Friday Graph: the US Post-War Miracle

 

Today’s graph is from a fascinating paper by David Henderson, published in November 2010 by the Mercatus Centre at George Mason University.

 

Henderson writes:

We often hear that big cuts in government spending over a short time are a bad idea. The case against big cuts, typically made by Keynesian economists, is twofold. First, large cuts in government spending, with no offsetting tax cuts, would lead to a large drop in aggregate demand for goods and services, thus causing a recession or even a depression.

Second, with a major shift in demand (fewer government goods and services and more private ones), the economy will experience a wrenching readjustment, during which people will be unemployed and the economy will slow.

Yet, this scenario has already occurred in the United States, and the result was an astonishing boom. In the four years from peak World War II spending in 1944 to 1948 the U.S. government cut spending by $72 billion—a 75-percent reduction.2 It brought federal spending down from a peak of 44 percent of gross national product (GNP) in 1944 to only 8.9 percent in 1948, a drop of over 35 percentage points of GNP (see figure 1).

Yet, the economy boomed. The unemployment rate, which was artificially low at the end of the war because many millions of workers had been drafted into the U.S. armed services, did increase. But during the years from 1945 to 1948, it reached its peak at only 3.9 percent in 1946, and, for the months from September 1945 to December 1948, the average unemployment rate was only 3.5 percent.

Ask people who lived through that period as young adults what economic conditions were like, and you will inevitably get the answer that they experienced an economic boom. The U.S. economy during the post-World War II years is exhibit A against the Keynesian view that economies will necessarily suffer high unemployment and slow growth when governments make big cuts in government spending. Why did the U.S. economy do so well in the years following World War II given how badly it had done in the years preceding America’s entry into the war? The answer, in a nutshell, is that dramatically reducing government spending and deregulating an economy can take that economy from sickness to health. In short, one of the main things a government can do to help a weak economy recover is to step aside.

Hello Asia

I was in Sydney last week at a Pacific Rim Policy Exchange conference of think tanks in the Asia Pacific region, led by the Property Rights Alliance.  A particular highlight was a dinner speech by Rowan Callick, the exceptionally well-qualified Asia Pacific editor of The Australian who has a deep knowledge of Asia and has lived for some years in China.  He started by reminding delegates of the Western-driven mentality behind the UN’s Millenium Goals:

The goals are worthy targets in themselves, emanating of course from guilt-laden but increasingly broke Europe, and largely devoid of an economic context. They have come to be identified with the affirmation of a certain take on the “development” process – that of kind rich folk developing hapless poor supplicants through noblesse oblige.

Callick noted that the same mentality pervades our ‘world’ view of the GFC:

For you are meeting in the wake of the recent North American-European financial crisis – NOT a GLOBAL financial crisis – and just as this region is taking over, in my view unshakeably, the leadership of economic growth, if not of the global economy itself.

He observed that the example so many Asian countries have set in climbing out of poverty through rapid economic growth has largely gone unnoticed by the Western-dominated world of official aid, but not by the rest of the world.

I was living in Beijing when 43 African heads of state and government almost four years ago attended a summit there, which launched China’s extraordinary burst onto that continent. China wanted resources primarily, and ultimately once Africans begin to spend, its markets too. And as in Latin America and central Asia and the Pacific islands, such economic vitality proved both attractive and contagious. China’s Premier Wen Jiabao said he wasn’t interested in exporting a China Model of development. And I believe him. His priorities are domestic, first second and third. His party’s legitimacy depends on economic health at home.

But Africans who have for generations seen Western taxpayers and NGOs donate $ billions to their kleptocratic rulers are naturally lured to the revolutionary idea coming from the East, that economic growth is good, not merely bad for the planet as they had been told by those sleek Westerners. They are attracted to the notion that shipping, selling and buying stuff provides a better prospect for their families than following anaemic World Bank prescriptions.

A fun formula has it that in 1949 only socialism could save China. In 1979, only capitalism could save China. In 1989, only China could save socialism. And in 2009, only China could save capitalism.

Imagine a Western leader of today proclaiming as Deng Xiaoping did: To get rich is glorious. She or he would be condemned for crass materialism, and for privileging elites.

That determination to get rich is the type of talking dirty that thrills people who are dirt poor – that is, those people who have not already been pre-conditioned towards petty envy and the redistributionist zeal that led so many societies down a false trail, one that ends in the desert – as we see in contemporary Europe.

Callick noted that China has succeeded economically despite hobbling itself with efforts to control its people’s lives – a tribute to Deng Xiaoping’s decision to open manufacturing to foreign investors but also to the Chinese people themselves and their core individualistic culture.

In covering the Beijing Olympics while I was living there, I followed the Chinese teams. When China wasn’t playing, the default country which Chinese sports fans tended to cheer, was the US of A. They feel very much at home in the individualistic American culture.

