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

I Introduction

J. Bradford DeLong
University of California at Berkeley and NBER

March 1997, draft 2.00

J. Bradford DeLong is an associate professor of economics at the University of California at Berkeley, the co-editor of the Journal of Economic Perspectives, a research associate of the National Bureau of Economic Research. He has also served the U.S. government as deputy assistant secretary for economic policy in the Department of the Treasury.
 
 

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The Millennial Perspective:

Three thousand years from now--to pick a number out of the air--world history survey courses will spend at most a single session on the twentieth century. And in that single session the teacher will try frantically and hastily to cover five points:

The twentieth century's history is overwhelmingly economic history.
The twentieth century has seen humankind's material wealth explode beyond all previous imagining.
The twentieth century has seen more brutal and more barbaric tyrannies than any previous century; moreover, its tyrannies have had their roots in economic ideologies and economic disconents.
The twentieth century has seen vast and growing relative economic gulfs between national economies: our world is more unequal today than ever before.
Economic policy in the twentieth century has been, to put it politely, inept.
Let me expand these five points:

The history of the twentieth century is overwhelmingly economic history.
Other centuries have other kinds of history. The history of the 1750-1850 century is primarily political: the American and French Revolutions and their consequences. The history of the fifteenth century is primarily cultural: in Europe the Renaissance, in China the flourishing under the Ming Dynasty. The history of the seventh century is primarily religious: the birth of Islam.

But the history of the twentieth century is primarily economic.

In the past humanity's economy--how people make, distribute, and consume the necessities and conveniences of their lives--changed at a glacial pace from decade to decade or century to century. The economic level of human activity provided the background for the rest of history. Perhaps in the very long run the economy was the material base on which the rest depended. But more that was interesting seemed to happen in political, cultural, religious, or intellectual history, where changes moved at a more rapid pace.

In the twentieth century, however, the pace of economic change has been so great as to shake the rest of history to its foundation. For perhaps the first time the making and using the necessities and conveniences of daily life--and how production, distribution, and consumption changed--was the driving force behind a single century's history.

The twentieth century has seen the material wealth of humankind explode beyond all previous imagining.
There had been much technological progress before the industrial revolution of the eighteenth and nineteenth centuries. The windmills, dikes, fields, crops, and animals of Holland in 1700 were very different from the marshes of 700. The ships that docked at the Chinese port of Canton had much greater range and the commodities loaded on and off them had much greater value in 1700 than in 700.

But pre-industrial technological progress led to little improvement in the standard of living of the average human: improvements in technology and productive power raised the numbers of the human race, not its material standard of living. And the pace of technological change was relatively slow. Historians write of the centuries that it took the horse collar, or the heavy plough, to diffuse throughout western Europe.

The eighteenth and nineteenth centuries saw change. For the first time technological capability outran population growth and natural resource scarcity. Manufacturing overtook agriculture as the major location of employment. For the first time ever food production made up less than half of total economic porduct. And by the last quarter of the nineteenth century the average inhabitant of a leading economies--a Briton, a Belgian, a Netherlander, an American, a Canadian, or an Australian--had perhaps three times the material wealth and standard of living of the typical inhabitant of a pre-industrial economy.

Thus standards of living did rise in the eighteenth and nineteenth centuries. But they did ont rise by much. Economic historians today debate whether the average British worker in 1850 was 75% better off than in 1750, or only 25% better off.

However, standards of living have exploded in the twentieth century.

What took a worker in 1890 an hour to produce takes an a worker in a leading economy today only seven minutes: by this measure we today have some eight times the material prosperity of our counterparts of a little more than a century ago. But such a calculation is a substantial underestimate of the boost to productivity and material prosperity of the past century. We today are better at making the goods of a century ago, but we also have the technological capability to make an enormously expanded range of goods and services: from videocassettes and antibiotics to airplane flights and plastic bottles.

We today would feel--would be--enormously impoverished if our incomes and prices remained the same, but if we were forbidden to use any commodity not produced in 1890. This expansion in the range of what we can make is an enormous additional multiplier of material well-being. Are we sixteen? thirty-two? sixty-four times as rich in a material sense as our predecessors of the late nineteenth century?

The magnitude of the growth in material wealth has been so great as to make it nearly impossible to measure. If you want a single number for the twentieth century, a thirty-fold increase--a 3000% increase, compared to the 25% to 75% increase in standards of living in the century around 1800--will do. But the qualitative gap is so great that the quantitative question hardly has meaning.

This explosion of material wealth is the most important piece of the history of the twentieth century. Toward the end of the nineteenth century the British historian Thomas Babington Macaulay could look back on previous centuries in which:

noblemen were destitute of the comforts the want of which would be intolerable to a modern footman... farmers and shopkeepers breakfasted on loaves the very sight of which would raise a riot in a modern workhouse... to have a clean shirt once a week was a privilege reserved for the higher class of gentry... men died faster in the purest country air than now die in the most pestilential lanes...

Today we look back on the era of Thomas Babington Macaulay--and the gulf that separates our material wealth and comfort from that of his age is greater than the gulf that separated him from any previous human community since the discovery of fire.
 
 

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The twentieth century has seen more brutal and more barbaric tyrannies than any previous century--and its tyrannies have had their origins in economic discontents and economic ideologies
In this century governments and their soldiers have killed perhaps forty million people in war: either soldiers unlucky enough to have been drafted into the mass armies of the twentieth century, or civilians killed in the course of what could be called military operations.

But wars have caused only about a fifth of this century's violent death toll. Governments and their police have killed perhaps one hundred and sixty million people in time of peace: class enemies, race enemies, political enemies, economic enemies, imagined enemies. You name them, governments have killed them on a scale that could not previously have been imagined. If the twentieth century has seen the growth of material wealth on a previously- inconceivable scale, it has also seen human slaughter at a previously-unimaginable rate.

Call those political leaders whose followers and supporters have slaughtered more than ten million of their fellow humans "members of the Ten-Million Club." All pre-twentieth century history may (but may not) have seen two members of the Ten-Million Club: Ghenghis Khan, ruler of the twelfth century Mongols, launcher of bloody invasions of Central Asia and China, and founder of China's Yuan Dynasty; and Hong Xiuquan, the mid-nineteenth-century Chinese intellectual whose visions convinced him that he was Jesus Christ's younger brother and who launched the Taiping Rebellion that turned south-central China into a slaughterhouse for decades in the middle of the nineteenth century.

By contrast the twentieth century has seen perhaps five people join the Ten Million Club: Adolf Hitler, Chiang Kaishek, Vladimir Lenin, Joseph Stalin, and Mao Zedong. Hitler, Stalin, and Mao have credentials that may well make them the charter members of the Thirty Million Club as well--perhaps the Fifty Million Club. A regime whose hands are as bloody as those of the Suharto regime in Indonesia--with perhaps 450,000 communists, suspected communists, and others in the wrong place at the wrong time dead at its creation in 1965, and perhaps 150,000 inhabitants of East Timor dead since the Indonesian annexation in the mid-1970s--barely makes the twentieth century's top twenty list of civilian-massacring regimes.

What does this--bloody--political and secret police history have to do with economic history, with the story of how people produced, distributed, and consumed the commodities needed and desired for their material well-being?

First, the possibility that the secret police will knock at your door and drag you off for torture and death is a serious threat to your material well-being. The seventeenth-century political philosopher Thomas Hobbes wrote that people are motivated by sticks and carrots: "the fear of violent death, and the desire for commodious living." In a century where the chance that a randomly-selected person will be shot or starved to death by his or her own government approaches two percent, the fact of large scale political murder becomes a very important aspect of everyday life and material well being.

Second, the twentieth century is unique in that its wars, purges, massacres, and executions have been largely the result of economic ideologies. Before the twentieth century people killed each other over theology: eternal paradise or damnation. Before the twentieth century people killed each other over power: who gets to be top dog, and to command the material resources of society. But only in the twentieth century have people killed each other on a large scale in disputes over the economic organization of society.

Fidel Castro rules in Havana whether or not farmers are allowed to sell their crops in roadside stands: his suppression of small-scale private markets in agriculture has nothing to do with the maintenance of his own power or improving the efficiency of production, and everything to do with ideology. In a similar way, collective power, personal status, or eternal salvation had little to do with such disastrous twentieth century episodes as the Soviet collectivization of agriculture, the Cuban suppression of farmers' markets, the Khmer Rouge's forced emptying of Cambodia's cities, or the disaster of Mao's Great Leap Forward. All were in large part attempts to guide and shift the economy in ways that their particular ideologies dictated--never mind that the ideologies never made much (substantive) sense as blueprints for economic organization, and served to do little more than to create and provide the excuse for creating yet more human misery.

Other twentieth century disasters had equally strong roots in economic ideology: it is hard to imagine how World War II could have come about in the absence of Adolf Hitler's insane idee fixe that the Germans needed more "living space" if they were to be a strong nation. Hitler was in deadly earnest when he wrote in his autobiography, My Struggle, that Germany could only be strong and prosperous if it had a better land-labor ratio: that it needed more "land for the German plough" to grow food for the Germany nation.

As Aleksandr Solzhenitsyn has written:

The imagination and inner force of Shakespeare's villains stopped short at ten or so cadavers, because they had no ideology.... It is thanks to ideology that it fell to the lot of the twentieth century to experience villainy on the scale of millions.
 
 

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The twentieth century has seen a vast and growing relative economic gulf between national economies.
Those economies that were relatively richer than most of the world at the start of the twentieth century have by and large seen their material wealth and prosperity explode. Those nations and economies that were relatively poor have grown richer, but for the most part slowly. The relative gulf between rich and poor economies has grown steadily over the past century. Today it is larger than at any time in humanity's previous experience, or at least larger than at any time since only some tribes knew how to use fire.

