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Slouching Towards Utopia?: The Economic History of the Twentieth Century

-XIX. Present at the Creation-

J. Bradford DeLong
University of California at Berkeley and NBER

February 1997


The end in the Great Depression of laissez faire--the idea that the government should keep its hands off of the economy--as a doctrine for guiding economic policy did not mean the end of the market economy as a social resource allocation mechanism. "Keynesianism" and the doctrine of the "mixed economy" that it supported emerged in the nick of time, soon became the ruling ideologies in the industrial core of the world economy, and provided North America and western Europe with a Keynesian escape route from what had seemed the insoluble crises of the interwar period.

The Keynesian escape route opened up key ground in the middle between fascist-style regimentation and socialist-style national planning. Keynes argued that the market economy and capitalist order could be salvaged, and salvaged by relatively minor reforms. An activist welfare-state government with a commitment to full employment had the tools to eliminate Great Depressions, and could put economies back onto the road to Utopia. If only governments would spend money freely (without raising taxes) in times when total demand was low, and raise taxes (without spending) in times when total demand was high, then fiuctuations in employment and production could be greatly reduced, and Great Depressions avoided.

Belief in this escape route was strongly reinforced by facts. Those countries that had tried it by accident during the Depression-had infiated early, printed money, ensured low interest rates, and run large budget deficits-managed to survive the Depression much more easily than others. World War II provided final proof, were any necessary--"vindication by Mars," as John Kenneth Galbraith calls it. Unemployment, called "structural" or "permanent" during the 1930s and seemingly-immune to the self-adjusting forces of the market as well as to the entire armament of the New Deal, vanished entirely in the 1940s. And the United States fought World War II without reducing civilian consumption: all of U.S. war production came from new capacity or from capacity that stood idle at the end of the 1930s.

Demand expansion--deliberate attempts by governments to put the unemployed back to work by deficit spending and loose-money low interest rate policies--was successful in the 1930s and 1940s. It put the unemployed back to work. It did not contain within itself the seeds of a renewed Great Depression. It did not explode into hyperinflation. The coming of "stablization policy" enlarged the policy steps that could be undertaken without forcing a definitive break with the market-capitalist order, and without forcing a choice between Hitler's way and Stalin's.

In retrospect, the effectiveness of accidently Keynesian policies of moderate expansion, infiation, and devaluation in the interwar period seems to some degree tied to the fact that they were the exception rather than the rule. They were effective in part because they were implemented in a context where the background assumption was one of gold standard discipline. The background assumption that defiation and adherence to the gold standard would be the rule ensured that "Keynesian" policies would be effective when tried, but it also ensured that they would not be systematically undertaken--for central bankers and politicians shared the same background assumption about how the world should work.

In later years--in the second and third post-World War II generation--tasks of macroeconomic management would prove harder, and the truth of the doctrines of Keynes's disciples less clear.

Another second important factor in making post-World War II economic reconstruction a success, a factor independent of the Keynesian revolution in economic policy, was the fact that post-World War II reconstruction was carried out in the shadow of the interwar period. The political and economic struggle between classes as it had been carried out in Europe between the wars had ended in complete disaster for all. Right-wing factions had wanted low wages, no welfare state, and stable prices; left-wing factions had wanted high wages and an extensive welfare state. The political and economic disruptions that this struggle generated led to fascism and Nazism. Hitler's rise had benefited no one.

Mainline politicians in the interwar period, whether social democrats looking forward to the implementation of the socialist Gotha Program or the Labour Party looking forward to the implementation of their Clause IV, or right-wing politicians interested in demolishing the embryonic welfare state, had looked forward to establishing their vision of what the distribution of wealth and the size of the government should be by overrunning the opposition. Mainline politicians after the interwar period were less interested in victory than in compromise, for they thought that compromise was necessary to avoid the possibility of political collapses like those that had led to fasciam, and economic collapses like the Great Depression.

The magnitude of the unemployment seen during the Great Depression also shifted politicians', industrialists', and bankers' beliefs about what the key goal of economic policy was. Before the Depression, the key goal was to maintain a stable currency and exchange rate. After the Depression, the overall level of employment became of prime importance: the magnitude of the employment shortfall of the 1930's created strong pressure in the 1940's and after to fulfill labor's agenda first. Somewhat to their surprise, entepreneurs and the owners and managers of real capital--industry--found that they had gained, not lost, from the new emphasis on high employment. For high employment means high capacity utilization. And as long as high employment was guaranteed, unions and liberals were not eager to engage in struggles for control of the workplace. Rather than seeing tight labor markets erode profit margins by raising wages, owners of property saw high demand spread fixed costs out over more commodities and so increase profitability.

