03 Oct 2009

Why Military Spending Didn’t Get Us Out of the Great Depression

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In a thread at ThinkMarkets, the ubiquitous question of WWII spending and the Great Depression came up. I realized that I don’t think I’ve ever succinctly summarized Bob Higgs’ research on this point. (I explain all of this in great detail in my book.)

OK so here is what the limited-government, anti-Keynesian is up against:

Well gee whiz, it sure looks like military spending got the US out of the Great Depression, doesn’t it? Sure, common sense tells you that directing scarce resources into tanks and bombers, and then shipping them overseas to get blown to smithereens, can’t possibly help the domestic economy. But the figures above don’t lie, right?

In a series of really first-class papers, Bob Higgs points out the problems with the conventional stats. First of all, GDP includes government expenditures. If we just look at the private component of GDP, we see a different story. (I can’t find the data right now, but I’m virtually certain that private sector GDP fell throughout the war years, and jumped way up in 1946.) So already we run into a methodological issue: If the government takes, say, $1 billion out of the hands of private citizens, and spends it on “$1 billion worth” of tanks and bombers, is that really just a change in the composition of total output? Isn’t there an objective sense in which $1 billion spent by millions of consumers corresponds to more “total output” than $1 billion spent by military procurement officers in a non-competitive process?

Yet it gets worse. A lot of the wartime expenditures were financed (perhaps indirectly) through the printing press. Just look at how much they jacked up the monetary base during the war; it’s shocking to anyone except Ben Bernanke.

Now normally, if the Fed printed up a bunch of money that allowed the government to spend billions (in nominal terms) on military equipment, that wouldn’t boost real GDP. Sure, nominal GDP would go up, since you tabulate it by counting up the actual dollar expenditures by everyone, including the government. But because of all the money printing, the prices of milk, eggs, bread, gasoline, and so forth would skyrocket. So because the CPI (or GDP deflator) would be changing so much, the “real GDP” figure would not (in theory) go up just because of Fed-financed war expenditures.

Ah here’s the great part: The government made it illegal for the CPI to go through the roof during the war years. And the ridiculous economic statisticians make no effort to adjust for this. In other words, they take the nominal expenditures during the war years at face value, and they take the statutory price schedules at face value.

So yes, if the Fed triples the monetary base in about six years, and for several of those years the government makes it illegal for prices to rise very quickly, then voila! You’ll see a big jump in “real Gross Domestic Product.” Woo hoo! Stones into bread!

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