This glass can be viewed either as half empty or as half full.

Half empty: we live today in the most unequal world ever. Half full: most of the world has already made the transition to sustained economic growth; most people live in economies that while far poorer than the leading-edge post-industrial nations of the world's economic core have successfully climbed onto the escalator of economic growth and thus the escalator to modernity. The economic transformation of most of the world is less than a century behind the of the leading-edge economies--only an eyeblink behind, from the millennial perspective.

On the other hand, one and a half billion people live in economies that have not made the transition to economic growth, and have not climbed onto the escalator to modernity. It is hard to argue that the median inhabitant of Africa is better off in material terms than his or her counterpart of a generation ago.

The existence, persistence, and increasing size of large gaps in productivity levels and living standards across nations is, in a word, bizarre. You can understand why pre-industrial civilizations had different levels of technology and prosperity: different civilizations had different exploitable nature resources, and the diffusion of new ideas from civilization to civilization was very slow.

But understanding why gaps in relative productivity persist and grow is more difficult. The source of the material prosperity seen today in leading-edge economies is no secret: it is the storehouse of technological capabilities that have been invented since the beginning of the industrial revolution. This storehouse is no one's property. Most of it is accessible to anyone who can read, and almost all of the rest is accessible to anyone who can obtain an M.S. in Engineering. Because of modern telecommunications ideas today spread at the speed of light. Governments, entrepreneurs, and individuals in poor economies should be straining every muscle--should in fact have long ago strained every muscle--to do what Japan began to do in the mid-nineteenth century: acquire and apply everything in humanity's storehouse of technological capabilities.

This "divergence" is another important aspect: economies are, by almost every measure, less alike today than a century ago in spite of a century's worth of revolutions in transportation and communication.
 
 

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Economic policy in the twentieth century has been, to put it very politely, inept.
The century has seen the century-long economic disaster of communism, and the quarter-century-long disaster of fascism.

But even governments that have avoided the mistakes of communism, or of fascist-inspired central planning, have often been inept as well at managing their economies: inept at coping with depressions, inept at coping with unemployment, inept at nurturing foreign trade, or inept at keeping inflation from turning into hyperinflation.

Some of this ineptness has arisen because often twentieth century economists did not know what to prescribe: the history of economic policy doctrines reads like alchemy, not chemistry. Often proposed remedies made economic problems worse. Take a representative respected economist on an average day and his advice is likely to have been bad--for three examples discussed below, consider Nobel Prize winner Friedrich Hayek during the Great Depression, Nobel Prize winner Milton Friedman in the mid-1980s, or Kennedy-Johnson stalwart Arthur Okun at the end of the 1960s

Some of it is that politicians did not like to follow their economists' advice, or at least sought for a more complaisant set of economists--those who would give advice that would be more politically pleasing and palatable to follow.

The twentieth century economy has been a tremendously powerful, efficient, and productive social mechanism--the market system. Yet few, or few have those in power, have known how to operate or fix it. The inescapable image is of an ocean liner crewed and steered by chimpanzees. Thus another important facet of twentieth century economic history is the story of economic policy: how governments have managed or mismanaged their economies, and how knowledge of how the economic system works has been painfully gained and painfully lost.
 
 

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Other Themes:

There are other important themes as well: shifts in the distribution of relative wealth and economic power from rich to middle-class and back again, as the wave of social democracy sloshes across the industrial economies in the twentieth century; the Great Depression, the defining moment of twentieth century economic history; the rise and fall of the economic preeminence of the United States.

But from the perspective of a millennium, the most important aspects of twentieth century economic history are those outlined above: the dominance of economic events in twentieth century history; the tremendous surge of material prosperity; the coupling of productive power and economic ideology with mass murder; the bizarrely uneven distribution of economic growth and prosperity around the world; and the failure of economic policy to advance from the stage of alchemy to chemistry.

The first part of this book tries to take such a millennial perspective: a chapter on each of the principal themes of the economic history of the twentieth century.

Only afterwards do I drop back into narrative: beginning with the state of the world economy at the end of the nineteenth century; skating over developments up through World War I; discussing attempts to rebuild and reorganize the world economy in the aftermath of World War I; tracing the causes, progress, and consequences--economic and political--of the disaster that was the Great Depression; analyzing the economic consequences of World War II; marveling at the job of reconstruction done in the aftermath of Adolf Hitler's war and at the pace of the subsequent Great Keynesian Boom of the generation after World War II; and last focusing on the more troubled economic period since 1973 or so.
 
 

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The Focus

The focus throughout is on the industrial core of the world economy: the rich nations, originally grouped around the North Atlantic Ocean, that have been at the leading edge of economic development, structural change, and technological advance in this century. But I hope that I have paid due attention to the economic history of the rest of the world as well.

The level of analysis attempts to be neither "history from above" nor "history from below" but rather "history from beside."

History from above tells of the doings of kings, princes, and general secretaries in marble-floored buildings. History from below tells of what ordinary people ate and wore and thought. Neither is fully adequate. The focus on the Duke of This or the Earl of That found in "history from above" is a trivially small part of the history. How did people try to get enough to eat? Were people well enough nourished for young women to easily reach puberty? How did patterns of daily life change? The answers to these questions tell us more about the history and are intrinsically at least as interesting as are stories of assassinations and intrigue at the courts of Tiberius Claudius Nero Caesar Germanicus (the Roman Emperor Claudius) or of Josef Vissarionovich Djugashvili (the Soviet General Secretary Stalin).

But the patterns of daily life of the general population and how they change make little sense if they are divorced from any consideration of high politics and changing technology. For high politics and changing technology shape and change how real people live.

It is a commonplace that each generation writes its own history: each generation is interested in different facets of the past, and a given work of history often tells as much about its own present in which it was written as about the past that it purports to analyze.

This commonplace is not completely true. One reason to write history is that it is entertaining: the stories of what people actually did and suffered that historians tell are some of the greatest stories on earth. The twentieth century has more than its share of such narratives. A second reason for history is simply to gratify curiosity, which may or may not be related to the circumstances of the writer's or the reader's era.

Yet the search for lessons of the past for the present and the future is a third powerful motive. Today, in the wealthy and industrialized countries of the world, our principal concerns are with the creation and maintenance of liberty and prosperity. Other audiences in other places and other times have had different concerns: how to ensure the triumph of the "true" theology, how to conquer one's neighbors, or how elites can maintain politial power or economic and social dominance. This history is written from our particular turn-of-the-twenty-first-century viewpoint: it tells the story of the twentieth century as the story of liberty and prosperity--the partial escapes from (and at time and places the falls back down into) servitude and poverty.

I think that this is the most interesting take on the history of the twentieth century. Others can disagree. One of the glories of the history of the twentieth century is that its story has a (relatively) happy ending: this is a (relatively) free country, and a (compared to the past) relatively free world, in which people can disagree. It might easily have been otherwise.
 

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from "The Second Coming"
by W.B. Yeats

...Things fall apart; the center cannot hold;
Mere anarchy is loosed upon the world,
The blood-dimmed tide is loosed, and everywhere
The ceremony of innocence is drowned;
The best lack all conviction, while the worst
Are full of passionate intensity.

Surely some revelation is at hand;
Surely the Second Coming is at hand...
The Second Coming!...
... now I know
That twenty centuries of stony sleep
Were vexed to nightmare by a rocking cradle,
And what rough beast, its hour come round at last,
Slouches towards Bethlehem to be born?
 

-II. Wealth-

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This twentieth century has been above all the century of increasing material wealth.

The growth in the wealth of the industrial economies over the twentieth century has been unprecedented compared with all other economies and all previous eras. Standards of material comfort and capabilities that were beyond the richest of previous centuries are within the grasp of the bulk of America's population today. Rates of increase that would have struck all other centuries as miraculous fast are today taken for granted.

This ratcheting-up by many notches of the pace of economic growth and change is the most important characteristic of twentieth century economic history. It is also surprisingly difficult to grasp. Computers, automobiles, airplanes, VCR's, washing machines, vacuum cleaners, telephones, and other technologies--combined with mass production--give middle-class citizens of the United States degrees of material wealth--control over commodities, and the ability to consume services--that previous generations could barely imagine.

In fact, the gulf is so large it is even hard for us to imagine what it has meant.
 
 

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Montgomery Ward and Consumers' Choices

A good place to begin is with the 1895 Montgomery Ward catalog. At the turn of the century Montgomery Ward was the largest mail-order business in the United States. It supplied rural and small-town households around the country with goods produced in America's factories. It was one of the ways that the forty percent or so of America's households that still lived in small towns or isolated farmsteads could purchase the products of industrial civilization.

The shops and stores of the big cities were much less convenient than the regular arrival of the mail-order catalogues. Shipping by mail order from centralized warehouses, companies like Montgomery Ward were willing to supply goods ranging from sterling silver teaspoons to sets of the Encyclopedia Britannica to drill presses.

The table above presents a typical sample of consumer goods available through Montgomery Ward at the start of the twentieth century. Near the top of the table is a one-speed bicycle, costing $65 if ordered from Montgomery Ward in 1895. The price of a bicycle measured in "nominal" dollars has more than doubled over the past century (as a result of inflation). But the bicycle today is much less expensive in terms of the only measure that truly counts, its "real" price: the work and sweat needed to earn its cost. It took perhaps 260 hours' worth of the average American worker's production in 1895 to amount to enough money to buy a one-speed bicycle. Today an average American worker can buy a one-speed bicycle of higher quality for a little less than one day's value added.