Christian and social democracy, the twin political powers of the post-World War II world, thus avoided many of the class-confiict based dilemmas of the interwar and pre-World War I period because the shock of the Great Depression had shifted politics from a concern over redistribution to a concern over production. All would lose heavily from another Great Depression. And so it seemed much more worthwhile to compromise, and to pursue policies that would enlarge the pie to be distributed rather than for either side--either the left or the right--to engage in substantial redistribution.

For all parties the post-World War II mission became, in Charles Maier's words, "one of expanding aggregate economic performance and eliminating poverty by enriching everyone, not one of redressing the balance among economic classes or political parties.The true dialectic was not one of class against class, but waste versus abundance."

It is hard to argue that anyone made a mistake in accepting the "mixed economy." It consisted of market capitalism, buttressed by both a public commitment to Keynesian policies to maintain full employment and an expanded social insurance system. Had either owners or workers held out for more, they might well have ended up with far less. How far down must one go in the income distribution to find citizens of the United States or West Germany who are worse off today, in a material sense, than the average citizen of Czechoslovakia?

To make this point another way, the lowest 80% of the population generally receive about 50% of the income. To reduce the excess share of the top 20% by two-thirds-from 50% to 30% of income-would raise the average income of the bottom eighty percent of the income distribution by only two-fifths. But this is smaller than the difference between the U.S. and France, or between Canada and Australia, or between Venezuela and Brazil. This is a difference that is made up in twenty years of economic growth at the post-World War II pace. Thus the question:

is upsetting the political and economic order of the industrial west worthwhile in order to attain a given level of wealth for the median citizen twenty years early? And can the order be transformed without losing more than 20 years' of growth in the uproar.

The social democratic answer since World War II has been that it is probably not worthwhile. Given the track record of the revolutions that have occurred in the twentieth century, this position appears crrect. Certainly communist revolutions have established régimes that have destroyed far more wealth than the property-owning strata at the top of industrial market economies have exacted. Overturning the political and economic structure of the industrial west, and replacing it with a large bureaucracy, can seem a possibly worthwhile goal if market capitalism cannot deliver economic growth. Not otherwise.

The fact that the Great Depression was the major impetus for the leftward shift from a laissez-faire to a more managed "mixed" economy had an impact on the form of the post-World War II welfare state. In Europe the mixed economy had a somewhat egalitarian bent: it was to level the income distribution as well as insure citizens against the market. In America the major welfare state programs were sold as "insurance" in which individuals on average got what they paid for. They were not tools to shift the distribution of income. Social Security made payments that were proportional to earlier contributions. The pro-labor Wagner Act framework that set up the National Labor Relations Board was of most use to relatively skilled and well-paid workers with secure job attachments who could use the legal machinery to share in their industries' profits. And the degree of progressiveness in the income tax was always limited.

Thus the fact that the expansion of the welfare state took place in the wake of the Great Depression when everyone felt threatened by the possibility of unemployment (rather than through social democratic election victories in normal times) had a strong impact on the substance of the mixed economies. It severely limited the redistributive content of welfare states, for the pro-welfare state coalition that ensured liberal political dominance in the years after World War II was focused not on working class, egalitarian but on middle class, social insurance concerns.

The Post-World War II Settlement: The United States

In America, the 1946 Employment Act declared that it was the "continuing policy and responsibility" of the federal government to "coordinate and utilize all its plans, functions, and resources... to foster and promote free competitive enterprise and the general welfare; conditions under which there will be afforded useful employment for those able, willing, and seeking to work; and to promote maximum employment, production, and purchasing power". The Act committed the federal government to the business of macroeconomic management. Laws that establish goals can and do serve as markers of changes in opinions, perceptions, and aims. When people then speak of the effects of such a law, in many cases they are using "the law" as a shorthand marker to describe changes in the hearts and the minds of the people. Whether the goal is achieved or pursuit of the goal effects and constrains public policy depends on the depth of the change in hearts and minds.

The Employment Act of 1946 marked the commitment of the federal government to the macroeconomic management business.

The largest shift in policy marked by the 1946 Employment Act is the post-WWII practice of allowing the government's automatic stabilizers to function. Not since the Great Depression have mainstream legislators or opinion leaders called for fiscal austerity in the midst of recession. As a result, the federal government's budget exhibits substantial cyclical variation, sliding into deeper deficit in recessions, and moving toward balance or into surplus as the economy expands.

In political discourse the argument has been the federal deficit in time of recession is "cyclical," and that steps to reduce it immediately would aggravate the recession, have been effective trump cards in public policy debates. Since World War II this argument has kept policy makers from seeking budget balance when unemployment is high.

The gap between this calm acceptance of automatic stabilizers and cyclical fiscal deficitsand pre-WWII attitudes is very large. Recall that Franklin Roosevelt made Herbert Hoover's failure to balance the federal budget in 1932 an issue in the 1932 presidential election. Or consider Joseph Schumpeter (in Brown, 1934), writing from Harvard in the middle of the Great Depression that there was a:

presumption against remedial measures [because] policies of this class are particularly apt toproduce additional trouble for the future.... [For depressions are] not simply evils, which we might attempt to suppress, butforms of something which has to be done, namely, adjustment tochange... [and] most of what would be effective in remedying a depression would be equally effective in preventing this adjustment...

