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Austerity or prosperity?

Posted By Russ Roberts On October 7, 2010 @ 12:48 pm In Stimulus,Uncategorized | Comments Disabled

When you ask Keynesians for empirical evidence of how government spending creates prosperity, their best and most frequently cited answer is how World War II ended the Depression–a massive, increase in deficit-financed government spending. But as Robert Higgs has pointed out [1], the sharp decrease in unemployment that resulted was not due to the magic of some Keynesian multiplier but rather from conscription—forcing Americans into the Army. Higgs also argues that the increase in GDP is distorted by the challenge of measuring the value of government output–does the price of a tank commissioned under government contract represent value the way the price of a car does?—and price controls–some things were cheap but they were not freely available.

I use a more anecdotal but perhaps more persuasive argument. There was no wartime prosperity in the US or the UK or Germany. No one who lived through those times remembers them as a time of booming economic activity. It was a time of hardship and privation unless you were in the business of making tanks or bombs or bullets. There was no Keynesian multiplier. A dollar of spending on a tank didn’t “stimulate” the private economy. A dollar of government spending didn’t create $1.52 worth of economic output. More tanks meant fewer cars because steel became more expensive and workers did too. And there were fewer resources available for private use.

When I mentioned this to my collaborator John Papola [2], he pointed me to this post by Paul Krugman [3] that dismissed my argument. Krugman was reacting to this post [4] by Bob Hall and Susan Woodward that made a similar observation to mine arguing that spending in WWII increased GDP by roughly the amount of the spending. There was no stimulative effect. Hall and Woodford don’t argue for a negative effect–here the Higgs argument about measurement is relevant. But they do argue there was no positive effect on the rest of the economy.

But Krugman wants to argue that the Keynesian multiplier was alive and well. He has a two word response to Hall and Woodward (and presumably to my argument as well):

Um, rationing?

He then quotes from a U.S history web site [5]:

With the onset of World War II [6], numerous challenges confronted the American people. The government found it necessary to ration food, gas, and even clothing during that time. Americans were asked to conserve on everything. With not a single person unaffected by the war, rationing meant sacrifices for all.

Help me out here folks. I and others argue that government spending in WWII—a giant spike in government spending financed by debt—did not create prosperity and economic recovery. It created hardship because you can’t eat bombs, you can’t wear tanks, and you can’t sweeten your coffee with bullets. And Krugman, who is a trained economist with a Nobel Prize argues that we’re wrong. It wasn’t crowding out or a failure of the Keynesian multiplier. The reason we’re wrong is that the US government forced people to get by with less because of a government program called rationing. He appears to be arguing that if it weren’t for rationing, then we would have seen the Keynesian multiplier in all its glory. What the heck is he talking about? Does he think the rationing is what produced scarcity rather then being a response to scarcity?

One of the most mindless aspects of the multiplier is to treat is as a constant, such as 1.52. It can’t be a constant, not in any meaningful way. If the government conscripted half of the US population to dig holes all day and conscripted the other half to fill them back in, and paid each of us a billion dollars a day for the task, and valued holes that were dug and holes that were filled in at a trillion dollars a hole, then GDP would be very very large, unemployment would be zero and there would be no stimulating effect and we would soon be dead from starvation. (I ignore the staffing challenge of forcing people to do their tasks.)

The fact that WWII did not stimulate the private sector does not prove that Keynesianism always fails. Maybe a smaller army and fewer tanks would have done the trick. But it certainly does not prove that it was a success. It was not a success. It did not stimulate the private sector. It did not create an extra 50 cents or two dollars on top of the original expenditure as the recipients of government contracts and their workers had more money to spend. It starved the private sector. It was a failure as an example of Keynesian stimulus.

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URL to article: http://cafehayek.com/2010/10/austerity-or-prosperity.html

URLs in this post:

[1] as Robert Higgs has pointed out: http://www.econtalk.org/archives/2008/12/higgs_on_the_gr.html

[2] my collaborator John Papola: http://econstories.tv/home.html

[3] this post by Paul Krugman: http://krugman.blogs.nytimes.com/2008/12/11/dont-know-much-about-history/

[4] this post: http://woodwardhall.wordpress.com/2008/12/11/measuring-the-effect-of-infrastructure-spending-on-gdp/

[5] a U.S history web site: http://www.u-s-history.com/pages/h1674.html

[6] World War II: http://www.u-s-history.com/pages/h1661.html

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