In terms of labor power, bicycles have become 36 times cheaper over the near-century from 1895 to 1990. On the bicycle standard--measuring wealth by counting up how many bicycles it can buy--Americans today are 36 times richer than they were back in 1895.

Other commodities would tell a different story. A cushioned office chair has become only 12 1/2 times cheaper, in terms of the time the average worker requires to produce enough to pay for it. A Steinway piano or an accordion is only twice as cheap.

The answer to the question "how much wealthier are we today than our counterparts of a century ago?" depends on which set of commodities you view as central and important. If you care only about personal services--having a butler around to answer the door and polish your silver spoons--then you would find little difference in national average wealth between 1895 and 1990: an hour of a butler's time then cost about an hour's worth of the time of an average worker; an hour of a butler's time today costs about the same; on the butler-hiring standard we are no richer off than a century ago. But suppose you care a lot, instead, about your ability to by mass-produced manufactured goods--like bicycles. On the bicycle standard, the table shows that Americans today are some 36 times as rich in a material sense as their counterparts of a century ago were in 1895.

If you average over all the commodities they made then and that we made now, you find that the average productivity multiplication is about eightfold: an average worker today could buy with one hour's work the average bundle of things that an average worker of a century ago took eight hours to earn.
 
 

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New Goods and New Kinds of Goods

So do we have an answer? Is the answer that we today are eight times as rich as our counterparts of a century ago? (And that the gulf is larger if we care more about manufactured goods; and smaller if we care more about personal services, or some kinds of luxuries.)

No we do not yet have an answer.

The set of calculations above--taking commodities that existed then and exist now and comparing their labor-standard prices--is conceptually flawed. It is flawed because there are many things we make today that were not made back in 1890. A lot of our wealth today is our ability to make a broader range of commodities than used to be possible. And that broader range is not factored into the calculations above anywhere.

Consider the automobile. The automobile replaces both the horse and buggy and the traction-driven cable car. It greatly expands the area that is "local." With a horse, a shopping expedition to a store six miles away is an all-day expedition. With a car, it takes an hour. Thus the automobile makes the standard suburb-with-shopping-malls "denser"--in the sense that there are more places and types of places you can reach in an hour--than even the densest of pre-industrial cities. It allows suburban residents to have the best of both worlds: the relatively large houses and lawns that had been associated with country or luxury living in the pre-industrial past, plus the density of human contacts, the cultural opportunities, and the economic opportunities of a densely-populated city. Today three million people live within half an hour of downtown Boston. A century ago only some 100,000 lived within half an hour of downtown Boston. Thus the automobile has made "living in Boston" an option for thirty times as many people.

The Atlantic Monthly of 1901 contains a short--anonymous--article by a college professor complaining about his low salary--which was about five times the productivity of the average worker in 1901, and gave him the same place in the relative income distribution as a salary of $330,000 a year would today. He could not afford an "appropriate" house within walking distance of campus. They did not have the spare income to keep a horse. So they rode bicycle--not comfortable in New England or the Midwest in winter, fall, or spring. And he spent as large a share of his income on the family bicycles as someone would on, say, a Honda Civic today.

The qualitative jump in our standard of living because we now know how to make cars--the jump from the shift to the automobile from the bicycle--is omitted entirely from the simple calculation above suggesting an eight-fold multiplication of material wealth.

A second example: in Looking Backward, Edward Bellamy's turn of the last century utopian novel, the narrator--thrown forward in time from 1895 to 2000--hears the question, "Would you like to hear some music?"He expects his host to play the piano--a social accomplishment of upper-class women around 1900. To listen to music on demand then, you had to have--in your house or nearby--an instrument, and someone trained to play it. It would have cost the average worker some 2400 hours, roughly a year at a 50-hour workweek, to earn the money to buy a high-quality piano, and then there would be the expense and the time committed to piano lessons.

But today, to listen to music-on-demand in your home, all you need is a CD or a tape player--or in a pinch, if you are willing to let others choose your music for you, a radio.

The labor-time value of a Steinway piano has fallen in price from 2400 average worker-hours a century ago 1100 average worker-hours today. But if what you value is not the piano itself but the capability of listening to music at home, the cost has fallen from 2400 average worker-hours a century ago to 10 hours today (240 dollars for the boom-box plus 10 dollars for the CD).

So when we calculate the increase in material wealth, do we count the halving of the real labor-time price of the commodity; or do we count the 240-fold decrease in the real labor-time price of the capability of listening to piano music? The experiences of live and recorded music are different in kind. But are they different enough to put a serious dent in the fact that a household today can acquire the capability of listening to piano music for only 1/240 the labor time cost a a household of a century ago? And whose piano playing do you really want to listen to--to one of the world's best and most accomplished pianists, or to that of your cousin Sarah?
 
 

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Measured Real GDP per Worker

How to summarize this pattern of higher productivity and greater economic prosperity?

Pull Historical Statistics of the United States down off of the library shelf, perform a few calculations, discover that GDP per worker in the United States today is some $57,000 dollars per year-measured at 1996's prices-and that what Historical Statistics tells us of GDP per worker in the United States in the past is as plotted in the figure below: a little over a century ago--back in 1890-GDP per worker (at 1996's prices) was some $12,000 a year.
 
 

The upward jump of productivity and wealth has not been confined to the core of the world economy. In 1987, 97 percent of households in Greece, not usually considered one of the world's industrial leaders, owned a television set. In Mexico there was one automobile for every sixteen people, one television for every eight, one telephone for every ten.

Why the "per worker"? Real GDP is a measure only of economic activity that passes through the market. As the share of the American adult population in the paid labor force has risen, so measured GDP has risen, even though part of what has been going on has been the shifting boundary between categories of work that used to be outside, but are now inside the market. So divide real GDP by the size of the American labor force (not by the population) to attempt to control for the shifting boundary between market and non-market work, and still arrive at a measure of material well-being and prosperity.

Note, first, that on this scale the business cycle-centered concerns of newspaper financial pages are barely visible. Almost all of the business cycles--the recessions and depressions--experienced in the past century appear as insignificant ripples that do not materially affect the pace of productivity growth or the level of production. The key feature is the upward trend, not the irregular cycle. Recessions are in fact not feared because they significantly reduce the volume of production. They are feared because of the distribution of the losses that they create. Most people are unaffected, but some of the people lose their jobs and a few of the rich lose their wealth

There is one exception: the Great Depression of 1929-1941, which temporarily annihilated a generation's growth in riches, saw unemployment peak at a quarter of the labor force and remain above ten percent until the beginnings of World War II, and provoked fears that the run of economic growth that had commenced with the industrial revolution had played itself out. But the Great Depression was unique, a watershed that has not been repeated.
 
 

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How Much Does Historical Statistics Underestimate Growth?

Thus Historical Statistics seems to say that the average American worker today--with a 1996-price GDP per worker of some $57,000--is nearly five times as well off in a material wealth or an economic productivity sense as his or her counterpart in 1890. Adjusting for the declining length of the work-year over the past century, as the eight- or the seven-and-a-half hour day has become the norm and as vacations have grown, and find that the multiplication of measured wealth is more like seven-fold.

This measure is relatively close to the eight-fold multiplication over the past century of our power to produce the average commodity that was produced a century ago. And this near-equality is no surprise, for the calculations in Historical Statistics are of the same conceptual experiment: suppose we could take everything produced in some past year, stuff it into a time machine, move it forward to today, and sell it; how much would it be worth? That is what the "1996 prices" in the statement "GDP per worker in 1890 was some $12,000 a year at 1996 prices" means.

But we already know that this way of measuring the multiplication of material wealth over the past century is flawed: it takes no account of improvements in material welfare that come not from getting better at producing the old goods but from producing new goods, and new types of goods.

My family's income today is roughly $110,000 a year--about twice average GDP per worker. Suppose that you stuffed me and my family into a time machine, sent us back a century to 1890, and then gave us an income equal to twelve times that of 1890 average GDP per worker--an income that would put us at the same place in the relative income distribution then as some $350,000 a year would today. We would not be among the 1,000 or so richest families in the country, those that might be invited to the most exclusive parties in the mansions of Newport Rhode Island. But we would be among the next outer circle of 10,000 or so.

Would we be happy--or at least not unhappy--with the switch? Our power to purchase some commodities would be vastly increased: we would have at least three live-in servants, a fifteen-room house (plus a summer place), if we lived in San Francisco we would live on Russian Hill, if we lived in Boston we would live on Beacon Hill, if we lived in New York we would live on Park or Fifth Avenue.

The answer is surely that we would not be happy.

I would want, first, health insurance: the ability to go to the doctor and be treated with late-twentieth-century medicines. Franklin Delano Roosevelt was crippled by polio. Without antibiotic and adrenaline shots I would now be dead of childhood pneumonia. The second thing I would want would be utility hookups--electricity and gas, central heating, and consumer appliances. The third thing I want to buy is access to information--audio and video broadcasts, recorded music, computing power, and access to databases.

None of these were available at any price back in 1890.

I could substitute other purchases for some. I could not buy a washing machine, but I could (and would) hire a live-in laundress to do the household's washing. I could not buy airplane tickets; I could make sure that when I did travel by long distance train and boat I could do so first class, so that even though travel churned up enormous amounts of time it would be time spent relatively pleasantly. But I could do nothing for medical care. And I could do nothing for access to information, communications, and entertainment technology save to leave the children home with the servants and go to the opera and the theater every other week. How much are the central heating, electric lights, flouridated toothpaste, electric toaster ovens, clothes-washing machines, dishwashers, synthetic fiber-blend clothes, radios, intercontinental telephones, xerox machines, notebook computers, automobiles, and steel-framed skyscrapers that I have used so far today worth--and it is only 10 A.M.?