The shift in the cyclical behavior of the federal budget, considered as a sea-anchor for the economy's level of total spending, is impressive. A good deal of this increase comes from the increase in the size of the government as a share of national product. The post-WWII federal government taxes and spends one-sixth or more of national product in peacetime. The Depression-era government taxed 5 to 7 percent and spent 8 to 10 percent of national product. The pre-Depression government taxed and spent at most 5 percent, and more typically 2 of national product in peacetime. With a large federal government, automatic stabilizers are significant. If revenues are one-fifth of national product, a 5-percent fall in output relative to previous forecasts would "automatically" produce a deficit of 1 percent of national product from the revenue side alone, even in the absence of overall progressivity. When, as before the Great Depression, both spending and revenues are 5 percent of national product or less, "automatic stabilizers" cannot have any macroeconomic significance.

The pre-WWI era shows no signs of stabilizing fiscal policy. The interwar period shows a degree of stabilization: a 5 percentage-point increase in the unemployment rate is associated with a 1.6 percentage-point increase in the deficit as a share of national product. And the post-World War II period shows the greatest cyclical responsiveness of fiscal balance to unemployment. A 5 percentage-point increase in the unemployment rate is associated with a 4.5 percentage-point increase in the federal deficit as a share of national product.

Looking back at the budget since World War II, it is difficult to argue that on balance "discretionary" fiscal policy has played any stabilizing role. The difficulty is that recessions are not expected, are not forecasted, and develop rapidly. Economic policy makers work with shaky data from one quarter or so in the past. Enacting legislation takes two or three quarters if not two to three years. Appropriated funds require two additional quarters before they are spent on any substantial scale. And by that time the "need" for stimulus has passed. The U.S. government lacks the knowledge to design and the institutional capacity to execute a countercyclical discretionary fiscal policy in response to any macroeconomic cycle of shorter duration than the Great Depression itself.

Whether the fall in nominal monetary aggregates during the slide into the Great Depression is best seen as a mistake of monetary policy or as a shortfall in demand for money is an old and unresolvable argument: it turns on theological disputes as to the definition of a policy. However, the same shifts in opinion and sentiment that made Congress announce in 1946 that macroeconomic stabilization was "the continuing responsibility and policy" of the federal government have also led the post-WW II Federal Reserve to make monetary policy with an eye not just on price stability but on a whole host of other factors as well. It is impossible to believe that the United States would ever see a repeat of the 1929-1933 experience, during which the Federal Reserve largely ignored the fall in monetary aggregates because it saw money and credit as "easy" in the sense that credit-worthy borrowers (of whom there were very few by 1933) could still borrow at very low nominal (but high real) rates of interest.

The post-Great Depression settlement in the United States also included a central place for labor unions. In 1919, union membership in America was some 5 million. It fell to a trough of perhaps 3 million by Roosevelt's inauguration in 1933, and then grew to 9 million by the end of 1941 and to some 17 million or so by the inauguration of Eisenhower in 1933. Before the mid-1930s there were very few employers who were not strongly opposed to unions: employers would compile and circulate "blacklists" of union organizers, hire permanent replacements for striking workers, refuse to hire known union workers, and refuse to negotiate with unions.

From 1933 to 1937 organizing unions became easier--in spite of high unemployment--because of the solid swing of the political system to the Democrats. The federal government was no longer an anti, but a pro-union force. And the government took action in the form of the Wagner Act, which established the National Labor Relations Board which monitored and greatly limited the ability of antiunion employers to punish union organizers and members. During World War II the extremely tight labor maket of the war years gave a further upward push to union membership. After World War II union membership remained high. The Wagner Act established, and the Taft-Hartley Act after World War II did not eliminate, substantial obstacles to union-busting by employers. Employers in large mass-production industries learned to value the mediation between bosses and employees that could be provided by unions. And workers learned to value the above-market wages that a union shop could negotiate.

The shift in economic policy across the Great Depression in the U.S. was mirrored by shifts in policy in other western European countries. The U.S. provided substantial carrots--as well as a highly-admired example--for western Europeans to remake their economies in a more American pattern. In the post-WWII period, the U.S. took on the responsbilities of global economic leadership.

U.S. Economic Leadership: The Marshall Plan

[T]he world of suffering people looks to us for leadership. Their thoughts, however, are not concentrated alone on this problem. They have more immediate and terribly pressing concerns where the mouthful of food will come from, where they will find shelter tonight, and where they will find warmth. Along with the great problem of maintaining the peace we must solve the problem of the pittance of food, of clothing and coal and homes. Neither of these problems can be solved alone.

