20 Century

Created 2/12/1997
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Slouching Towards Utopia?: The Economic History of the Twentieth Century

-XX. The Great Keynesian Boom: "Thirty Glorious Years"-

J. Bradford DeLong
University of California at Berkeley and NBER

February 1997

European Supergrowth

Even a casual glance at numbers and growth rates reveals that growth and recovery after World War II was astonishingly rapid. Considering the three largest Western European economies-Britain, France, and Germany-the Second World War infiicted much more damage and destruction on a much wider area than the First. And (except for France) manpower losses were greater in World War II as well. The war ended with 24 percent of Germans born in 1924 dead or missing, and 31 percent disabled; post-war Germany contained 26 percent more women than men. In 1946, the year after the end of World War II, GNP per capita in the three largest Western European economies had fallen by a quarter relative to its pre-war, 1938 level. This was half again as much as production per capita in 1919 had fallen below its pre-war, 1913 level.

Yet the pace of post-World War II recovery soon surpassed that seen after World War I. By 1949 average GNP per capita in the three large countries had recovered to within a hair of its pre-war level, and in comparative terms recovery was two years ahead of its post-World War I pace. By 1951, six years after the war, GNP per capita was more than ten percent above its pre-war level, a degree of recovery that post-World War I Europe did not reach in the eleven post-World War I years before the Great Depression began. What post-World War II Europe accomplished in six years had taken post-World War I Europe sixteen.

The restoration of financial stability and the free play of market forces launched the European economy onto a two-decaDeLong path of unprecedented rapid growth. European economic growth between 1953 and 1973 was twice as fast as for any comparable period before or since. The growth rate of GDP was 2 percent per annum between 1870 and 1913 and 2.5 percent per annum between 1922 and 1937. In contrast, growth accelerated to an astonishing 4.8 percent per year between 1953 and 1973, before slowing to half that rate from 1973 to 1979.

Moreover, the post-World War II recovery did more than just rapidly restore Western Europe to its previous peacetime long-run growth path. French and German growth during the long-post World War II boom carried total production per capita to levels that far outstripped their economies' pre-1929 or even pre-1913 growth trends. In both France and West Germany labor productivity had outstripped their pre-1913 trends by 1955, and thereafter saw no noticeable slackening of growth. The dynamic of western European growth after World War II is an order of magnitude stronger than had hitherto been seen.

Consider, as an example, the west German economy. In the 1950s it certainly boomed. Recovery in the 1940s can be understood as recovering the productive capacity that had existed before the war, with the added benefit of an extra decade and a half's worth of technology. But the German economy in the 1950s crashed through the output-per-capita levels that would have been projected by someone connecting pre-World War II peaks, and has come to rest since 1973 at about its pre-1913 growth rate, at a level of output-per-capita some forty percent higher than anyone would have dared to project on the basis of the pre-World War II experience.

The magnitude of the boom came as a surprise to the Germans. The real value of a basket of German stocks multiplied eightfold during the 1950s--without any reinvestment of dividends--for an average real return of twenty-five percent per year.

In addition the German economy showed itself able to absorb a very large population displaced from the east in a relatively small number of years. Unemployment in 1950 was ten percent. By 1960 it was down to one percent of the labor force.

This reduction of unemployment from double-digit levels to zero-digit levels took place with no sign of inflation or excess demand pressure at all: the average inflation rate from 1949 to 1970 was 1.7 percent per year. And this reduction of unemployment did not trigger anything like the degree of labor strife that had characterized pre-World War II (and pre-World War I) Germany.

The Moderation of the Business Cycle

Europe's rapid growth in the 1950's and 1960's was associated with exceptionally high investment rates. The investment share of GNP was nearly twice as high as it had been in the last decade before World War II or was again to be after 1972. Accompanying high rates of investment was rapid growth of productivity. Even in Britain, the laggard, productivity growth rose sharply between 1924-37 and 1951- 73, from 1 to 2.4 percent per annum. This high investment share did not, however, reflect unusual investment behavior during expansion phases of the business cycle. Rather, it reflected the tendency of investment to collapse during cyclical contractions and the absence of significant cyclical downturns between 1950 and 1971.

