The Myth of War Prosperity

0:00You know, the mainstream economists pretend that they know how to forecast. A lot of mainstream economists actually call themselves forecasters and they purport to know what's going to happen in the future. But actually, the Mises Institute knows what's going to happen in the future. And I'm going to prove it to you because this morning, when I went to breakfast in the hotel I picked up USA Today, not because I regard this as the paper of record, but because it was there and I picked one up and the headline reads 150 billion dollar insurance policy aimed at shaky economy and the subheadline says stimulus seeks to prevent recession.

0:57and I'm sure if you've been following the news lately you've already heard about all of this discussion going on in Washington DC in which the government is figuring out how to stimulate the economy and we're used to this kind of talk so very few of us probably are startled to say stimulate the economy I've never heard of the government doing that before in fact If you're my age or younger, this is the kind of talk you've heard and seen in the news for your entire life. But there was a time, not so long before my generation, when people would have been brought up short by that idea.

1:45They would have said, what do you mean, government stimulate the economy? How can the government stimulate the economy? Wouldn't have made any sense to people once upon a time that that government had the Knowledge or the ability to do any such thing Of course whenever the government promises to hand out money a lot of people immediately favor the program And this time of course they purport to have a program that's going to give all of us or nearly all of us Some money so that promises to get a lot of support of course But a friend of mine a few days ago likened this stimulus program to the idea that you're going to dip water out of the deep end of the swimming pool and dump it in the shallow end and you do this with the expectation that the water level is going to rise.

2:52Now my old friend Walter Block has been defaming these Chicago economists and once upon a time I taught for years at the University of Washington with many colleagues from the University of Washington and so I want to say a kind word on their behalf. One of the things they used to always ask whenever we had a lecture or seminar on macroeconomics that would often boil down to this kind of stimulus proposal at the end, these Chicagoans would always say, where does the money come from? And it was an excellent question because if you ask about these stimulus proposals, where does the money come from, you immediately begin to see the fallacy of the idea that simply by spending money, even a large amount of money, the government can stimulate the economy.

4:00Now, some would say, of course, your old-fashioned Keynesian would say, well, it's not really like taking water out of the deep end of the pool and dumping it in the shallow, because In fact, the government is going to take any money out. It's just going to dump money in, because the government is going to not tax anybody anymore. It's going to pay for these stimulus payments by increasing the government deficit. So it's not going to take anything away from you and taxes, it's just going to borrow more money and that won't cost you a dime, will it?

4:46Well, that's the idea behind Keynesian economics that when the government runs a deficit, it can just create real income out of thin air just by spending the money, which otherwise presumably would have been put in mattresses or never come into existence in the first place. Now, if you ask yourself, how is it that we came to be in this country a people who, for several generations, have taken this stimulus talk for granted, you could say, well, it's Cain's fault. He wrote this book, The General Theory of Employment, Interest and Money, in 1936, and he had all these bad ideas, and economists picked them up and made them the and the focus of their study for decades thereafter and while they were doing that, they spilled over onto journalists and other opinion leaders and they became sort of the common lore by which politics is carried out in this country.

5:53But I don't think that's quite how it happened. Not that that didn't occur. Yes, the mainstream economists did absorb Keynesian ideas and for several decades, they were very influential in the economics profession. But I don't think that's how the general public and the journalists and other opinion leaders really came to embrace this idea that the government can spend money, especially spend money while running a budget deficit and somehow stimulate the economy, me raise it from recession or prevent it from going into recession as they they now pretend they're doing I think actually the way people came to embrace this sort of thinking was as is normal based on an interpretation of history and that's what I'm going to talk to you about today there's a fallacy that war War creates prosperity, and the reason in this country so many people subscribe to that fallacy is not because they've thought it through and realized that war creates death and destruction and waste of resources rather than creation of wealth. The reason they think

7:14that is that they've all been told, or if they're old enough, they recall that for a A decade or more in the 1930s, this country wallowed in a deep depression, the worst in its history, and that eventually it came out of that. And what got it out? As the saying goes, the war got the economy out of the depression. And not only is that a belief that ordinary People subscribed to, but to this day, most economists subscribe to that. When I started writing seriously about this topic almost 20 years ago, I started out by looking at what economic historians had to say about this episode of our history. And I went back and I found in the first article I wrote on it, about 12 or 13 citations from leading The War Got the Economy Out of the Depression

8:44Profession, and the editor interviewed all these people and one of the things he asked them was what got the economy out of the depression and practically every one of them said the war got the economy out of the depression. These are people that included several Nobel Prize winners, including Paul Samuelson and a number of other people, including Milton Milton Friedman emphasized that it wasn't just government spending but it was also the big increase in money supply that the Federal Reserve brought about during the war but he basically with that proviso agreed that the war got the economy out of the depression.