--George C. Marshall, November 1945

Can you imagine [the plan's] chances of passage in an election year in a Republican congress if it is named for Truman and not Marshall?

--Harry S Truman, October 1947


The post-World War II reconstruction of the economies and polities of Western Europe was an extraordinary success. Growth was fast, distributional conflicts in large part finessed, world trade booming. The stability of representative democracies in Western Europe made its political institutions the envy of much of the world. The politicians who in the post- World War II years laid the foundations of the postwar order had good warrant to be proud. They were, as Truman's Secretary of State Dean Acheson put it in the title of his memoirs, Present at the Creation of an extraordinarily successful set of political and economic institutions.

A sizeable--but not overwhelming--part of the credit for Europe's successful post-WWII reconstruction belongs to acts of statesmanship: the Marshall Plan and other initiatives that significantly sped Western European growth by altering the environment in which economic policy was made. In the immediate aftermath of World War II politicians who recalled the disasters of the Great Depression were ill-disposed to "trust the market," and eager to embrace regulation and government control. Had European political economy taken a different turn, post-World War II European recovery might have been hobbled by clumsy allocative bureaucracies that rationed scarce foreign exchange and placed ceiling prices on exportables to protect the consumption of urban working classes.

Yet in fact the Marshall Plan era saw the creation of the social-democratic "mixed economy": the restoration of price freedom and exchange rate stability, and the reliance on market forces within a context of some public ownership and a great deal of public demand management. To some degree the creation of the social-democratic mixed economy came about because and no one in Europe wanted a repeat of interwar experience; to some degree it came about because the governments in power believed that the "mixed economies" they were building should have a strong pro-market orientation, and Marshall Plan aid gave them room to maneuver in order to carry out their intentions--without such aid, they would have soon faced a harsh choice between contraction to balance their international payments and severe controls on admissible imports--to some degree it came about because Marshall Plan administrators it pressured European governments to decontrol and liberalize their economies in an American mold even when they wished to do otherwise.

Without the Marshall Plan, the pattern of post-World War II European political economy might might well have resembled the overregulation and relative economic stagnation of post-World War II Argentina, a nation that has dropped from First to Third World status in two generations. Or post-World War II Europe might have replicated the financial instability-alternate episodes of inflation and deflation-experienced by much of Europe in the 1920's as interest groups and social classes bitterly struggled over the distribution of wealth and in the process stalled economic growth. This is not to say that post-World War II Western Europe was a laissez faire economy. Post World War II European welfare states are among the most extensive in history.

In contrast to the post-World War II era, after World War I European reconstruction had been a failure. Alternating inflation and deflation retarded recovery. Growth had been slow, distributional conflicts had been bitter, and the network of trade fragile and stagnant. Representative government had been tried and rejected by all save a handful of European nations.

In contrast to post-WWII Europe, the experience of post-WWII Latin America--especially Argentina--is also one of relative economic failure. Before the war, Argentina had been as rich as Continental Europe. In 1913 Buenos Aires was among the top 20 cities of the world in telephones per capita. In 1929 Argentina had been perhaps fourth in density of motor vehicles per capita, with approximately the same number of vehicles per person as France or Germany. Argentina from 1870­1950 was a country in the same class as Canada or Australia. Yet after World War II, Argentina grew very much more slowly than France or Germany, rapidly falling from the ranks of the First World to the Third. Features of the international economic environment affecting Argentina as well as Europe--the rapid growth of world trade under the Bretton Woods system, for example--do not explain the latter's singular stability and rapid growth.

In the immediate aftermath of World War II, it was not clear that western Europe would utilize market mechanisms to coordinate economic activity. Belief in the ability of the market to coordinate economic activity and support economic growth had been severely shaken by the Great Depression. Wartime controls and plans, while implemented as extraordinary measures for extraordinary times, had created a governmental habit of control and regulation. Seduced by the very high economic growth rates reported by Stalin's Soviet Union and awed by its war effort, many expected centrally-planned economies to reconstruct faster and grow more rapidly than market economies.

Memory of the Great Depression was fresh, and countries relying on the market were seen as likely to lapse into a period of underemployment and stagnation. A not uncommon judgment was that, in the words of Paul Sweezy, "the socialist sector of the world would [after World War II] quickly stabilize itself and push forward to higher standards of living, while the imperialist sector would flounder in difficulties": history was expected to dramatically reveal the superiority of central planning.

British historian A.J.P. Taylor spoke in 1945 of how "nobody in Europe believes in the American way of life--that is, in private enterprise; or rather those who believe in it are a defeated party--a party which seems to have no more future."

