the real story, we examine newspapers, diaries, and other primary source material to reveal the retrogression in living standards in the US during the war. Our investigation suggests that wartime prosperity is largely a myth and hardly a model for recovery from the Great Recession.
What of New Zealand? Did war expenditure get us out of the depression? It appears not. This piece from Greasley and Oxley (2002) suggests that changes to New Zealand's monetary regime was behind the recovery from the depression here.
New Zealand's recovery from the Great Depression was unusually fast, and was associated with a fundamental shift in monetary regime. The new regime ended the conventional sterling standard, and diminished the influence of the trading banks on monetary conditions in New Zealand. Since the trading banks' operations spanned to Australia, the new monetary regime also decoupled the Dominion's monetary conditions from those across the Tasman. Devaluation and the formation of a reserve bank underpinned the new regime. This article shows that monetary growth in New Zealand was dramatically faster in the 1930s than it would have been had the old regime survived the Great Depression. New Zealand's nominal money stock, measured by M1, fell during the years 1923-9, but almost doubled between 1929 and 1939. The new monetary regime stimulated a recovery from New Zealand's long depression of the 1920s, as well as from the Great Depression. Had the old regime survived, New Zealand's GDP per caput in 1938 would have been around one-third lower.

New Zealand's recovery experience in the 1930s differed sharply from that of other export economies of the periphery, and was based on a new monetary regime that took effect in two stages. In contrast to what happened in Brazil, Mexico, and Australia, devaluation was chosen rather than forced, and eventually associated with a new inflationary regime. Initially, though, devaluation in New Zealand promoted recovery, in 1933, by redistributing income to the hard-pressed farm sector (the 'Copland effect'). Subsequently, during 1934-5, New Zealand's record to some extent mirrors that of the Argentine where the destruction of deflationary sentiments also ameliorated the depression (the 'Mundell effect'). However, New Zealand went much further, by more than doubling money supply between 1932 and 1937, which led to lower real interest rates (the 'Keynes effect').

New Zealand's experience also differed from that of the US, where monetary growth woe initially rapid but was curtailed in 1936 by the Federal Reserve increasing reserve requirements to counter possible inflation. Moreover, the strategy for redistributing income towards farmers in New Zealand did not rest, as it did in the US, on output restrictions, but on monetary manipulation. In concert, the three mutually reinforcing monetary transmission mechanisms, the 'Copland', 'Keynes', and 'Mundell' effects, stimulated powerfully real economic recovery. The growth potential of New Zealand's economy was strong in the 1920s but constrained by a deflationary regime. The Great Depression destroyed the Dominion's old monetary regime, and the new regime promoted a remarkable recovery.
  • David Greasley and Les Oxley, "Regime shift and fast recovery on the periphery: New Zealand in the 1930s", Economic History Review, LV, 4 (2002), pp. 697-720.

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