9:34Now I've been actually teaching for 30 years or more that that's wrong. First of all, the war didn't get the economy out of the depression, certainly not in the way people think, because they think there was prosperity during the war. And what I've been trying to show people is that even if you accept all the standard forms of evidence that economists use to make their arguments, the evidence is not consistent with that idea. And there are many other problems, I'll touch upon some of them as I go along today, but I've actually pulled together some of my more important writings on this subject and those writings form the first half of a book Lou mentioned called Depression War and Cold War.

10:26It was published last year. So if you want to follow this and see some of the details and the historical evidence, I invite you to have a look at that book, and I hope it will convince you that I'm not a crank, as Walter said. You know, we libertarians or Austrian economists are constantly having to fight the indictment of being cranks and of not knowing what we're talking about. I didn't start out as an Austrian economist. I was trained in a mainstream university, a very good one in the usual way, and I only came to my beliefs over a long period of time of examining them and holding them up against what I learned from Austrians such as Mises and Hayek and others over the years.

11:23So I think I do know what I'm talking about, and I think my book will attest to that, so I invite you to have a look at it. Today I want to just go through some of the highlights of what happened to convince people at the time. Now, here in the chart that I've put up is a very long-term view of the growth of the U.S. economy. You can't see this very well, so I'll tell you what it shows. It really starts way back in 1869 and runs all the way up to the 1990s. Now, it shows the real gross domestic product for the United States.

12:11And the remarkable things I want to call to your attention are these. First of all, by and large, this chart just shows steady, long-run growth. The American economy has been growing fairly rapidly since actually the early part of the 19th century. And most of the time, it grows not perfectly regularly, but with slight ups and downs, it continues to grow year after year. There are reasons for that having to do with the institutions that became established, such as reasonably good private property rights, most of all, but at all events, that's the long run record.

13:01Now, you'll see that this is a record that extends right up to the present, basically, and in all of our history, there are only two large deviations. One is the big negative deviation that fills up the entire decade of the 1930s where the economy dips drastically below its trend line and then it recovers and in this chart it looks as if it's sometime in the early 40s it's back on its trend line and then it shoots way above its trend line and it has a big bulge during the World War II years and then it falls falls back at the end of the war and if you didn't know about the Great Depression in 1946, you've all heard of that, right, the Great Depression in 1946?

13:53Well, you should have because here it's plainly shown right here on the chart using the data that all mainstream economists rely on for their macroeconomic theorizing. That drop in real GDP from 1945 to 1946 was the largest single-year drop of income in American history. And that's why you've all heard about the great suffering of 1946 and the people who were dying in the streets. And, of course, that was all caused by capitalism. So there's something wrong here, I suggest. There's something badly wrong. Now, this is a chart that shows the rate of unemployment in the American economy from 1890 to 1990.

14:57Thank you, Walter. And as you can see, the unemployment rate tends to be about 5% in our economy, sometimes higher, sometimes lower. And there have only been two times in our history when it got substantially higher. One was in the 1890s when there was a period of several years of depression. but that ended by the 1897, 98 or thereabouts but the other, the one that really stands out in the chart is of course in the 1930s when the unemployment rate rose well above 20% and according to the standard figures it became as high as 25% in 1933 so unemployment rates were very high in the 1930s and that's the principal thing that everybody thinks about when they think of the Great Depression. Of course, real income fell drastically and many other measures of economic well-being deteriorated during the 1930s, but the thing that really struck hardest was this massive unemployment. And not only were nearly a quarter of the workers without jobs in the early 30s, but probably a third of those who still had jobs

16:21were working reduced hours and virtually everybody was living in fear of becoming unemployed even if he wasn't at the moment so it was a really horrifying episode in American history nothing had ever happened like that before and fortunately nothing like that has happened since but it made a huge impact on people at the time who lived through it and even carried forward to their children into the next generation and had many effects. I can't talk about all of them today, but it has an effect you can still see to this day. If you look at people who came to maturity during the Great Depression, those people were marked for life and they're very old people now, but you can see if you sample their attitudes about government involvement in the economy They are the cohort most favorable to government intervention, and this has much to do with their experience in the Great Depression.