Moreover, it seemed at least an even bet that the United States would withdraw from Western Europe. The U.S. government had done so after World War I, when the cycles of U.S. politics had led to the erosion of the internationalist Wilson administration and the rise to dominance of a Republican isolationist Congress. The same pattern appeared likely after World War II: Republican Congressional leader Robert Taft, the dominant figure in the Senate after the election of 1946, was extremely isolationist in temperament. By all indications, the American commitment to relief and reconstruction was limited. The Truman administration was internationalist, but weak. Congressional critics called for balanced budgets. The 1946 Congressional elections were a disaster for the Democratic Party.

Considerable economic aid had been extended to Europe from the U.S. after World War I, first by the Herbert Hoover-led relief and reconstruction effort and then by private capital speculating on a restoration of monetary stability. Post-World War I reconstruction loans had been sold as sound private investments. They did not turn out to be so. Seymour Harris calculated that in present value terms nearly half of American private investments in Europe between the wars had been lost. Once burned, twice shy. With strong Communist parties in Italy and France, a nationalization-minded Labour government in Britain, and a Germany once again pressed for reparations transfers, capital flows from American investors gambling on European recovery and political stability seemed unlikely.

Nevertheless, within two years after the end of the war it became U.S. government policy to build up Western Europe politically, economically, and militarily. The Truman Doctrine inaugurated the policy of "containment" of the Soviet Union. Included in the Doctrine was a declaration that containment required steps to quickly regenerate economic prosperity in Western Europe. And as columnist Richard Strout wrote, "one way of combating Communism is to give western Europe a full dinner pail."

Employing Secretary of State George C. Marshall's reputation as the architect of military victory in World War II, conservative fears of the further extension of Stalin's empire, and a political alliance with influential Republican Senator Arthur Vandenberg, Truman and his administration outflanked isolationist and anti-spending opposition and maneuvered first the Truman Doctrine, then the Marshall Plan, and then an open-ended commitment through NATO to the defense of Europe through Congress.

In the first two post-World War II years the U.S. contributed about four billion dollars a year to relief and reconstruction through UNRRA and other programs. The Marshall Plan continued these flows at comparable rates and was a multi-year commitment. From 1948 to 1951, the U.S. contributed $13.2 billion to European recovery. $3.2 billion went to the United Kingdom, $2.7 billion to France, $1.5 billion to Italy, and $1.4 billion to the Western-occupied zones of Germany that would become the post-World War II Bundesrepublik.



Two years after the end of the war, coal production in Western Europe was still below levels reached before or during the war. German coal production in 1947 proceeded at little more than half of the pre-World War II pace. Dutch and Belgian production was 20 percent below, and British 10 percent below, pre-World War II 1938 levels. Demands for coal for heating reduced the continent's capacity to produce energy for industry. During the cold winter of 1946-47 coal earmarked for industrial uses had to be diverted to heating. Coal shortages led to the shutdown of perhaps a fifth of Britain's coal-burning and electricity-using industry in February 1947.

Western European industrial production in 1946 was only 60 percent, and in 1947 only 70 percent, of the pre-World War II norm.

Western Europe in 1946-47 had four-fifths its 1938 supply of food. Its population had increased by twenty million--more than a tenth--even after accounting for military and civilian deaths. Traditionally, Western Europe had exported industrial and imported agricultural goods from Eastern Europe, the Far East, and the Americas. Now there was little prospect of rapidly restoring this international division of labor. Eastern European nations adopted Russian-style central planning and looked to the Soviet Union for economic links. Industry in the United States and Latin America had expanded during the war to fill the void created by the cessation of Europe's exports. Imports of food and consumer goods for relief diverted hard currency from purchases of capital goods needed for long-term reconstruction.

Changes in net overseas asset positions reduced Western Europe's annual earnings from net investments abroad. Britain had liquidated its entire overseas portfolio in order to finance imports during the war. The reduction in invisible earnings reduced Western Europe's capacity to import by approximately 30 percent of 1938 imports. The movement of the terms of trade against Western Europe gave it in 1947-48 32 percent fewer imports for export volumes themselves running 10 percent below pre-World War II levels; higher export volumes might worsen the terms of trade further. The net effect of the inward shift in demand for exports and the collapse of the net investment position was to give Europe in 1947-8 only 40 percent of the capacity to import that it had possessed in 1938.

By contrast, after World War I Europe's external position had been much more favorable.

Thus Europe after World War II was in worse economic shape than it had been after World War I. Another episode of financial and political chaos like that which had plagued the Continent following World War I appeared likely. U.S. State Department officials wondered whether Europe might be dying--like a wounded soldier who bleeds to death after the fighting. State Department memoranda in 1946-7 presented an apocalyptic vision of a complete breakdown in Europe of the division of labor-between city and country, industry and agriculture, and between different industries themselves.

A Communist political triumph was seen as a definite possibility.

Yet the pace of post-World War II recovery soon surpassed that which followed World War I. As figure 4 shows, by 1949 national income per capita in Britain, France, and Germany had recovered to within a hair of pre-war levels.

