on October 8, 2009
There's a story that most Americans of my and later generations have grown up with. It goes something like this: in the late 1920's our economy spontaneously dropped off a cliff due to an (unexplained) failure of capitalism and free enterprise. Although the situation was initially made worse by the laissez faire ideology of the Hoover administration, from 1933 onward FDR boldly enacted needed government policies to compensate for the inability of free markets to generate full employment and to self-correct. Thus government "demand" substituted for the absence of private "demand" and the grave situation was ameliorated through the 1930's. Then World War II arrived and provided just the Keynesian stimulus the economy really needed to come out of the Great Depression once and for all. Prosperity returned with the War, and America never looked back.
Trouble is, the story is almost entirely wrong. In this collection of essays, all written well before our current crisis-driven expansion in government power, Higgs logically and systematically explodes all of the myths and provides new insights as to how the state response to the Great Depression and Second World War permanently changed both the size and dynamics of government spending in relation to the private economy, and in particular how the larger share of GDP devoted to military spending evolved through the Cold War period.
He starts with the late 1930's and "Great Duration": the question of why the Great Depression lasted so long, much longer than any previous downturn, even ones that were substantially deeper. In fact, it is becoming increasingly accepted in the economics profession (ok, with the exception of DeLong and Krugman) that the policies of the New Deal directly served to prolong the misery.
Higgs' contribution to this debate is his focus on "regime uncertainty" as a deterrent to the private investment necessary to restore genuine prosperity. In FDR's second term, the hostility to private enterprise was turned up dramatically as compared to FDR's own policies in his first term and to his own rhetoric theretofore. Scapegoating of "economic royalists", punitive tax rates, and ongoing battles with both a friendly Congress and an (initially) less-friendly judiciary over expansions of executive power to regulate, and a pattern of ad-hoc policy zigzagging all added up to create a genuine fear for the security of private property rights. In this environment, private capitalists were made reluctant to invest because they could not be certain or even confident in their future rights to harvest the fruits of investment. America appeared headed down the road to fascism. Thus private investment both in real dollars and as a percent of GDP remained below its pre-Depression level throughout the 1930's and through the war years.
Higgs uses contemporaneous survey data to support the thesis that businessmen genuinely feared for the future of free enterprise. The turnaround in opinion seemed to come as FDR shifted his focus to mobilization for the war effort, beginning in 1940. There was a changing of the guard in the Administration away from the "economic planners" and towards the "dollar a year men" who came from private industry with the organizational capabilities to direct the large scale war effort that was approaching. This was a group that was friendlier to business and the focus on war mobilization led to a lessening of the open hostility to enterprise. This changing of the tone of the Administration, combined with a change in control in Congress in 1944 (and the fact that FDR was gone by the end of the war) set the stage for the "Great Escape", the surge of private investment and return to real prosperity that ensued almost immediately after the conclusion of the war.
The poll data provided by Higgs to demonstrate these changes in the climate of opinion are corroborated by the financial markets which began to surge as the war wound down. The regime uncertainty hypothesis is thus consistent as an explanation of both the Great Duration and the Great Escape. The conventional Keynesian explanation that the war pulled us out of the Great Depression by the sheer magnitude of government expenditures cannot explain the postwar prosperity and indeed most mainstream economists at the time were expecting a return to depression following the war.
Of course the conventional Keynesian view (and the conventional civics book storyline) also holds that the war years themselves were a time of great prosperity. The argument usually rests, rather thoughtlessly, on the simple facts of dramatically reduced unemployment and substantial growth in conventional measures of national output. But this superficial view ignores the fact that some 22% of the prewar labor force was pulled into military service in the war years, the majority by conscription. Surely this is no measure of economic well-being. In fact, non-defense employment dropped dramatically.
As far as conventional measures of economic growth, Higgs explains that the statistical data gathered in the war years are virtually worthless as measures of economic well-being. The U.S. in wartime was a command economy, subject to widespread rationing, price controls and, of course, compulsory military service. Thus the national accounts data did not conform to the underlying economic theory behind them. In a command economy, quantities and values do not measure end consumer value, prices do not represent marginal rates of substitution, etc. As anyone who actually lived through the period can attest, the war years were a time of privation, not prosperity.
Higgs shows that the error of relying on conventional measures of GDP also leads to false conclusions about the return to prosperity immediately following the war. Although real GDP conventionally measured dropped in each of 1945, 1946 (by over 20%!) and 1947, private GDP and private investment soared. In addition to the conceptual problems with output data in the war years, some 40% of total output for the period was munitions spending - subtracting such spending from postwar GDP does not seem to represent a step backwards in human well-being. As Higgs says, false boom, false bust.
And the surge in private investment helped provide employment for the dramatically increased civilian labor force. Between 1945 and 1947 the civilian labor force increased by over 6 million, while civilian unemployment increased by only 1 million. The real miracle of the transition years is how quickly the government controls over economic activity were removed, which not only had the direct benefit of allowing the private sector to respond flexibly but also the benefit to confidence that fed the investment boom - the removal of regime uncertainty.
Of course the trauma of the Great Depression and Second World War altered the size, scope and behavior of the Federal government permanently. In this volume, Higgs also shows how the model for defense contracting developed in the mobilization period directly led to the "iron triangle" and "military-industrial complex" of the postwar period, which in turn has resulted in ongoing defense spending orders of magnitude higher than any prior peacetime experience. He reviews the Cold War history of crises, shooting wars and periodic alleged preparedness "gaps" and the associated ups and downs (mostly ups) in military spending of the last 60 years. Some of the descriptions are startlingly familiar:
"In a perceived crisis, public opinion became volatile. Many people suspended their reason, critical faculties, and long-term judgment, reacting emotionally and with heightened deference to political leaders. As Senator Arthur Vandenberg observed when Truman was first attempting to persuade the public to support a policy of containment in 1947, gaining such support required that national leaders `scare hell out of the American people.'"
A little War in Iraq or Troubled Asset Relief Program, anyone?
As a parent whose children have been making their way through the history lessons taught in our secondary schools, I am painfully aware that the conventional view of America's 20th century is well-established and will be slow to give way. But factual, careful and thoughtful analysis like that of which Higgs is a master is the only way to the truth. And we all must hope that truth will prevail.
October 8, 2009