17:32Now, before the 20th century, if you had said to somebody, war causes economic prosperity, they would have thought you were a lunatic. People knew perfectly well that even though there may be some suppliers to the armies that make money from war, and the undertakers do well, that war is a destructive thing, that it saps resources, that it wastes resources, that it's a horrifying thing economically as well as personally, there's nothing good to be said about it unless you are a very special bloodsucker If you are a merchant of death, okay, then death is good for your business. But otherwise, war is a bad thing.

18:23It's only in the 20th century, and particularly it's only since World War II that in any serious way, this notion of wartime prosperity has resonated with the American people People and to some extent with people in other countries too. And the reason is because of this idea that the war got the economy out of the depression and to some extent it got other economies in Europe and elsewhere out of the depression as well. So war has come to have this this aura of being at least perhaps a good thing and I've noticed in my life every time we're at the onset of of a War, there's always a rash of articles in the business press and elsewhere saying, you know, will this be good for business? You see that every time the U.S. goes to war, is this going to stimulate business? Is this going to help the economy? Is it going to drive down unemployment? And what we're seeing there is the grip that this fallacy has on

19:32for Some People. Now again, particularly for those of you in the back of the room, you may not be able to see very clearly what's going on in this chart. So I'm going to call to your attention the certain outstanding features of it. If you look at the civilian unemployment rate, which is in the fourth column, you see that in fiscal year 1940 it was 15.7 percent.

20:20So even after more than a decade of depression, the unemployment rate was very high, so obviously the New Deal had failed to get the economy out of the depression if after all of the improvement that it claimed to have brought about, we still had almost 16% unemployment according to the official measure of unemployment. Unemployment. Now, we'll note that the official way of measuring unemployment counted millions of people who were working in government emergency employment programs as unemployed. And if you didn't do that, if instead you counted them as employed, then the unemployment rate would have been about five points less. But nonetheless, unemployment as the decade of the 40s began, was in the neighborhood of ten percent. Now what happened is that after that it fell very rapidly and and you can see that that by 1943 it's only three percent and then for the next couple of years it's only about one percent and these are the lowest rates of unemployment ever measured in American

21:34economic history and anybody who knows about the labor market during World War Number two can tell you that in fact there was no unemployment during the war. Anybody who wanted to work could get a job almost immediately and the only reason anybody was out of a job was because he was moving from one job to a better one. So there's no doubt that unemployment disappeared as any kind of a problem whatsoever and in fact employment was ample during the war. Now, can we then conclude that it's true, the war got the economy out of the depression? Well, not exactly. That is, what we're seeing here is not the reduction of unemployment that we would normally see in a business expansion.

22:28And the way to see that is to look at another column, the third column, which is defense employment. And that shows the percent of the total labor force that was in defense related employment, either in the armed forces or civilian employees of the armed forces or working in arms supply industries. You'll see in fiscal 1940, less than two percent of the total labor force fell into that category. The armed forces were very small in 1940, only a few hundred thousand people in the Army and Navy together, a handful of people in the arms industries, a handful of people working for the War Department and the Navy Department, so they didn't amount to much, not even 2% of the total labor force, but that figure rose very quickly starting in 1941, 1941, and you'll see that by the peak years of the war, for about four years, close to 40 percent of the American labor force was either in the armed forces, and that's about half of that category, or in the arms supply industries or civilians working for the armed forces.

23:52What we have is a huge drain of people into military related employment during the war. Now, one way they got them, of course, was simply to offer them jobs, and so people would go take a job at the Pentagon as a secretary or somewhere else in a regular job, working in war related activity, but what all these people were doing was working in some capacity to support the actual armed forces, and the actual armed forces went from the few hundred thousand I mentioned a minute ago to more than 12 million men and women, almost all men, by 1945. And how did that happen? It happened because more than 10 million men were drafted, and of the other six million who served at some time in the armed forces but had enlisted voluntarily, many of them actually joined because they wanted to join before they got drafted.