I would not be satisfied with my attempts to substitute using late nineteenth century technology. First of all, I would be dead. Second a very large chunk of my-high-material standard of living is the broad range of commodities newly-invented over the course of the past century that I can choose to purchase, and that I do use because they give me capabilities that were simply not possible a century ago.

The most important component of the past century's economic growth is the new commodity component--the goods and services of which people alive in the 1890s could dream but not purchase.

Whenever we hear a sentence like "average GDP per worker in 1890 was equal to some $12,000 at 1995 prices," we cannot help but think that the material standard of living then was about what we could obtain now if we had $12,000 to spend. But it was not. The simple valuing of the past's production at the present's prices leaves out a very important part of the picture: the material standard of living then was about what we could obtain now if we had $12,000 to spend, but were required to spend it all on commodities that have been around for more than a century: no modern entertainment or communications or transportation technologies; no modern appliances; buildings, roads, bridges, and other infrastructure built using century-old technologies.

Return for a moment to Edward Bellamy's utopian novel Looking Backward. Of the two hundred pages of his book, Bellamy devotes six to a technological marvel of the late twentieth century. After answering "yes" to the question "would you like to hear some music?" Bellamy's protagonist is stupefied to find his host "merely touched one or two screws," and immediately the room was "filled with music; filled, not flooded, for, by some means, the volume of melody had been perfectly graduated to the size of the apartment. 'Grand!' I cried. 'Bach must be at the keys of that organ; but where is the organ?'" He learns that his host has called the orchestra on the telephone--in Bellamy's utopia you can dial one of four orchestras and then put it on the speakerphone.

Bellamy than has his protagonist say that "'if we [in the nineteenth century] could have devised an arrangement for providing everybody with music in their homes, perfect in quality, unlimited in quantity, suited to every mood, and beginning and ceasing at will, we should have considered the limit of human felicity already attained...'"

To Edward Bellamy--a self-described utopian visionary, a late-nineteenth century well-educated minister's son from an industrial town in western Massachusetts--the equivalent of a modern radio that can receive any of four stations is "the limit of human felicity." What if someone were to take him to Tower Records? Or Blockbuster Video? His heart would stop on the spot. We do not think of our modern ability to listen to high-fidelity go-anywhere listen-to-anything music for a very small labor time cost as truly remarkable. We do not daily give thanks for our cassette players and our CD collections, and reflect that because of them we have reached the limit of human felicity.

For Bellamy, listening to good music--any kind of well-composed and performed music--was a big deal. You got dressed up to go to the symphony and the opera. You could do so only rarely. Yet to us today it is not a big deal. New products and new technological capabilities invented and introduced over the past century have transformed experiences that were rare and valued luxuries, possible only to a rich few at great expense, into features of modern life almost as common as water--and that we take for granted as much as we take our water for granted. In Bellamy's mind, music played on many instruments at once by an ensemble of professional musicians was close to being the ultimate luxury. Such performances were rare and expensive to produce. They were valuable--like diamonds. Bellamy's view of us would be somewhat analogous to our vew of a civilization in which everyone has boxes of gem-quality diamonds in their basement, and thinks of these boxes as no big deal.

So how much has material wealth grown in the past century?

My own personal guess (and if you do not agree, your introspection-based assessment is certainly as valid as mine) is that--if confined to purchasing and consuming only those commodities that were in the set of items producible in 1890--I would be very, very unhappy indeed. I am not sure that anyone in 1890--not even Andrew Carnegie, John D. Rockefeller, or Queen Victoria--was as well-off then in a material-welfare sense as I am today.

So that perhaps the right answer is that we are so much wealthier than our counterparts of a century ago that the question has no meaning: no one then had the material wealth of a middle-class citizen of the industrial economies today.

And if it does have meaning, the answer is astronomical. William Nordhaus--a Yale professor, and a member of President Carter's Council of Economic Advisers--brackets the growth in real wages over the past century as somewhere between a 21-fold and a 182-fold increase.

Alan Greenspan--Chairman of the Federal Reserve--has guessed that failure to take proper account of new goods and new types of goods has led us to overstate inflation and understate real income growth by 1.5 percent per year. Compounding this overstatement for a century and applying it to the numbers in Historical Statistics leads to an estimate of a thirty-fold increase in material wealth over the past century.

That will do if we must have a single number.
 
 

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Pre-Twentieth Century Growth:

The twentieth century appears is unique in its pace of economic growth. Such rapid growth in standards of living has never been seen before, anywhere--save possibly in the generation that saw the discovery of fire.

The nineteenth century saw, according to Historical Statistics, perhaps a doubling of material standards of living in the United States--perhaps a tripling or quadrupling once proper account is taken of the impact of new technologies like the railroad and the telegraph, and the expanded range of technological capabilities. Nineteenth century growth was itself remarkably fast: people christened the nineteenth century the "industrial revolution" because it seemed a remarkable event relative to what had happened before. Before the nineteenth century growth was even slower. The standard of living in the Netherlands, probably the richest economy in the world at the end of the eighteenth century, might have been some fifty percent higher than it had been three centuries before, at the time of the Renaissance.

And before that?

Between the invention of agriculture and the commercial revolution that marked the end of the middle ages, wealth and technology developed slowly indeed. Medieval historians speak of centuries and half-millennia when they speak of the pace at which key inventions like the watermill, or the heavy plow, or the horse collar diffused across the landscape. And improvements in technology relatively quickly led to increases in population, until the human population once again reached a new Malthusian steady state in which births were held in checks by death. For most of human history before the industrial revolution, increases in technological capability led to increases in the population that could be supported on a given natural resource base, with little if any appearing as an improvement in the median standard of living.

So slow was the pace of change that people, or at least aristocratic intellectuals, could think of their predecessors of a thousand years before or more as effectively their contemporaries. And they were not far wrong. Marcus Tullius Cicero, a Roman aristocrat and politician of the generation before the Emperor Augustus, might have felt more or less at home in the company of Virginia planter Thomas Jefferson. The slaves outside grew different crops. The plows were better in Jefferson's time. Sailing ships were much improved.

Printing technology would have struck Cicero as amazing and wonderful: for Cicero acquiring one copy of one book involved two months' worth of copying labor by a literate slave, an amount of labor that we would value at perhaps $4,000 dollars compared to the $10 price of a trade paperback book today; we today find the real price of books in terms of human labor to be 1/400 of what it was for Cicero, and even in Jefferson's day the real price of books had already fallen to perhaps 1/50 of what it had been at the beginning of the Roman Empire. But overall the differences in standards of living and in technologies used to manipulate the world were small.

Even the first century of the industrial revolution produced more "improvements"than "revolutions" in standards of living. With the railroad and the spinning and weaving of textiles as very important exceptions, most innovations during the first century or so of the industrial revolution proper were innovations in transportation, in how goods were produced, and in new kinds of capital but not consumer goods. Standards of living improved because of these innovations in production processes and capital goods. But styles of life remained much the same. Improvements in productivity in the first half of the nineteenth century at least were concentrated in a few relatively narrow sectors rather than spread throughout the economy.

So slow was the pace of improvement that literary intellectuals in the first half of the nineteenth century debated whether this industrial revolution was worthwhile. Was it an improvement or a degeneration in the standard of living? And opinions were genuinely divided.

The figure below shows--approximately--the relative pace of economic growth in productivity levels and living standards for the leading-edge economies of Europe (plus the European-settled North American economies) over the past ten centuries. The estimates are rough and approximate only. But the figure does not do violence to the qualitative picture as it tries to indicate the relative economic growth over each of the past ten centuries of the leading-edge economies.
 
 

In 1848, in the middle of the nineteenth century, before the industrial revolution proper had spread far from its original homes in Belgium and in the British midlands, a young German philosopher-turned-political activist marveled at the extraordinary pace of economic growth in his day. He saw it as a new historical epoch that was only a century old and yet was opening wide the door to utopia. He saw the epoch as equivalent to that of Prometheus, the mythological Greek demigod who defied the chief god Zeus, brought knowledge of fire to humanity, and transformed humanity's condition. He wrote that the economically ruling class--the capitalist class, the enterpreneurial class, the business class, the bourgeoisie--of this epoch was:

...the first to show what man's activity can bring about. It has accomplished wonders far surpassing Egyptian pyramids, Roman aqueducts, and Gothic cathedrals; it has conducted expeditions that put in the shade all former Exoduses of nations and crusades....

[It has], during its rule of scarce one hundred years...created more massive and more colossal productive forces than have all preceding generations together. The subjection of nature's forces to man, machinery, the application of chemistry to industry and agriculture, steam-navigation, the railways, electric telegraphs, the clearing of entire continents for cultivation, the canalization of rivers, the conjuring of entire populations out of the ground--what earlier century had even a presentiment that such productive forces slumbered in the lap of social labor?

Karl Marx was dumbfounded at the pace of the economic transition he saw around him. Yet compared to the pace of economic growth in the twentieth century, all other centuries--even the nineteenth century that so impressed Karl Marx--were standing still.
-III. The Meaning of Economic Growth-

J. Bradford DeLong
University of California at Berkeley and NBER

January 1997; DRAFT 1.00
 
 

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Population Growth:

The tremendous increases in material wealth and living standards in the twentieth century have been accompanied by a three-fold multiplication in the human population of the world as well-the fastest rate of increase in human population ever, or at least since the invention of fire, and an increase that has carried the human population of the world to levels that far outstrip those of previous centuries: today there are, we think, more than six billion people alive on this earth.