By 1951, six years after the war and at the effective end of the Marshall Plan, national incomes per capita were more than 10 percent above pre-war levels. Measured by the yardstick of the admittedly imperfect national product estimates, the three major economies of Western Europe had achieved a degree of recovery that post-World War I Europe had not reached in the 11 years separating World War I from the Great Depression.

Post-World War II recovery dominated post-World War I recovery by other economic indicators as well: in steel, cement, and coal production. The recovery of coal production after World War II also outran its post-World War I pace by a substantial margin, even though coal was seen as in notoriously short supply in the post-World War II years. By contrast, the recovery of coal production after World War I was erratic. Coal production declined from 1920 to 1921--falling from 83 percent of pre-World War I levels in 1920 to 72 percent in 1921--as a result of the deflation imposed on the European economy by central banks that sought the restoration of pre-World War I gold standard parities, accepted the burden of deflation, and allowed the 1921 recession in the United States to be transmitted to their own countries. After World War II, no central bank or government pursued monetary orthodoxy so aggressively to roll back price and wage increases and preserve the real wealth of rentiers. Coal production fell again in 1923-1924, when the French army occupied Germany's Ruhr valley because reparations were not being delivered fast enough. And coal production fell in 1925-26, when the aftermath of Britain's return to gold put heavy pressure to lower wages on Britain's coal producers, and triggered first a coal and then a brief general strike.

Thus the major factors hindering a rapid post-World War I recovery were not strictly economic but social and political. Post-World War I Europe saw the recovery of output repeatedly interrupted

by political and economic "wars of attrition" between contendng classes and interests. In the aftermath of World War I, the distribution of wealth both within and between nations, the question of who would bear the burden of postwar adjustment, and the degree to which government would act to secure the property of the rentier were all unresolved issues. Social classes, political factions, and nation-states saw that they had much to lose if they did not aggressively promote their claims for favorable redistribution. And much of the social and economic history of interwar Europe is the history of such "wars of attrition," in which fiscal, financial, monetary, and labor relations instability--and concomitant slow economic growth--were trials of strength over who would succeed in obtaining a favorable redistribution of wealth.

After World War II such "wars of attrition" were less virulent. Memories of the disastrous consequences of the aggressive pursuit of redistributional goals during the interwar period made moderation appear more attractive to all. The availability of Marshall Plan aid to nations that had accomplished stabilization provided a very strong incentive to compromise such distributional conflicts early, and gave European countries a pool of resources that could be used to cushion the wealth losses sustained in restructuring.

Post-World War II reconstruction did more than return western Europe to its previous growth path. French, Italian, Low Countries, and West German growth during the post-World War II boom raised national product per capita at rates that far exceeded pre-World War II, pre-1929, or even pre-1913 trends. The reconstruction after World War II appears to have created economies capable of dynamic economic growth an order of magnitude stronger than had previously been seen in Europe. Postwar Europe saw "supergrowth," as Charles Kindleberger has termed it.

Yet a Latin American country like Argentina, as rich in the years before and immediately after World War II as industrial Western Europe, grew slowly even under the post-World War II expansionary Bretton Woods regime. Fast post-World War II growth and catchup to American standards of productivity were to a large degree specific to Western Europe, and thus to the countries that received Marshall Plan aid.

Marshall Plan dollars did affect the level of investment: countries that received large amounts of Marshall Plan aid invested more. Eichengreen and Uzan (1991) calculate that out of each dollar of Marshall Plan aid some 65 cents went to increased consumption and 35 cents to increased investment. The returns to new investment were high. Eichengreen and Uzan's analysis suggests that social returns may have been as high as 50 percent a year: an extra dollar of investment raised national product by 50 cents in the subsequent year.

Another channel through which Marshall Plan aid stimulated growth was by relaxing foreign exchange constraints. Marshall Plan funds were hard currency in a dollar-scarce world. After the war, coal, cotton, petroleum, and other materials were in short supply. The Marshall Plan allowed them to be purchased at a higher rate than would have been possible otherwise. Marshall Plan dollars added to Europe's international liquidity and played a role in restoring intra-European trade.

A live possibility in the absence of the Marshall Plan was that governments would not stand aside and allow the market system to do its job. In the wake of the Great Depression, many still recalled the disastrous outcome of the laissez-faire policies then in effect. Politicians were predisposed toward intervention and regulation: no matter how damaging "government failure" might be to the economy, it had to be better than the "market failure" of the Depression. Had European political economy taken a different turn, post-World War II European recovery might have been stagnant. Governments might have been slow to dismantle wartime allocation controls, and so have severely constrained the market mechanism.

An alternative scenario would have seen the maintenance and expansion of wartime controls in order to guard against substantial shifts in income distribution. The late 1940's and early 1950's might have seen the creation in Western Europe of allocative bureaucracies to ration scarce foreign exchange, and the imposition of price controls on exportables in order to protect the living standards of urban working classes--as happened in Latin America, which nearly stagnated in the two decades after World War II.