Post-World War II economic policy was surely far better than what had been seen in the Depression, and somewhat better than what had been seen in the pre-Depression era. On average, year in and year out, the economy's production was perhaps one or two percentage points closer to its full employment level than in the pre-Depression period. This is not a small number in absolute terms: it is $75 billion a year at present rates, or $300 a year per capita. But it outweighs the costs imposed by the tolerance of infiation only as long as the Federal Reserve is able to keep infiation moderate through its games of bluff and recession. And it is small relative to the benefits of faster long-run economic growth-which was the truly important and impressive feature of the post-World War II Great Keynesian Boom.

The political and economic environment within the industrial nations was extraordinarily favorable in the years immediately after World War II. All parties and economists were terrified lest the Great Depression return. To fight off this possibility, politicians and economists paid very close attention to the lessons of the Great Depression and of the New Deal, which were seen as roughly three: unemployment is the disease, high demand is the medicine, and the federal government-though loose monetary policy and deficit spending-is the doctor. Confidence in the mixed economy commitment to maintain spending, demand, and production helped, perhaps more than the commitment itself, to keep the post-WWII era free of Great Depressions. Instead, the mixed economies risked an acceleration in infiation, rather than even a small chance of a severe Depression. Over time, this pro-infiation bias intensified, became anticipated, and so lost some of its efficacy at preventing unemployment.

As time passed, and the memory of the Great Depression dimmed, governments' commitments to fight unemployment fiercely even at the cost of risking some infiation began to fiag. This became of great importance because the post-World War II economic system's ability to deliver low unemployment without high infiation began to erode as well. Between 1954 and 1969-between the Korean War and the height of the Vietnam War-it looked as though the U.S. economy was sliding back and forth along a stable infiation-unemployment "Phillips Curve." Democratic governments tended to spend more time at the left end of the curve, with relatively high infiation and relatively low unemployment. Republican governments tended to spend more time at the right end, with low infiation and higher unemployment. But by absolute and by historical standards, both infiation and unemployment were low.

Labor Peace

Some of Europe's cyclical stability was due to the advent of Keynesian stabilization policy. But Keynesian policy was effective only so long as labor markets were accomodating. So long as increased pressure of demand applied by governments in response to slowdowns produced additional output and employment rather than higher wages and hence higher prices, the macroeconomy was stable. Investment was maintained at high levels, and rapid growth persisted.

The key to Europe's rapid growth, from this perspective, was its relatively inflation-resistant labor markets. So long as they accomodated demand pressure by supplying more labor input rather than demanding higher wages, the other pieces of the puzzle fell into place. What then accounted for the accomodating nature of postwar labo markets?

The conventional explanation, following Kindleberger (1967), is elastic supplies of underemployed labor from rural sectors within the advanced countries and from Europe's southern and eastern fringe. Elastic supplies of labor disciplined potentially militant labor unions. Another explanation is "History." Memory of high unemployment and strife between the wars served to moderate labor-market conflict. Conservatives could recall that attempts to roll back interwar welfare states had led to polarization, destabilizing representative institutions and setting the stage for fascism. Left-wingers could recall the other side of the same story. Both could reflect on the stagnation of the interwar period and blame it on political deadlock.

Yet another potential explanation is the Bretton Woods System. Bretton Woods linked the dollar to gold at $35 an ounce and other currencies to the dollar. So long as American policy makers' commitment to the Bretton Woods parity remained firm, limits were placed on the extent of inflationary policies. So long as European policy makers were loath to devalue against the dollar, limits were placed on their policies as well. Price expectations were stabilized. Inflation, where it surfaced, was more likely to be regarded as transitory. Consequently, increased pressure of demand was less likely to translate into higher prices instead of higher output, higher employment, and greater macroeconomic stability.