And they mostly hate paying taxes, and avoid doing so, just as Americans, and I must say Australians, do. When I told a Chinese friend after I had begun working in Beijing, that I thought I should start paying some personal tax, he said I was crazy. Neither he nor any of his pals paid tax, he said. Why should they, when they didn’t choose the government, and mostly disagreed with what it spent money on.

 China also has a huge grey income, and its property and financial sectors are rife with insider trading, market manipulation and much misuse of power for personal gain.

Deng Xiaoping spoke of crossing the river by feeling the stones – cautious progress. He was not referring to taking China from a communist river bank to a liberal democratic one, but taking the party and the country towards prosperity. Where did this great pilgrimage start? With formally conceding the space to do business.

Much of China’s rapid change can be attributed to the determination of its “masses” to carve out better lives for themselves come what may, with the party’s legitimacy relying on its capacity to shift its tactics, even its values, in response to demands from below. 

And with Deng’s contract of 30 years ago beginning to fade, the party is now searching for a new source of legitimacy for itself as, among other roles, the source of security, stability and safety.

And now the party is beginning to use domestic Chinese NGOs to deliver the social services for which the country is increasingly clamouring as it ages, but which the government lacks the structures to deliver. The state’s wealth, including the massive foreign exchange largely still held in $US, was in part built on denying its own citizens a fair share – in the economic as in other realms. But this is proving not to be sustainable. A higher proportion of the economy is steadily being seized by consumers and workers, as part effect and part cause of the structural change from cheap surplus labour and towards domestic services and greater productivity.

In Asia more broadly, the right to do things for yourself, to be an autonomous actor, is coveted more highly than the right to receive support from the state – in part because success in the former will move you up to a higher realm of wellbeing and control over your life.

… I usually tell people who ask my advice on books to read about China today, to start with Charles Dickens. He was also writing of a society that was rapidly urbanising and industrialising, in which ancient extended families were shrinking into nuclear families, a world of casual injustices and astounding coincidences, and of resourceful heroes and, especially, heroines. 

As Callick concludes:

Asia is hardly perfect, it’s a long way from liberal, but for the most part it loves globalization, its people prefer governments to keep out of sight, and… well, welcome to our region.

At the same conference I was invited to speak in a session on free trade and emphasised the case for organisations like the Australian Productivity Commission to shed light on the costs of protectionist policies to consumers and other industries.  I’m a member of the Tasman Transparency Group, a collection of Australian and New Zealand economists and business people who’ve been urging governments to set up transparent agencies of this kind.  A bill to set up a New Zealand Productivity Commission is currently before parliament. 

Also at the conference was Kiwiblogger David Farrar who spoke on the role of social media in debating public policy in an era where there seems to be less and less focus on policy analysis in the regular media.  What was particularly interesting was the representation of the free market institutes from the Asia region, most notably China, Korea and India.  I particularly liked the Mongolian Institute for Fair Taxes and Wise Spending.

It was interesting that none of their preoccupations related to the economic debates raging in the West around things like Keynesian stimulus policies, fiscal deficits and the burden of welfare states.

Protectionism in our backyard

Driving home from work in Wellington I pass a huge Turners and Growers billboard near the Beehive, and there is now another near the airport. I think they’re innovative.

  

The billboards are a small move in a big battle to remove New Zealand’s last remaining, innovation stifling, export monopoly.

The company Zespri has a monopoly on exporting New Zealand kiwifruit to all countries except Australia. Technically a monopsony, because they have a monopoly on buying all kiwifruit from New Zealand growers who wish to export their produce outside Australasia, Zespri is one of only two single-desk sellers of agricultural products left in the developed world.

On the issue, Agriculture Minister David Carter has said the government will be guided by what most growers want – but what about the other growers? Blocking non-Zespri growers from exporting overseas because they are a minority is like banning all dairy producers who don’t supply Fonterra from exporting overseas. Fonterra is subject to competition as Zespri should be.

An Australian Productivity Commission research paper said that pooling of returns across growers “tends to reward lower-valued products at the expense of higher valued products, discouraging the more efficient and innovative producers”. If Zespri is doing as well as it claims, it should have nothing to fear from innovative competition. And what is wrong with competition? In Econ 101 you will learn that a monopoly exporter selling 10 units into an overseas market won’t normally get a better price than two suppliers selling 5 units of the same product. Obviously a firm with rivals will be more innovative and efficient than a monopoly.

Meanwhile a recent Turners & Growers press release, Turners & Growers ‘Mobbed’ by Media And Buyers At Asia Fruit Logistica, highlights missed opportunities:

Buyers here are fascinated with the look of our ENZARed kiwifruit and love the flavour. ENZA Gold is also proving extremely popular and the combination of new high quality apple and kiwifruit varieties under the ENZA brand is creating strong demand. Buyers here want New Zealand kiwifruit. They can’t believe that there’s a monopoly around New Zealand kiwifruit.