Demographers guess that on the eve of the invention of agriculture--say, sometime around 10,000 B.C.--the hunting and gathering human population of the world was about five million. From then up until roughly the year one populations grew relatively swiftly, as civilizations based on agriculture and herding spread throughout the world as different groups learned the techniques of farming and livestock management from their neighbors. By the year one perhaps 250 million people lived on the earth.

Thereafter populations grew more slowly. Arable land that could be used to grow crops using the technologies of the time was mostly occupied. When population expanded, it would run into sociological or biological limits: more people scratching a living from the same plot of land would reduce nutrition, and deprive some women of the chance of conceiving; a lack of open farmsteads would keep young adults single and in their parents' households for an extended time, rather than forming households and having children of their own. Slow improvements in technology and investments in land-clearing would raise the pool of available natural resources to a population, fertility would rise, and population would grow-until once again the population would begin to press against the sociological or biological limits given available technology, fertility would fall, and the episode of growth would come to an end. Between the year one and the year 1700 demographers guess that the population of the world grew from roughly 250 milion to roughly 700 million.

After 1700 population growth began to accelerate. Some argue that it was due to improving climates: both Europe and China appear to see substantial population growth in the eighteenth century, and China certainly did not benefit from the waves of technological innovation and improvement that were beginning to sweep over Europe. Others argue that the quadruple congruence of printing, religious doctrines generating higher literacy, technological innovation driven by constant wars between European nationa-states, and expanded trade greatly multiplied Europe's command over its environment and banished the Malthusian forces that had previously swung into action to check population growth.
 
 

The eighteenth century appears to have seen human populations grow by perhaps fifty percent worldwide. The nineteenth century saw human population grow by some eighty percent. And--as modern technologies have diffused throughout the world--in the twentieth century human populations have tripled.

Before the twentieth century, the fastest-growing populations on the globe were almost invariably the richest populations on the globe. In the twentieth century things have been different: population growth in the richest countries has slowed down markedly. People are living longer than ever before, but also fewer children are being born, per couple of childbearing age, than ever before. This slowdown in fertility-based population growth to near-stasis in the world's richest countries is the second stage in what is called the demographic transition. Thus the population of Europe has grown relatively slowly in the twentieth century--and are growing even more slowly today--even though it was the richest continent in this century.
 
 

The demographic transition has two components, and is driven by rising income and wealth and the sociological changes that rising income and wealth set in motion. The first stage is one of greatly accelerated growth: a richer population has better nutrition, sees more opportunities, and receives better medical care. Thus both the biological and sociological checks to rapid population growth vanish. And population growth accelerates: life expectancy rises and more children are born.
 

The second stage comes when children cease to be a short-term addition to the economic resources of a household and become a short-term use of economic resources: when-at least from the standpoint of five or ten years-having more children is no longer "investment" (in the number of people who will soon be able to help with odd jobs or the harvest, or the number of people who will be able to keep the household's textile spinning and weaving moving smoothly), but is instead more like "consumption". In relatively rich, urban populations most children are in school, and there is little that a pre-adolescent can do that would significantly increase household income in any case.
 
 

Thus mothers and fathers put more energy into sharply limiting the number of children in their households, and more energy into improving the quality of life and education for the children that they do have. Throughout the world, as countries have industrialized and urbanized, the pattern of rapid initial population growth followed by a sharp reduction in fertility and in the rate of population growth has repeated itself.

The first nation to go through the demographic transition was France. Today developing economies, like Mexico and China, are undergoing the same process. Population grows extremely rapidly during the transition--the historical range is from a less-than-doubling for France to an apparent seven-fold multiple of population in Mexico's transition. But the period of rapid population growth has, in almost all cases to date, come to an end usually less than a century after the beginning of the steep fall in the death rate that marks the start of the transition.

 
Indeed. the demographic transition has progressed sufficiently far that the world appears to be past the time of maximum percentage population growth. In the late 1960s, the world population was growing at some 2.1 percent per year. Today it is growing somewhat more slowly, at some 1.7 percent per year.
 
 

But how fast the rate of population growth will decline in the future, and what the trend of global population will be--that is anyone's guess. Some observers are predicting that the human species will run up against its natural resource constraints in short order, and begin seeing a return to a time in which widespead famine and disease check human populations and are a normal part of human experience. Indeed, some observers have been predicting the beginnings of widespread death from famine for thirty years. According to Paul Ehrlich's popularization The Population Bomb, the first major famines were supposed to hit the developing world in the 1970s.

Yet so far nutritional levels around the globe keep rising, food supply has more than kept pace with population growth. There is no sign yet of a return of human populations to any "Malthusian" regime.

Whether declining rates of population growth will be the result of human choices in the presence of relative material abundance, or the result of a "Malthusian" apocalypse of war, famine, disease, and death is not clear. However there is every reason to hope for the first.
 
 

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Causes of Growth: the Importance of the Market

Why has the twentieth century been so different from all previous centuries in the pace of its economic growth?

One answer is that the twentieth century has been blessed with market economies. Market economies have many powerful advantage over other ways of organizing economic activity--whether by redistribution within extended kin groups, reciprocal exchanges of goods for goods among people who know each other well, or large-scale government- or temple-mediated redistribution and storage. Market economies give manufacturers and traders every incentive to use resources most efficiently. They have the additional advantage of providing a "sunset" for relatively inefficient organizations: enterprises that are relatively inefficient cannot pay their bills, and vanish. This automatic weeding-out of inefficient organizations that fail the test of the market is so lacking where state enterprises draw on the general taxation or money-printing power of the state.

How important has the fact that most economic life has been governed by the market in the twentieth century been? We are lucky to be able to take a look at what production, distribution, and economic growth in the twentieth century would have been like in the absence of the market system by looking across what used to be the iron curtain, at how economic growth proceeded under the central planning system in the Soviet Union that Columbia economist Richard Ericson calls the "classical Soviet-type economy."

In the Soviet Union the production and distribution of commodities was determined by vast bureaucracies. A complex structure of overlapping administrative hierarchies that gathered information, coordinated interactions, disseminated instructions, and moniored performance. The heads of the Communist Party stood at the top of the system, drawing information from and sending information to more than twenty ministerial committees, with such names as Gosplan (responsible for planning), Gossnab (materials supply), Gostroi (responsible for construction), and Goskontrud (responsible for labor relations). These ministerial committess in turn issued directives to and gathered information from more than fifty branch ministries composed of several hundred departments. At the base of the bureaucratic pyramid were the enterprises: 46,000 industrial enterprises, 50,000 state and collective farms; 47,000 construction enterprises, and 1,000,000 wholesale and retail trade enterprises.

Planning began with directives from on high, that Gosplan used to produce numerical targets and priorities, and that were specified in increasing detail down the administrative hierarchy until they became specific targets for enterprises: your factory will produce five million ball bearings next year. Enterprises respond to these assignments by requesting machines, buildings, raw materials, workers, and other resources. Central authorities strive for maximal performance with threats of punishment and demotion, while subordinates plead their inability to perform their assigned tasks. The outcome is a comprehensive set of commands to all ministries that--in the eyes of the top, at least--involves a rough, tolerable balance between supplies and demands. Typically the result demands from each organization is a small percentage increase in what it is doing.

When it becomes impossible to do what was commanded because the plan is inconsistent or impossible, subordinates make critical choices on the spot in which they have every incentive to appear to fulfill the plan: a producer of ball-bearings will find itself driven to produce that assortment of bearing sizes and qualities which it can accomplish--whether or not fulfilling planned categories and numbers has any relation to social demand or to the needs of users. Thus tractor components are produced that do not fit with other components; buildings are built without the utility connections to make them habitable. Attempts by cenral planners to bring enterprise production into closer conformity with social needs tend, in Ericson's words, to "generate additional inconsistencies, as they are ill-informed, taken under time pressure, and themselves channeled and compartmentalized by the hierarchy."

In Ericson's view, the resulting system lacked flexibility--no one has or can gain authority to solve problems--and lacked incentives: every incentive is to meet the plans and desires of superiors, and not to achieve beneficial economic consequences.

It functioned in certain, limited circumstances. When the task was to accomplish something where even the highest political authorities could see whether it had been accomplished or not, the system functioned: when the task was to build a subway for Moscow or a dam at Dnepropetrovsk, and when the party was willing to shoot people from chief engineers on down if the task was not accomplished, then Moscow got a subway and Dnepropetrovsk got a dam; when the task was to replicate something that existed elsewhere in the world, it could be replicated (although at enormously greater cost); when the consumers of an industry ran it, and had a blank check to use whatever methods and resources they wished to achieve the production of what they desired, then it could indeed be produced. The Soviet armed forces, with first claim on national resources and with the ability to send defaulters to Siberia or worse, got not state-of-the-art but functional equipment produced by the Soviet military production complex.

But elsewhere? The Soviet Union singularly failed to produce quality consumer goods, or a varied crop of foodstuffs, or habitable apartments. As Richard Ericson assessed the harvest of seventy years of Soviet rule, it left the Communists' successors with:

over sixty years where building physical capital and institutions has been largely an arbitrary, willful political act, independent of economic considerations. The result is a capital stock that is massively obsolete, abuse and destrution of the resource base, and an environmental poisoning unmatched in history. Most Soviet steel output uses a technology all but abandoned by the rest of the world. The bulk of investment goes to the backlog of unfinished, and never to be finished, construction. New industrial facilities that take less than two years to build in the rest of the world remain under construction for over fifteen years. Vast amounts of expensive imported equipment rusts at ports, rail sidings, and construction sites. Large oil reserves have been rendered inaccessible by use of technologies allowing rapid and easy meeting of quotas. The entire Aral Sea area of central sia has been poisoned, the sea itself reduced to a salinated cesspool and the agriculture around it ruined by excessive use of chemicals, all in pursuit of the plan.