In the absence of the Marshall Plan, might have Western Europe followed a similar trajectory? In Carlos Díaz-Alejandro's estimation, four factors set the stage for Argentina's relative decline: a politically-active and militant urban industrial working class, economic nationalism, sharp divisions between traditional elites and poorer strata, and a government used to exercising control over goods allocation that viewed the price system as a tool for redistributing wealth rather than for regulating the pattern of economic activity.

From the perspective of 1947, the political economy of Western Europe would lead one to think that it was at least as vulnerable as Argentina to economic stagnation induced by populist overregulation.

The war had given Europe more experience than Argentina with economic planning and rationing. Militant urban working classes calling for wealth redistribution voted in such numbers as to make Communists plausibly part of a permanent ruling political coalition in France and Italy. Economic nationalism had been nurtured by a decade and a half of Depression, autarky and war. European political parties had been divided substantially along economic class lines for two generations.

Yet Europe avoided this trap. After World War II Western Europe's mixed economies built substantial redistributional systems, but they were built on top of and not as replacements for market allocations of goods and factors. Just as post-World War II Western Europe saw the avoidance of the political-economic "wars of attrition" that had put a brake on post-World War I European recovery, so post-World War II Western Europe avoided the tight web of controls that kept post-World War II Argentina from being able to adjust and grow.

Financial instability was pervasive in post-World War II Europe. Governments responded to inflation by retaining controls, prompting the growth of black markets. The post-World War II food shortage reflected not merely bad weather in 1947 but the reluctance of farmers to deliver food to cities. Moreover, manufactured goods farmers might have purchased remained in short supply. Manufacturing enterprises had the same incentive to hoard inventories. As long as food shortages persisted, workers had little ability--or incentive--to devote their full effort to market work.

The market-oriented solution to the crisis was straightforward. Prices had to be decontrolled to coax producers to bring their goods to market. Inflation had to be halted for the price mechanism to operate smoothly and to encourage saving and initiative. Budgets had to be balanced to remove inflationary pressure. With financial stability restored and market forces given free reign, individuals could direct their attention to market work.

For budgets to be balanced and inflation to be halted, however, political compromise was required. Consumers had to accept higher posted prices for foodstuffs and necessities. Workers had to moderate their demands for higher wages. Owners had to moderate demands for profits. Taxpayers had to shoulder additional liabilities. There had to be broad agreement on a "fair" distribution of income, or at least on a distribution of the burdens that was not so unfair as to be intolerable. Only then could pressure on central banks to continually monetize budget deficits and cause either explicit or repressed inflation be removed.

Here the Marshall Plan may have played a critical role. It did not obviate the need for sacrifice. But it increased the size of the pie available for division among interest groups. Two-and-a-half percent--Marshall Plan aid as a share of recipient GDP--was not an overwhelmingly large change in the size of the pie. But if the sum of notional demands exceeded aggregate supply by five or seven-and-a-half percent, Marshall Plan transfers could reduce the sacrifices required of competing distributional interests by a third or as much as a half.

Moreover, its potential availability if the government's stabilization plan met the criteria required by Plan administrators provided a powerful incentive for governments to impose financial discipline. With Marshall Plan aid available, the benefits for quick resolution of "wars of attrition" were greater, and so the Plan in all likelihood advanced the date of financial stabilization. While internal price stabilization after World War II took four years, the German hyperinflation took place in the sixth year after the end of World War I, and France's post-World War I inflation lasted for eight years.

In some instances the U.S. insisted that Marshall funds be used to buttress financial stability. Britain used the bulk of its counterpart funds to retire public debt. Vincent Auriol claims that the U.S. refused to release French counterpart funds in 1948 until the new government affirmed its willingness to continue policies leading to a balanced budget. French officials were outraged: nevertheless, they took steps to obtain release and raised taxes. Moreover, counterpart funds were only one of several available levers. Plan administrators believed that if governments could afford to divert funds from reconstruction to social services, Marshall aid could be eliminated proportionately. Britain lost its Marshall Plan timber line item as a result of the government's entry into the construction of public housing. West Germany found the release of counterpart funds delayed until the nationalized railway had reduced expenditures to match revenues.

Renewed growth required, in addition to financial stability, the free play of market forces. Though there was support for the restoration of a market economy in Western Europe, it was far from universal. Wartime controls were viewed as exceptional policies for exceptional times, but it was not clear what was to replace them. Communist and some Socialist ministers opposed a return to the market. It was not clear when, or even if, the transition would take place.

On this issue the Marshall Plan left Western Europeans with no choice. Each recipient had to sign a bilateral pact with the United States. Countries had to agree to balance government budgets, restore internal financial stability, and stabilize exchange rates at realistic levels. Marshall plan aid was available only if Europe was committed to the "mixed economy" with the market playing a large part in the mix.