Quite rightly the New Zealand government has pushed strongly on the world stage for the freeing-up of trade barriers – yet the Zespri monopoly is blatant protectionism right in our back yard.

It is prosperity that creates spending

Over at Café Hayek Russ Roberts has a post ‘Does spending create prosperity?’ which begins:

Does spending create prosperity? It’s a weird idea when you think about it. Spending is consumption. Consumption uses stuff up. How could it create prosperity? If anything, the causation is reversed – it is prosperity that creates spending.

I’ve often wondered why this basic concept, boiled down to the marrow here by Roberts, is so difficult for some people (and governments) to grasp. The idea that government spending generates prosperity has long been exposed for the Keynesian fallacy that it is.

IMF figures show that central government expenditure in New Zealand is 34.6% of GDP – which is enormous when you compare it to top performers like Hong Kong (17.5%) and Singapore (22.4%). The people of both those countries receive quality public goods and services – and have lower taxes and higher wages.

Roberts uses a neat analogy to describe US stimulus package policy later in his post:

Think of having a lot of wet wood and trying to get it going by lighting newspaper as kindling. There’s a fire for a while, while the newspaper is burning. But once the newspaper is consumed, the wood hasn’t caught. Even burning a lot more newspaper (bigger stimulus package) isn’t going to get the wood dry enough to catch fire.

The same applies to government spending in New Zealand. The role of the government should be to provide a framework that allows the economy to prosper. Cutting government spending is a sure way to heat up a damp economy.

Cutting government spending will generate higher growth. Growth generates prosperity. Prosperity creates spending: a roaring fire using dry wood without wasting stacks of paper getting it going.

For more on this topic read an article I wrote last year titled Faith in Government Spending is Misplaced.

Ask Joe

An article by Kevin A Hassett Bury Keynesian Voodoo before It Can Bury Us on aei.org draws some similar conclusions to this one I wrote for the ODT a couple of weeks ago.

 I’ll paste in a few sections from Hassett’s article:

Initial claims for unemployment benefits surged to 500,000 in mid-August, a level more typical of a recession than a recovery. The bad news confirmed what conservative economists have been saying for some time: The biggest Keynesian stimulus in U.S. history was a bust.

But the Keynesians still weren’t fazed:

Incredibly, some Keynesians who supported Barack Obama’s $862 billion stimulus now claim it fell short of their goals not because the idea was flawed, but because the spending package was too small.

So where to turn for evidence for that claim?   The US stimulus package was in fact the largest ever tried in that country and bigger than that tried by any other OECD country. Hassett asks Joe the plumber:

Why is the left so profoundly committed to stimulus-by-spending, even though there is scant evidence that it succeeds?

Joe the Plumber knows the answer: The left has become religiously Keynesian because that is the only corner of economics consistent with its redistributive ideology.

You remember Joe. During a campaign stop in the 2008 presidential election, Samuel Joseph Wurzelbacher asked Obama whether higher taxes would punish his business. Obama answered in part, “I think when you spread the wealth around, it’s good for everybody.”

Obama’s words captured Democrats’ ideology: outside of fairy tales, only government can play Robin Hood, taking money from the rich and giving it to the poor.

Joe the plumber won instant fame in the US after this exchange. The truth is Joe was right – higher taxes would punish his business. Tax cuts rather than tax increases are far more effective in a recession. Obama’s outgoing chief economic adviser recently said herself “tax increases are highly contractionary … tax cuts have very large and persistent positive output effects.”  As Hassett notes, that fact is bad news for the Robin Hooders:

If you cut tax rates in a recession in order to stimulate the economy, then you are conceding that lower tax rates can be a good thing. And if that’s true, then higher tax rates will be harmful–something the left has always denied.

So the Obama economic team was left to rely totally on spending in its response to the recession.

 Which turns out to be bad medicine:

Supporters of this type of stimulus are either unfamiliar with the literature or willing to ignore it. The result is policy that is harmful to our country and inconsistent with modern economic science. If the Obama economic team were medical doctors, they would be pushing the use of medicine not approved by the Food and Drug Administration.

Indeed, as I wrote in my article, naïve Keynesian ideas have not survived the GFC well, and should never have been contemplated.  Keynes once wrote:

 “If the Treasury were to fill old bottles with banknotes, bury them at suitable depths in disused coal mines which are then filled up to the surface with town rubbish, and leave it to private enterprise [to dig them up again] … there need be no more unemployment and … the real income of the community, and its capital wealth also, would probably become a great deal greater than it actually is.”

Few economists would take that proposition seriously today.

In all likelihood, the data will soon be so convincingly bad that we’ll again debate the need for an economic stimulus. Let’s hope that when that begins, all will finally concede that the ideas of John Maynard Keynes are as dead as the man himself, and that Keynesianism is the real voodoo economics.

Let’s hope. 

Read Kevin A. Hassett’s full article here and my article The Dubious Benefits of Fiscal Stimulus here.