How does a market system do a better job? First, it imposes a reality check on every organization--an organization that is relatively inefficient at producing will find its customers going elsewhere, and its revenues falling. It will soon go bankrupt and vanish. This "sunset" concentrates the minds of bosses and managers on figuring out how to produce more goods, more efficently. Second, it imposes a reality check on every line of business because products that are unsatisfactory to customers do not sell: there is no such thing in a market economy as "overfulfilling" your plan targets by producing something that is useless to all of your customers. Third, the market possesses enormous flexibility: organizations and individuals can change their production patterns any time they choose, without seeking approval at all levels up to and including the highest levels of the national government.

Comparisons of the Soviet Union's economy, and of the economies of the other Communist regimes of Eastern Europe, with Western European patterns suggest that adoption of the market economy has the capacity to multiply economic prosperity by a factor of two to five.

Indeed, previous episodes of mercantile capitalism--like Classical Athens around 400 B.C., Sung dynasty China around 1000 A.D., Mediterranean Islam circa 1000, northern Italy around 1500, or Augustan Britain around 1750--have been relatively bright spots in human history. They have been richer than their neighbors, and they have seen wealth and enterprise spread and increase. But until this century no episode of "capitalism", no market economy has generated anything like the explosion of wealth seen in this century.

So two additional factors have been very necessary to the economic miracle of the twentieth century: first, political democracy; second, technological density.
 
 

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Causes of Growth: Political Democracy

Before our century, a productive mercantile economy was a goose that laid golden eggs. But from a historical perspective, a golden goose is a short-lived beast. The ruling prince was always subject to the temptation to squeeze the goose a little tighter, either to pay for a slightly greater degree of courtly splendor or to pay for a slightly higher military effort on whatever was the current active conquest frontier.

In fact, history is littered with the corpses of golden geese.

One of the oldest themes in economics is the incompatibility of despotism and development. Economies in which security of property is lacking--because of either the possibility of arrest, ruin, or execution at the command of the ruling prince, or the possibility of ruinous taxation--experiencee relative stagnation. By contrast, economies in which property is secure--either because of strong constitutional restrictions on the government's power, or because the ruling class is itself a mercantile, property-owning, entrepreneurial class--should prosper and grow. Even in the eighteenth century, both Adam Smith and Montesquieu remarked on the correlation between constitutional republican rule and economic growth, and between despotism and economic decline.

And a transition from a mercantile republican to a despotic or a dictatorial regime usually meant that the best days of the local economy were past--that economic decline was on the way as higher and higher taxes and greater and greater exactions to achieve whatever were the current goals of the rulers disrupted the mercantile economy.

Successful democracy changes the calculus. Once people have gotten it into their heads that legitimate governmental authority comes not because God has anointed the king or through inheritance, it becomes hard to maintain a government that does not have popular support. At the very least, regular plebiscites are necessary to demonstrate that the current bunch of thugs-with-guns holds power by the will of the people. If not, then other bunches of thugs-with-guns will be tempted to stage coups, or the government will fall because mass discontent and demonstrations undermines the loyalty of the army: think of the fall of the Shah of Iran in 1979, of President Ferdinand Marcos of the Philippines in 1986, of the Argentine junta that attempted to imprison Juan Peron in 1945, or of Erich Honeker's Communist regime in East Germany in 1989. In the later stages of the twentieth century, especially, governments may not be elected by the people but they can be overthrown by popular discontent.

Hence courtly splendor and an overmighty military budget become of less interest and less urgency to rulers--even to non-democratic rulers. Keeping real wages rising, employment high, and profits growing becomes the principal aim of governments. For political parties that are either unlucky to catch an unfavorable wave of the business cycle or unskillful enough to disrupt economic growth are likely to vanish rapidly. Economic growth becomes an aim of government policy in itself, rather than a way station on the way to a larger military budget.

This is not to say that governments know how to achieve economic prosperity. It is possible to question whether the net impact of government attempts to boost output and employment in this century has been positive. But before the coming of modern democracy, government policy had a substantial bias against economic growth.

Some--mostly apologists for Lee Kuan Yew of Singapore, or for other semi-authoritarian semi- or un-elected East Asian rulers of rapidly-growing economies--argue that democracies are subject to "indiscipline": civil disorder, or cycles of tax-your-enemies and reward-your-political-friends. By contrast, they argue, a benevolent dictator has every inclination to take the long view, for his security of tenure and the power of his successors are closely linked to rapid economic growth.

But there is a problem with this argument. There is no such thing as a "secure" dictatorship, and no such thing as an authoritarian ruler who can afford to take the long view. There never was. Consider, as an example, the monarchy of England, the strongest in Europe for the five hundred years 1000-1500, and still strong up until the Glorious Revolution of 1688. Queen Elizabeth I Tudor executed her legal heir. King Richard I Plantagenet "Lion-Heart" found that his younger brother had bribed the Duke of Austria to imprison him. 18 out of 31 monarchs had something go seriously awry with the succession before or upon their death. Only one time in five did the English throne pass peacefully down to the legitimate second-generation heir of any monarch. Any one dictator can be "enlightened", and pro-development. The chance of a chain of such despotic rulers being benevolent is vey small indeed.

Bet on democracy as a co-requisite for successful economic development in the long run.
 
 

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Causes of Growth: Technological Density

Even the conjunction of market economic organizations and political democracy is insufficient to account for the economic miracle of the twentieth century. Both of these factors are only tangentially related to the extraordinary explosion of technology--of scientific knowledge and its application to production in every day life--in this century. In order to achieve this centuries' revolutions in science and technology, we need "technological density" as well: research and development has to become an industry in itself, rather than an avocation of a few learned gentlemen reading papers before a Royal Society, to maintain the pace of invention and innovation that we now take for granted. Only the confluence of all three, market institutions, political democracy, and high technological density, could generate the economic revolutions of the twentieth century.

Hiero of Alexandria built the first steam engine roughly two thousand years ago. An enclosed sphere on a vertical pole with two openings, one on the right side and one on the left, each pointing counterclockwise. Put some water in the sphere and put the apparatus over a fire. The water boils, the steam escapes through the jets, and the sphere begins to spin clockwise.

A pleasant toy.

It would be more than seventeen hundred years before the steam engine would be used to substitute for human or animal musclepower to boost production. Much pre-industrial technology seems similar: ideas that contain the germ of powerful advances in human command over nature, but just the germ, and are never developed. There is technological progress in the ancient and the medieval world, but it takes place at a glacially slow pace. Medieval historians plot the hundreds of years that it takes the horse collar--so that the weight of whatever the horse is pulling rests on its shoulders, not its neck; thus the horse does not half-choke itself every time it tries to pull--to diffuse and become general across Europe. They plot the thousands of years that it takes the water wheel to become common, and the extraordinary lapses of time before simple improvements--like going from the "undershot" to the "overshot" wheel--are introduced.

And there are times of retrogression. Go to the Musee de Cluny in Paris and look at the crowns of the Visigoths. The Visigoths were a tribe of barbarians that conquered and ruled what is now Spain for more than two centuries at the end of the Roman Empire and before the Muslim invasion of Iberia. Their crowns show pathetically poor workmanship: the Visigoths in 600 A.D. could not find any goldsmiths in Spain capable of doing work even one-tenth as competent as was routinely done in the Iberian city of New Carthage--now Cartagena--800 years before.

Some of it was cultural. Archimedes is reputed to have refused to write a handbook of engineering; Henry Hodges reports that the reason given was that "the work of an engineer... was ignoble and vulgar."

We can track the very, very long run growth of human technology--from "One Million B.C.", in MIT economist Michael Kremer's phrase--by looking at the growth of human population density. For almost all of human history until the industrial revolution, human populations have been in Malthusian equilibrium: average living standards were close to subsistence, and improvements in technology led to increases in population that brought population to the level that could be supported at near-subsistence given the technological capability to use natural resources. If we look at the relationship between human population levels and population growth rates before the industrial revolution, it looks as though the higher the population the higher the growth rate: back when the human population was less than 100,000, population growth averaged less than one-tenth of a percent per year; by the time the human population reached a billion, population growth averaged half a percent per year. It is tempting to speculate that, back before the industrial revolution, higher populations meant higher growth rates because higher populations led to greater technological density and a faster rate of technical progress: the larger the population, the more people there are to hear about and improve on previous discoveries and to make new ones. Thus the faster technological capability grows.

Moreover, the rise in sea level at the end of the last ice age some fifteen thousand years ago cut the major continents off from one another as far as technological diffusion was concerned: Eurasia plus Africa, the Americas, Australia, and Tasmania formed four separate human cultural populations as far as technological progress was concerned for most of the past fifteen thousand years. Of these four regions Eurasia plus Africa had more than twice the land area of the Americas, Australia had about one tenth the non-desert land area of the Americas, and Tasmania had about one-thirtieth the non-desert land area of Australia.
 