25:00If you waited to get drafted, you might well find yourself in the infantry where life was going to be unpleasant at best and fatal at worst. So many men decided to jump the gun, as it were, and join before they got drafted and stuck in the infantry. So basically the armed forces during World War II, despite all the patriotic sentiment that existed at the time, the armed forces were built up overwhelmingly by coercion, by forcing men into the armed forces, by giving them a choice of entering the armed forces or entering prison. Well, that's not normally how we reduce unemployment in this country.

25:51And if you think, well, this is a good deal to get rid of unemployment, I think you need to ask, well, doesn't it depend on how we get rid of unemployment? If we get rid of unemployment by taking a lot of innocent men and threatening them with violence and imprisonment if they don't do as they're told, That's not quite what we think of as a business cycle expansion.

26:20Now the remarkable thing you see when the war ends, the armed forces were disbanded very quickly. In the first year after the end of the war, about 10 million or so of the 12 million then in uniform were released from service, and then a few more in the following year. So the armed forces were drastically reduced in 1946. And you see that in the figures here. By 1947, that defense-related employment has fallen back to 5% from 40. So this was a drastic cutback in the thing that had reduced the unemployment.

27:07But look what happens to the official rate of unemployment in the next column, it only goes up to 3.8% maximum. Nowadays, 3.8% would be regarded as superheated economy, right? But in this Great Depression of 1946, unemployment never got above 4%. That's because, of course, there was no Great Depression. and what there was, was just a cut back in defense employment and production. So let's go next to that and have a look.

28:04In this chart, we have several different measures of military output as a percent of gross national product in the 1940s. And what you see is that military output was a trivial part of the American economy's production before the war. One percent or so, one to two percent, rose very rapidly during the early years of the war and then leveled up at approximately 40 percent or more of total output during the peak years of the war. So the economy was very, very heavily focused on military production during those years.

28:53And that's what produced that big bulge you saw in my first chart, what threw the economy so far above its trend line. The question we have to ask is what does it mean? What does this production mean? How do we evaluate it? When it was put into Gross National or Gross Domestic Product by the accountants, they thought it meant something straightforward. They thought they could put in the value of B-29s just the way they put in the value of breakfast cereal. But the value of breakfast cereal is basically the product of the number of boxes sold times the price per box, and that price is the result of demand and supply interacting in markets where people are free to buy breakfast cereal or not. The price of B-29s was arrived at in a completely different way. The B-29s were priced in negotiations between a War Department buyer and some guys from the Boeing Company who sat down and decided what price they would set on the airplanes, and when the payments were made for the airplanes,

30:13they were made with money which had been taken by force from the American people. So what are we to make of the price of a B-29? What does it mean? If we say a box of breakfast cereal cost $0.50 in 1944 and a B-29 cost $150,000, you know, prices were low then, what does that mean? Does that mean that one was worth 300,000 times more than the other? Well no, we have no way to know what it means. In fact, it doesn't mean anything because there's no economic process that generates It's the pricing of these war products. They're just arbitrary. And so if you put this kind of product pricing into the measure of gross national or gross domestic product, you're throwing noise in there. You don't know what it means. At least in the ordinary cases, you have some anchor. You have the anchor of market pricing to keep you from going totally astray in the valuation you attach to different forms of goods and services the economy

31:22Regenerates. In the case of these war products, you don't have anything like that. But the point here is that during the war, this so-called war prosperity consists entirely of war production.

31:52This is another way to view it. Here we've got the government purchases measured with the dark bars and the private investment measured in the light bars and runs from 1929 to 1950. And of course you can see here the big fall in private investment during the Great Depression and some recovery later. But notice there's another big fall in private investment during During the war, at the same time that government spending is skyrocketing, and in fact during the war, government spending was skyrocketing not only to pay the wages of men in the armed forces, but it was taking over investment.