A final potential explanation is the legacy of the Marshall Plan. Putting the point in this way serves to underscore that the Marshall Plan was but one of several factors contributing to observed outcomes. In principle, the Marshall Plan could have mattered directly. Marshall Planners sought a labor movement interested in raising productivity rather than in redistributing income from rich to poor. With labor peace a potential precondition for substantial Marshall Plan aid, labor organizations agreed to push for productivity improvements first and defer redistributions to later.

Moreover, money was channeled to non-Communist labor organizations. European labor movements split over the question of whether Marshall aid should be welcomed--which left the Communists on the wrong side, opposed to economic recovery.


Bretton Woods

International monetary disorder--financial crises, devaluations, hyperinflations, trade restrictions for balance-of-payments reasons--had been a principal obstacle to recovery after World War I. The international monetary system has relatively little role in the history-of-events of the generation after World War II because not much went wrong: another example of the principle that "happy is the land that has no history."

When the delegations--the American delegation headed by Treasury Assistant Secretary Harry Dexter White, the British delegation headed by John Maynard Keynes, and the other delegations--met in the somewhat faded mountain resort of Bretton Woods, New Hampshire to build a post-WWII international monetary system, their minds were focused on what they saw as the lessons of the interwar period. Thus the Bretton Woods system that they build departed from the gold exchange standard in three interlinked ways:

The Bretton Woods conference of 1944 set up the post-World War II international economic system which was to prove extraorinarily successful. In intention, obedience to the rules of the International Mondetary Fund would provide macroeconomic equilibrium. Countries would maintain fixed exchange rate parities vis-a-vis one another. When one country ran a persistent balance of payments deficit that threatened to exhaust its reserves, it could borrow from the IMF. In return, the IMF would seek macroeconomic policy adjustments in order to bring the balance of payments back to a sustainable level, or, in the case of "fundamental disequilibrium," would recommend a devaluation.

The existence of the Bretton Woods framework made it much easier to achieve and maintain a régime of low tariffs and free trade. With stable exchange rates, a chief weapon that domestic industries could pressure governments to use to protect them (and a chief excuse for protection) would not be in operation. And to the extent that the IMF's rules helped keep employment high and Great Depressions at bay, there would be little pressure for protectionism. Absent macroeconomic collapse, it would be hard to make a case that protecting countries would gain more than-as they cut themselves off from the international division of labor-they stood to lose.

A second institution, itself not the creation of Bretton Woods but a stopgap that grew up when the institution envisioned at Bretton Woods, the International Trade Organization, failed to be born, was the General Agreement on Tariffs and Trade. It established general rules-multilateralism and non-discrimination-that meant that trade liberalisation for one would become trade liberalisation for all, and established, for the first time, an ongoing institution dedicated to the reduction of barriers to trade throughout the world. The Bretton Woods framework, and GATT, were successful. The average tariff imposed by the United States declined by nearly 92 percent over the 33 years from the Geneva Round of 1947 to the Tokyo Round of 1974­79. From 1953 to 1973, world real GNP grew at an average rate of 4.7 percent, and world trade at a rate of 7.5 percent per year.

Did trade liberalization cause the trade expansion? To a large degree, yes. Did the trade expansion drive the economic prosperity of the long Keynesian boom? It seems likely that, to some degree, it did. Intra-industry trade became very important in the post-World War II era. World trade became not the exchange of coffee for washing machines, but the exchange of small cars for large cars, or of high-priced silks for moderate-priced synthetics. The post-World War II industrial world was populated by a large number of firms making differentiated products, and then selling these products worldwide. The added scope of the market allowed for a greater division of labor, and here-in consumers' choice certainly, and in productivity possibly-was a major gain from trade. Moreover, many World Bank and other studies have documented a strong link between trade liberalization and economic performance in the developing world. There is no reason to think that such a link does not exist for the industrial west as well.

Technological Diffusion:

As industries in the industrial core became more and more mechanized-more and more characterized by "mass production"-they should have become more and more vulnerable to foreign competition from other, lower wage countries. If Ford can redesign production so that unskilled assembly line workers do what skilled craftsmen used to do, why can't Ford also-or someone else-redesign production so that it can be carried out by low wage Peruvians or Poles or Kenyans rather than by Americans, who are extraordinarily expensive labor by world standards?