 

In 1500, when improvements in ship construction and other factors restored cultural contact between continents, Eurasia plus Africa had some twelve times the population density of the Americas; the Americas had some five times the population density (on non-desert lands) of Australia; and Australia had some three times the population density of Tasmania. It is almost inevitable to attribute these differences in population density to differences in technology: much of metallurgy, the plough, the wheel, and the domestication of many large animals (rather than hunting them to extinction) were known in Eurasia plus Africa, but not in the Americas. And it is hard to see any cause for these divergences in technological development in a relatively small number of thousands of years other than technological density: the old world had more spaces for people and civilizations to live, hence more possibilities for good ideas to develop and then diffuse. The higher the population--and the more that different members and segments of the population can communicate with one another--the higher the technological density.

Technological density depends on more than just sheer numbers alone. We today have much more than the ten times the capability to invent and discover that the human race had five hundred years ago and that a simple count of human numbers would suggest. In broad historical perspective, there have been four upward leaps in technological density over the past ten thousand years that have greatly improved communication at any given level of population density: writing, printing, the development of the specialized vocabularies and procedures of modern science, and the long-distance telecommunications revolutions that make communication nearly instantaneous across the entire globe.

Information about what human life was like before the invention of writing is--not surprisingly--scarce. That it transformed humanity's capability to remember and thus to build technological knowledge there can be no doubt: as Sir Isaac Newton put it, "If I have seen further than other men, it is because I have stood on the shoulders of giants." And shoulder-standing is not possible without writing to make reliable communication across generations possible. We know of no "civilizations" without writing of some form.

Printing--in the sense of Johann Gutenburg and movable type--is only some five hundred years old in Europe, and only some twelve hundred years old in China. The impact of printing on China (little impact: used for the mass distribution of some Buddhist texts, but for little else) should caution us against any narrow belief in technological determinism. Sir Francis Bacon, for example, noted that the three inventions of gunpowder, the compass, and printing had utterly transformed Europe. Yet all three of these were known, indeed invented, in China. And they had not transformed China.

But in Europe the invention of printing had a profound effect on much of cultural, religious, and scientific development. Over the fifty years separating pre-Gutenberg times from the start of the sixteenth century, the cost of producing a book fell by a factor of several hundredfold: for the time and skilled labor that a monastic scribe would have taken to produce several manuscript copies of a work, a post-Gutenberg printer could (using a different kind of skilled labor) produce 1,000 copies.

After Gutenberg the purchase of a book was a more significant decision than today, when buying a book consumes the money earned in 15 or 30 minutes of work by the average established member of the literati. Technical progress in book production has contributed to further tenfold or so since the immediate post-Gutenberg age; offsetting this is the fact that the average established member of the literati ranked considerably higher in the income scale in the sixteenth century than today; the representative book purchaser in the sixteenth century spent the equivalent of an hour or two's wages on a book.

Contrast this with the month or more's worth spent on creating and purchasing a pre-Gutenberg manuscript--overhead for maintaining the library and the scriptorium, the time of the copyist (and the requirement that the copyist be highly literate lest he corrupt the manuscript), and distribution of what was truly a one-of-a-kind product.

What difference did it make that the cost of production of the "unit of information" that was a book went from weeks or months of skilled labor time to hours of skilled labor time? The historian Elizabeth Eisenstein makes a strong case for four very important consequences of this reduction in the cost of books:

The fifteenth-century European Renaissance did not peter out, as had previous episodes of "classical revival." The Carolingian renaissance of the ninth century and the renaissance of the thirteenth century never acquired their capital letters, because the rediscovery of Greek and Roman learning proved temporary and was confined to a relatively small number of people. The fact that the fifteenth-century Renaissance took place at the smae time as printing meant that the newly discoverd and translated Greek and Latin authors were distributed in great numbers around Europe--and never again was European culture to lose contact with the intellectual world of the Roman Empire that had come before it.

The sixteenth-century Reformation was not suppressed, as previous episodes of heresy and religious revival had been suppressed or absorbed by the Roman-ruled Latin European church. A century or two before, a Hus or a Wycliffe had been able to spread their doctrines only as fast as they could travel and only to as many people as they could speak; counteraction, by contrast, could draw on the entire communications, church, and abbey structure of the Latin church. Without printing, Martin Luther's and Jean Calvin's heresies would have met the same fate. The religious history of early modern Europe would have been very different: it is quite possible that modern science would have been successfully suppressed, without the reservoir of protestant governments and churches willing to trumpet whatever the Rome-based Latin church wished to disapprove.

The seventeenth-century origin of modern science is unthinkable without the density of information exchange made possible by printing. Is it a coincidence that Copernicus follows Gutenberg by less than a century?

The creation--around networks of printers and authors--of a "cosmopolitan" and tolerant outlook. Liberalism has an elective affinity with printers' workshops.

The process of economic growth was perhaps unstoppable after Galileo, and probably unstoppable after Newton. The success of each previous generation's scientists and engineers enlarged the pool of those willing to work on science and technology in the next generation. The printing press made the diffusion of work and knowledge across Europe cheap, easy, and rapid. The second half of the seventeenth century saw the invention of the pendulum clock, the pocket watch, the microscope, the vacuum pump (without which the steam engine was impossible)--and champagne. The first half of the eighteenth century saw the invention of the flying shuttle (which doubled weaving productivity) and the Newcomen "atmospheric" steam engine. The second half of the eighteenth century saw the invenstion of Arkwright's automatic spinning machine, of the improved Watt "condenser" steam engine, the power loom, the cotton gin, the hot-air balloon, vaccination, and lithographic printing.

Thereafter the flow of inventions became a flood. European governments made it profitable to become inventors by adopting the patent system: the power to devise patent and copyright laws is one of the few powers explicitly granted congress by the U.S. constitution. The links between science and industry became close and tight with the invention of electric technologies and with the appliation of physics to engineering design. Thomas Edison was among the first to assemble a research laboratory: more than fifty mechanics and scientists in a facilty in Menlo Park, New Jersey.

We can approximately gauge the increasing technological capability of humanity before the industrial revolution by looking at non-mechanized sources of power. An "overshot" waterwheel (so called because the water shoots over the wheel and falls on the wheel from above; better than an "undershot" wheel which requires that the steam flow be neither too low nor too high) generates the power of perhaps two hundred humans (for humans get tired, while the waterwheel does not). Pictures of the Dutch countryside before the industrial revolution that are populated with windmills are not pictures of an idyllic pre-technological utopia; rather, they are pictures of one of the most technologically-advanced eocnomies of its day.

 Pre-Industrial Sources of Power
 
 Source
 Horsepower
 
 Man working a pump 0.04
 
Man working a crank 0.08
 
 Man pushing a capstan 0.05
 
 Horse in a circle at a walk 0.58
 
 18-foot overshot waterwheel 5.0
 
 Post windmill 8.0
 
 Turret windmill 14.0
 
 

But the industrial revolution moved things a full order of magnitude forward. The energy at the disposal of the average Belgian industrial worker in 1910 was some ten times what his or her own muscles could have provided.

The first half of the twentieth century saw power at the service of the average manufacturing worker improve roughly fivefold as electricity replaced steam, and as capital accumulation muitplied the number and capability of machines. By 1953 the average American manufacturing worker had roughly three hundred times as much power at his or her disposal as did his or her colonial predecessor of two hundred years before. And simply counting horsepower understates the change, for the precision with which power and force can be used vastly exceeds what was possible in previous centuries as well, and there are many applications where the precise application is more important than the amount of force.

How long will this go on? There might have been a time when people might have thought that the industrial revolution would run its course: the industrial revolution of the eighteenth and nineteenth centuries was based on power (first steam, then electricity and gasoline), simple automation using power (looms and spinning machines), and metalworking. Perhaps at some point the pace of productivity improvement in these technologies would begin to slow. But power, simple automation, and metalworking were followed by industrial revolutions in chemicals and in artificial materials; in transportation; in communications; and then in microelectronics and information processing--not to mention the atomic bomb. So far there are no signs that invention and innovation have begun to run into increasing returns, and the technological density of the world continues to grow.
 
 

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Consequences of Growth: Structural Change

Looking at simple one-dimensional measures of growth hide extraordinary shifts in the relative quantities and the character of the goods consumed. Turn of the century urban households spent half or more of their money on food. Households today spend one fifth on food. Half of Americans were farmers in 1900. Only three percent are farmers today. As economic growth proceeds, agriculture shrinks and industry grows, until industry in its turn peaks at a little more than one-third of the economy and then itself begins a slow decline relative to services. The balance between agriculture and industry, between design and craftwork, between production and distribution, and-most important-between labor within and without the household all underwent profound shifts in the past century.

Employment Structure in Great Britain
 
Before the industrial revolution, even during the industrial revolution, agriculture had always been more important than industry in the sense of making up a greater part of employment and of real national product. Representative urban families had always spent more than half of their incomes on food. The overwhelming majority of rural families had always raised their own food,plus if they were lucky enough surplus for the lord, the taxman, andperhaps a little to exchange in addition.

Farming was always hard work, especially in the pre-industrial Malthusian days when improvements in technology soon generated increases in population, and thus reductions in the amount of land each farmer could work. The Greek philosopher Aristotle of Stagira believed that farming dulled the brain--that the contemplation and education necessary for full human mental development would inevitably be beyond the reach of all but a small portion of the human race, because the destiny of most of the human race was to farm the land, and farming left no leisure for philosophy. Eighty to ninety percent of households in the world of Aristotle had to labor, and as far as he could see would always have to labor, full time to grow food for themselves and the rest of the population. This Aristotle saw as the law of nature. Aristotle also believed that the first prerequisite of philosophy was leisure--which required, in Classical Athens, property, wealth, and slaves.

All this changed in the twentieth century. By its end, instead of the 4:1 ratio of farmers to non-farmers of the middle ages or the 1:1 ratio in the later nineteenth century, the ratio was 1:30: one farm for every thirty non farm households.

