Turning Guns to Butter

When World War II ended in 1945, public opinion called for a rapid demobilisation. But Keynesian economists warned that a rapid decline in government spending and the size of the public workforce would produce high unemployment, says Arnold Kling, a member of the Financial Markets Working Group at the Mercatus Center at George Mason University.

Thankfully, President Truman ignored the Keynesians.

Government spending plummeted by nearly two-thirds between 1945 and 1947, from $93 billion to $36.3 billion in nominal terms.

If we used the "multiplier" of 1.5 for government spending that is favoured by Obama administration economists, that $63.7 billion plunge should have caused gross domestic product (GDP) to fall by $95 billion, a 40 per cent economic decline.

In reality, GDP increased almost 10 per cent during that period, from $223 billion in 1945 to $244.1 billion in 1947.

The end of World War II thrust more than 10 million demobilised servicemen back into the labour market, but without the catastrophic consequences Keynesians feared, says Kling.

Close to one million took advantage of the GI bill to attend college.

Overall, from 1945 to 1947 the civilian labour force increased by seven million, or 12 per cent.

There are important differences between circumstances today and the circumstances in 1945, of course. Indeed, there are other factors that make change more difficult today.

During World War II, the personal savings rate climbed to more than 20 per cent, so households were able to offset the decline in government spending by consuming a larger share of their incomes.

Today, with a savings rate of about 5 per cent, households have much less room to expand.

In addition, the skill requirements of today's industries make it more difficult to match workers with jobs than was the case in the 1940s.

Any way you look at it, though, America's experience from 1945 to 1947 demonstrates that the private sector is capable of overcoming a tremendous drop in government spending, says Kling.

Source: Arnold Kling, Turning Guns To Butter, Reason Magazine, November 2010.

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First published by the National Center for Policy Analysis, United States

FMF Policy Bulletin/ 19 October 2010