The demand that European governments trust the market came from the highest levels of the Marshall Plan administration. Secretary of State Dean Acheson described the chief Marshall Plan administrator, Paul Hoffman, as an "economic Savonarola." Acheson describes watching Hoffman "preach his doctrine of salvation by exports" to British Foreign Secretary Ernest Bevin. "I have heard it said," wrote Acheson, "that Paul Hoffman missed his calling: that he should have been an evangelist. Both parts of the statement miss the mark. He did not miss his calling, and he was and is an evangelist."

Post-World War II Europe was very far from laissez faire. Government ownership of utilities and heavy industry was substantial. Government redistributions of income were large. The magnitude of the "safety nets" and social insurance programs provided by the post-World War II welfare states were far beyond anything that had been thought possible before World War I. But these large welfare states were accompanied by financial stability, and by substantial reliance on market processes for allocation and exchange.

The Post-WWII Settlement in Western Europe: NATO, Cold War, and Prosperity

The Marshall Plan was followed by the Korean War. And the Korean War had important long-run consequences for U.S. relations with Europe. As a result of the Korean War, by the middle of the 1950s there was a full U.S. army--corps, divisions, airwings, and the standard enormous logistical tail--sitting in West Germany waiting for Stalin's successors to attempt in Germany what Stalin, Mao, and Kim Il Sung had attempted in Korea: the reunification by force of a country that had been divided in the armistice that ended World War II. Stalin's successors were largely unknown: the only solid thing about them was that they had flourished under Stalin and shot a couple of their own number in the power struggle that followed Stalin's death.

Stalin had exhibited a taste for snatching up territory when he thought it could be taken cheaply--starting with the suppression of the Mensheviks in Georgia, including the annexation of Moldova, Latvia, Lithuania, and Estonia. That Western Germany could probably not be snatched up cheaply was not wholly reassuring, because Stalin had also exhibited a certain degree of bad judgment: in addition to allowing Kim Il Sung to launch the Korean War, there was the unsuccessful attack on Finland in 1939 and the mother of all miscalculations, the belief that the way to deal with Hitler was to become his ally and then watch Nazi Germany and the western democracies exhaust themselves in trench warfare. Perhaps Stalin's successors would exhibit a similar appetite for conquest on the cheap, and a similar weak grasp of geopolitical realities.

So by the mid-1950s a full U.S. army was sitting in Western Germany as a deterrent. And the U.S. was spending on a relatively large scale to project its Cold War military power beyond its borders. Roughly three-quarters of a percent of U.S. national product in the mid 1950s was "net military transactions"--expenditures abroad by the U.S. army which generated no dollar inflow.

As the figure above shows, the increase in net U.S. military transactions partially offset the winding-down of the Marshall Plan. Thus the forces of the Supreme Allied Commander, Europe, provided one secure source of demand for European production during Europe's boom in the 1950s.

And boom in the 1950s the European economy certainly did.

Post-WWII Success

One way to think about the post-World War II settlement, and the contrast with the interwar period, is as a coordination problem. Labor, management and government in Europe could, in effect, choose to try to maximize their current share of national income--as after World War I. Inflation, strikes, financial disarray, cyclical instability and productivity problems can all be seen as corollaries of this equilibrium.

Alternatively, the parties could trade current compensation for faster long-term growth and higher living standards, even in present-value terms. Workers would moderate their wage demands, management its demands for profits. Government agreed to use demand management to maintain employment in return for wage restraint on the part of unions. Higher investment and faster productivity growth could ensue, eventually rendering everyone better off.

Such a "social contract" is advantageous only if it is generally accepted. If workers continued to aggressively press for higher wages, management had little incentive to plow back profits in return for the promise of higher future profits. If management failed to plow back profits, workers had little incentive to moderate current wage demands in return for higher future productivity and compensation. If labor relations were conflictual rather than harmonious, productivity would be the casualty. The post-WWII reconstruction shifted Europe onto this "social contract" equilibrium path, for once workers and management began coordinating on the superior equilibrium they had no obvious reason to stop--at least not until the mid 1970s.

U.S. aid policy after WWII encouraged European governments to pursue investment-friendly policies. Productivity soared in the wake of financial stabilization and the advent of the Marshall Plan. The advantages of the cooperative equilibrium were suddenly clear. Within the group of reconstructing nations, those where the United States had most leverage had the fastest-growing economies. Within Europe United States influence was strongest in Germany, weaker in France and Italy, and weakest in Britain. In the post-World War II period the German economy was the most successful, the British economy least. And Japan, where General MacArthur was America's proconsul, is the extreme example that proves the rule.

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Created 2/12/1997
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Associate Professor of Economics Brad DeLong, 601 Evans
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