32:40One of the chapters in my book is called The Socialization of Investment During World War and has to do with the fact that almost all the investment during the war was made either directly by the government or under some kind of government subsidy and arrangement. In fact, during the war, you couldn't really make any kind of investment at all without government's approval because just getting raw materials required an allocation of materials from the government. You couldn't build a new house for yourself, for example, because you wouldn't be allowed to purchase the lumber to do that during the war. So all the materials were being directed to war purposes for about four years at that time. So the government spending went up enormously for everything connected with the war, but private investment plummeted.

33:37This is one of my favorite charts I've ever drawn. It shows a lot of things. One is that it shows at the top with that solid line, that's the standard kind of measure of gross domestic product and you see the big drop during the depression and then the great bulge during the winter. War and I've fitted a trend line to that to connect the values for 1929 with the next year of comparable prosperity in 1948. So you can see the economy operating way below trend throughout the the 30s and into the beginning of the 40s and then operating way above trend. Now anybody who had looked at these data should have already smelled a rat because these trend lines constructed in this way where you connect the values of two prosperous years are like measures of the economy's capacity to produce. The economist says, well, the economy had the resources to have grown along that trend line. So instead of getting from 1929 to 48 by first dipping and then

35:01Jumping up and then falling back. It could have simply grown smoothly along that trend line. It had the labor and capital and other resources necessary to do that. And unfortunately, it suffered these deviations from trend. But if that's a capacity trend line, how do you produce more than your capacity? How do you go way above trend if that's a capacity line? And the answer is, well, it doesn't make sense. And the reason you do that on these charts is because of the accounting problems I was just describing. This war output wasn't real output. It was arbitrary numbers. It looks in the data as if it means something, but it doesn't. It's just nonsense.

35:49Now, an important thing is to look at the bars at the bottom, these black bars, because they measure the private part of gross domestic product. Now, during the 1930s, you see that it looks very much like the line above it. There's the big drop between 1929 and 1933, and there's some recovery, and then there's the depression of 37, 38, and some more recovery. more recovery but but what you see is that that even in 1940 41 when the economy has recovered quite a bit it's still far below its trend line the economy in 1941 it has not recovered fully at all if it had grown smoothly as it was capable of doing as we know from the trend I've connected between 29 and in 1948, it could have been much higher than it was in 1941. So private output had not recovered and then to make things worse, it began to fall. Many of the writers about World War II like to say that the great thing about it was we had guns and butter. We didn't

37:06We didn't have to bear any opportunity cost when we produced all these B-29s and Sherman tanks. But that isn't true. And you see that when you look at the private part of gross domestic product. It dropped substantially and it stayed down at a low level until the war was almost over. Even in 1945, the private part of gross domestic product was lower than it had been in 1941. at which time, as I said, it was still representative of a subpar economy, a depressed economy. So the economy hadn't fully recovered before the war started. Then the meaningful part of it sank even lower.

37:53And it was only during that glorious year, 1946, when the war ended, Most of the men were released from the armed forces. Most of the controls on raw materials, prices, and other aspects of the economy were removed. Only in that year did the private economy rebound, and it rebounded enormously. A minimum estimate of the growth in 1946 is 30% in one year. 30% in a single year. There's never a year like that in our history, ever. Not even half that good, ever. 30% in one year. And what that shows is real. And that's why that first chart I showed you that shows the Great Depression of 46 is not just spurious, not just nonsense, but it's nonsense in spades. What looks like the second worst year in American history from the standard GDP data was in reality the best year ever in year-to-year performance of all time. This was the real peace dividend, the real peace dividend. And after that the economy began to perform much better and it continued to perform much better from that time forward

39:20because it never had to endure this kind of wrenching deprivation that it occurred during during World War II, when the government sucked nearly half of the resources out of it for war purposes. Some of my fellow economists who've argued with me over the years about this argue most strongly with regard to what happened to consumption during the war. They say, yeah, it's true that the government did a lot of things, produced a lot of military output, but nonetheless, American consumers were better off during the war than they had been before.

40:13And if you look at, again, the standard data that economists use, I've made those into an index number in the second column there, they do look as if they get bigger during the war. War, looks as if personal consumption per capita actually is growing during the war. Not much, but okay, they seem to have a case there. Unfortunately, that case is bogus too. Unfortunately for them, and unfortunately for me, I didn't bring the chart that wraps this up, so let me tell you what is going on here.