Industries do migrate from the rich industrial core to the poor periphery, but they do so surprisingly slowly. One reason is added risk-political risk of all kinds tends to make investors wary of committing their money in places where it is easy to imagine political disruptions from the left or the right. Moreover, there are substantial advantages for a firm in keeping production in the industrial core, near to other machines and near other factories making similar products. It is much easier to keep the machines running. A reliable electric power grid is much more likely to be found in the industrial core. And so are the services of specialists needed to fix the many things that can go wrong-minimum efficient scale for an industrial civilization can be far larger than the apparent minimum efficient scale for a plant.

These factors are an order of magnitude more important for industries that are in technological fiux than for those that have a settled, relatively unchanging technology. A principal advantage of locating near the firms that make your machines comes from the interchange and feedback of users and producers-feedback that is valuable only if designs are still evolving. And the principal advantage of a machine-knowing and relatively well-educated labor force is the ability to adapt to using slightly different machines in somewhat different ways-once again, valuable only if small changes are constantly being made. As industries reach technological maturity, freeze their production processes into set patterns, and become businesses in which sales are made on the basis of the lowest price, they tend to migrate to the periphery of the world economy: handed down to poorer countries as, in the words of a Japanese development advisor, older siblings hand down to younger ones clothes they no longer need.

Thus the maintenance of American industrial preeminence throughout the twentieth century depended on the constant introduction of new products and processes that did require immediate feedback, and that could not be easily copied or reproduced outside the United States. This requires that the United States continue to be the locus of invention and innovation. The process of technological change does not make leaps. Continuity of development and the importance of hands-on experience are crucial. In this context, "continuity" means that most innovation and productivity growth is the result not of single, discrete, major inventions or borrowings but rather of a continuous and ongoing process of improvement and adaptation, no one step in which is particularly important or noteworthy. In this context, "experience" means that the skills needed to handle and productively use modern technology are most easily and rapidly gained by using modern technology.

As Nathan Rosenberg puts it: "most inventions are relatively crude and inefficient [at first].They are, of necessity, badly adapted to many of the ultimate uses to which they will eventually be putthey offer only small advantages, or perhaps none at all." Consider that, that over the forty years from 1870 to 1910, the lion's share of cost reduction in American railroads was contributed by incremental changes in the design of freight cars and locomotives. One by one, these changes were small and barely noticed: most of them have origins that are unknown today. But over forty years they added up to a doubling of the effective power of locomotives and to a tripling of the capacity of freight cars. There is a similar pattern in the CAT scanner industry: only the explosion of incremental improvements and developments in the decade after invention made the CAT scanner a useful device rather than an intriguing toy.

How are incremental improvements made? Clearly they are made by those who are already very familiar with the technology and its uses. Without workers and managers with hands-on experience, the process of technology transfer and technological adaptation becomes impossibly difficult. The principle that hands-on experience is the best, and perhaps the only, way to develop expertise at the technologies of the industrial revolution, and indeed to develop the technologies themselves, is not limited to technologies narrowly embodied in machines. It applies to the "technologies" of modern business organization as well, to the Ford Motor Company's attempt to transplant mass production to Great Britain in the period during and after World War I as well as to the attempts of Japanese producers to transplant what is called "lean production" back to the United States in the 1980's.

It is worth noting that mass production had similar difficulties diffusing throughout the United States in the beginning. Only one firm-General Motors-could even come close to matching Ford's productivity levels in the 1920's and the 1930's, and General Motors found its transition to mass production eased by its ability to hire the production management team that had invented mass production at Highland Park as its individual members, one after the other, fell out of favor with Henry Ford.

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20 Century

Created 2/12/1997
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Associate Professor of Economics Brad DeLong, 601 Evans
University of California at Berkeley; Berkeley, CA 94720-3880
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