World War II and the Economy

With an economic summit planned for December, it is likely that the Obama administration will ask for a second stimulus early next year. Part of the reasoning comes from a group of economists led by Paul Krugman. They maintain that the Great Depression and Japan's Lost Decade happened because the governments had not spent enough money. They point out that spending for WWII reached astronomical levels but just a few years later the national debt was back to manageable levels and the country began a twenty-five year boom. If the government just spends enough money then history will repeat itself.

It would be nice to believe that economics were that simple but there are a number of factors that make WWII unique. Simply spending without these other factors will not produce the same result.

The most obvious factor is that WWII was a war. It had a beginning and an end. By the end of the war the nation was sick of it. There was strong pressure to send the troops back home and get on with life. That put a natural end on the spending. In contrast, Krugman and company are proposing peacetime spending which will be hard to cut once it is established. What starts out as a short-term stimulus will likely turn into permanent programs.

Another factor was pent-up demand. The war years were years of deprivation. No new cars were built and few new houses. Even new clothing was a luxury and food items that we take for granted such as hams and chocolate were hard to come by. With the war over, people wanted these things.

By the end of the war, the US was the only major power to end the war with its manufacturing base intact. In fact, years of war spending had paid for upgrades to American factories. At the same time, Japanese and European manufacturing was in ruins. These other countries had to buy from the US in order to rebuild their own manufacturing bases.

In contrast, we are not experiencing any long-term privation nor are we bombing our competition out of business. No amount of spending in the US is going to dismantle Chinese factories.

WWII was financed by war bonds which were bought by Americans. When the debt was paid down, the money went to Americans who could spend it in the American economy. Our current debt is largely financed by long-term bonds sold to foreign countries. Running up a massive debt today means shipping dollars overseas and draining them from the economy.

When the Great Depression started, the Roosevelt Administration feared deflation. Under normal market conditions, high unemployment should have meant falling wages. The Roosevelt administration kept wages high through a combination of government coercion and union support. This system was finally scrapped during the war and never reestablished. This lowered the cost of hiring new employees. Krugman is advocating the opposite approach today. In a recent column he suggested that the government make it harder to fire or lay off employees. The Democrats have been working hard at raising the cost of hiring with increases to minimum wage and health insurance mandates.

Obviously the huge deficit that the nation ran up during WWII was only a small part of the story. Running up a new deficit and expecting a boom is irrational.