41:03During the war, there were price controls over nearly everything in the civilian economy. You didn't need price controls over the military output, because that was already being set by the military authorities, as I explained. But nearly all civilian goods and services were subject to price controls, whether it was rents or the price of shirts or shoes or beef steaks, you name it. Practically everything had a maximum price that you could charge by law. A number of important goods, because when their prices were controlled, they became very scarce, were rationed. So that if you went to buy a pair of shoes, or you went to buy a gallon of gasoline, you had to not only pay the official price, but you also had to have a ration coupons of a stipulated amount, so there was a kind of two-price system.

42:00System. I've actually brought a ration book with me today because I intend to be prepared in case our masters decide once again to reimpose the system on us. But this made life even more difficult for consumers because it meant that because the goods were priced below market Values. Sellers are not eager to sell them in great abundance and so people would have to troop around looking for somebody willing to sell them the goods they wanted at the controlled price with their coupons, which the government, you know, said it was unlawful to sell. Naturally, of course, there was a thriving black market and people commonly gave these things to their friends and relatives when they didn't need them at the moment because it every month you had to go to the Ration Board and get a fresh supply.

42:58And every living human being had to have a booklet. The one I hold in my hand was issued to a two-year-old child. So this was how a wonderful life was during the war. And these price controls completely distort the official data. We don't really know what the values of goods were because of these controls. The official prices are obviously not meaningful ones. We can try to estimate, and a number of economists have tried to estimate, how much higher actual prices were than the control prices, and to make adjustments for the measured rate of inflation. Probably the best estimate, and I still think it's insufficient for various reasons explained in my book, was one that Milton Friedman and Anna Schwartz made in the 1980s based on very careful statistical work, but nonetheless, it has deficiencies, which I know they will own up to.

44:02I know that because Anna has endorsed my work, so Milton, I can't get his endorsement today, But I think Milton was starting to come around too, actually, from what people have told me before he died, and I know Anna has. So if you adjust for the mismeasurement of the rate of inflation during the war, what you find is that the real value of consumer output was much lower than the official numbers would have you believe. That is, consumers were not better off during the war. War, they were not holding their own during the war, they were in fact getting worse off. Many goods of course weren't available at all, at any price. In the beginning months of 1942, the government simply ordered the automobile industry to shut down production of civilian automobiles, and it did, so they weren't available again in substantial numbers from the beginning of the 1940s until starting in 1946, so no new cars, used cars of course were hard to come by because everybody was trying to get hold of one, there being no new ones available, consumer appliances, things like stoves for your kitchen, practically any appliance made with steel was either not available at all or available in very, very limited quantities, as I said, people had to spend a lot of money

45:33A lot more time and effort just finding the goods they wanted to buy and these jobs they held in order to buy goods during the war often required that they move long distances to centers of defense production where they could get these jobs and when they got there they found that the housing was very hard to get. They often ended up doubling or tripling up with other people living in very cramped quarters, Living in tents or shanties or some such housing in places where defense production was concentrated. So housing really deteriorated during the war. Rent controls removed the incentive for landlords to maintain properties and so they almost gave up maintenance, which meant that the housing deteriorated steadily during the war, which by the way, the entire capital stock of the American economy did as well.

46:28There's one reason for this miracle of production in the sense that they did produce a lot of guns and ammunition without doubt. One reason is that they did it by using up capital. They did not do the usual maintenance and repairs on factories and other equipment. They ran shifts two and three a day instead of one, and so they simply ate up the capital stock, This is one of the great lessons that Ludwig von Mises taught about war economy, that it results in the destruction of capital. They gloried in the fact that the government was building new additions to capital, new factories, shipyards, airplane plants and so forth. But if you look at what was built and look at what it was worth after the war was over, you find that it had very little value in most cases.

47:20So this offset that many economists think the government was making to offset using up the old capital stock is mostly bogus as well. This doesn't say that the factories didn't produce tanks and airplanes and so forth. They did. But if you ask what was that worth to consumers, the answer in a sense is nothing. It was valuable because it helped the country win the war. That was its only value in most cases. So even World War II, the classic case that convinced all Americans that the war got the economy out of the depression, that government can use huge deficits to stimulate the economy, the whole episode is bogus.

48:10It's historically bogus. It's economically bogus and it's been a terribly destructive myth and Fallacy, to this very day. Thank you very much.