What would Aristotle say if told that in the United States today not eighty percent, but three percent of households are farmers? What would he say if he went on to learn that a major political flashpoint is that these three percent grow too much food? What would he say to the observation that the United States today could maintain its entire population at the material standard of living of classical Athens without requiring more than 100 hours a year of work from each of its adult citizens? The number of families fed by the food grown by one farm family has gone from 1.2 in Aristotle's day to 2.5 in the late nineteenth century to 33 today. What had been the principal occupation of the human race for 10,000 years-agriculture-has become the occupation of only a small part of the late twentieth century population.

Within industry, the balance of work also underwent profound shifts. Even in 1900, most industrial production was handwork, craft production. Even the most mass-produced and machine-intensive commodities-textiles and weapons-still required considerable handwork and final filing and fitting to complete their production. In the late twentieth century, most industrial production was mass production: handwork by skilled, specially trained, long-time experienced workers was the exception rather than the rule. Skills entered the production process mostly at the design stage, and at the maintenance stage-not, except for luxury goods, at the stage of direct craft production.

The balance between production and distribution also changed. By the end of the twentieth century, the United States had more people employed selling cars than making cars. Assembly-line auto workers were a smaller part of the total automobile production and distribution workforce than the employees of the distribution channel.

The character of the service sector changed as well. Think of the service sector as being divided into two components: those who perform services directly (whether cutting hair, carrying goods from place to place, or extracting appendixes) and those whose service-sector work is largely directed toward creating and manipulating information: governors, tax accountants, scribes and recorders, teachers, messengers (and others who work in communications technology), and entertainers. Throughout most of human history the number of service-sector workers has been relatively small: trade and personal services are luxuries largely for the rich. And there is little information to be processed: how many bushels of wheat the serfs owe to Baron Fred. As the commercial revolution took hold, and as trade greatly expanded, the size of the distribution component of the service sector grew rapidly. Perhaps one in five workers in Britain in 1800 was serving as a butler, or a porter, or a waiter, or a carter.

More recently it has been the turn of the information-intensive services to grow. This is not to say that information-intensive service-sector jobs are high-paying high-skill jobs. In fact, the growth of the retail scanner in the past generation has completed a process begun with the invention of the original cash register that has turned "cashier" from a high-wage, high-skill, high-trust job into one of the lowest-skilled of entry-level jobs in the modern economy. Yet the job of cashier continues to be very information intensive: tracking what is bought, and how much money is paid for it.

And perhaps most important of all, the balance between work within and without the household also shifted profoundly. Reductions in infant mortality, the advancing average age of marriage, and the increasing costs of child raising together drove a decrease in fertility. The rate of population growth slowed drastically, from an approximate doubling each generation to a rate approximately consistent with zero long-run population growth in the advanced industrial economies. The number of babies per potential mother dropped by about two-thirds.

Along with the reduction in fertility came an expansion of household technology: microwaves, dishwashers, washing machines, dryers, vacuum cleaners, improved chemical cleansing products, and so on all made the tasks of keeping the household clean, ordered, and functioning much easier. Maintaining a nineteenth century, high-fertility household was a much more than fulltime job. Maintaining a twentieth century household was-except in peak periods surrounding birth and illness-a part time job. Large reserves of female labor that had, for most of the nineteenth century and before, been effectively tied to work within the household because of the backward state of household technology could now be used for other purposes.

It is presumably no accident that the reduction in the internal time demands of running a household came at the same time as the rise of modern feminism. It is presumably an accident that this reduction and rise of feminism came at a time when women's liberation could turn to its own account ideological and intellectual weapons that had already proven effective for two centuries. First, the Third Estate had used equality among adult males-the principle of "careers open to talents" to overthrow status-based distinctions between classes of nobles and classes of commoners. Second, ethnic and religious groups that were victims of discrimination had used the same principles-judgment not by the color of their skin but by the content of their character-to win a series of partial victories, and to end racism as a dominant public ideology in the industrial west.

Third, the same principles could be applied by feminists. Restrictions on female education, on female voting, and on female career choice could all be attacked using the same set of principles and ideals that had proven effective in the first two waves of equality. In response to the declining time demands of within household work and the expanding set of outside opportunities, female participation in the paid labor force surged. At the turn of the twentieth century, the principle was that (with the sizeable exceptions of female domestic servants and-principally unmarried-female factory operatives) the paid labor force consisted of men. At the end of the twentieth century, things were very different.

In the United States, the end of the twentieth century saw female levels of training and education rapidly approaching male levels, and poised to surpass them. Male wages and earnings still appeared higher than female wages and earnings by more than could be easily accounted for by differences in education, training, and degree of labor force attachment: there was still discrimination visible at the aggregate level. But the discrimination-driven wedges between male and female wages appeared to be closing-slowly-with every passing decade.
 
 

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Consequences of Growth: Slouching Towards Utopia?

I have spent nearly forty pages arguing that the most important thing about twentieth century economic history is its extraordinary surge in material prosperity, a surge so great as to remake the world in which the average human being lives, at least in the leading-edge nations that make up the industrial core of the world economy.

Yet turn to other forms of history, whether political, cultural, or social, and the enormous absolute and relative pace of twentieth century economic growth has much lower billing. It is seen out of the corners of their eyes, at the edge of their peripheral vision--if it is noted at all.

To some degree this is the result of an overnarrowness of focus forced by their specialization: a professional deformation. Cultural historians typically track eras by the styles of life lived by the upper classes. Political historians look at the distribution of power and influence at the top of the income distribution. Social historians spend more time looking at the relative gap between top and bottom than looking for significant shifts at the bottom. The rich today are very rich indeed, but they are rich in different things and in different ways than the rich of a century ago.

So a view of the century that concentrates on changing elite styles of life, on the use of political power and influence, or on the relative gap between rich and poor, will not see economic growth at the center of its picture.

This fuzziness of vision is reinforced by the fact that in some ways, today's rich are impoverished when compared to their predecessors a century ago. The formal marks of deference and service that they were accustomed to receive have in large part disappeared. The ability to boss one's many servants around has traditionally been the mark of belonging to the truly upper class, and this style of life is the one that has become rarest--because it has become much more expensive in relative terms-today.

The rich today live in smaller houses. They have fewer servants. They share modes of intercity and international transport with those who a century ago would not have been allowed on the boat or in the railroad car. The upper classes today are far richer than their predecessors of a century ago, if wealth is understood in terms of command over nature and over commodities. But the rich of today have less ability to command human beings. If what you value in wealth is domination--the command and control over the wills of others that wealth gives you--then the rich are poorer in spirit (although much more prosperous in body) than the rich of a century ago.

A small detail is revealing. Consider George Orwell, who after the end of World War II was to become famous as the author of Animal Farm and of 1984: anti-utopian novels about how the future might go horribly wrong--and had gone horribly wrong in the Soviet Union. But before World War II George Orwell was a socialist. His most famous pre-World War II books were Homage to Catalonia, an account of his experience fighting for the left in the Spanish Civil War, and The Road to Wigan Pier--an account of his travels among the unemployed and desperate of England during the Great Depression of the 1930's. Orwell wrote Wigan Pier as a call for fundamental reform at the least, and possibly for revolution. He sought to convince middle class citizens that they had interests in common with the working classes: interests in prosperity, in fairness, in the avoidance of unemployment, and in an egalitarian distribution of wealth.

One of Orwell's major points is that the system (which Orwell, writing during the Great Depression, argues is not working at all for the lower classes) is not working for the middle classes either. So Orwell tries to sketch the plight of the British "lower upper-middle class" in the years just after World War I. As Orwell tells it, this class-to which he belonged-was becoming relatively impoverished. They had lost the traditional marks of British upper-class status:

[Y]our gentility was almost purely theoretical.... Theoretically you knew all about servants and how to tip them, although in practice you had one or, at most, two resident servants. Theoretically you knew how to wear your clothes and how to order a dinner, although in practice you could never afford to go to a decent tailor or a decent restaurant....[I]n [this]...kind of shabby-genteel family... there is far more consciousness of poverty than in any working-class family above the level of the dole

From today's perspective, Orwell's vision seems nonsense. It divides the world into two groups: those with more than two live-in servants-those with a nanny, a cook, a butler, and perhaps more-and everyone else. A household with "one or, at most, two resident servants" has only a "shabby" gentility. It is, Orwell thinks, ripe for recruitment to the cause of socialism, for there is no real difference between them and the industrial working classes.

But how many upper-class American families have permanent live-in servants today? As Orwell counts, rich Americans today cannot claim to be "genteel"--and should presumably be socialist--even though they have levels of real wealth some thirty-fold greater than their counterparts of the past century.

The answer is that Orwell believes that the touchstone of being truly well off is to boss many people around in your private life: only if there are people always waiting on you. Note the marks of gentility: servants, multiple restaurant waiters, tailors. The upper and middle classes in England were indeed losing their ability to casually employ armies of resident servants in the first third of this century. But they were not losing this ability because they were becoming poorer. They were losing this power because those who would otherwise have become their servants were becoming richer. Real wages were rising, opportunities for employment outside domestic service appeared more attractive, and potential servants were demanding higher real wages to enter domestic service.

Moreover, technology was creating cheap and effective replacements for many forms of personal service. Scrubwomen have been replaced by dry cleaners and washing machines. Maids (for the rich) have been replaced by vacuum cleaners and dishwashers. Messengers have been replaced by telephones. Butlers have been replaced by answering machines. Automobiles have become more reliable, so that each car does not need to come with a full-time chauffeur cum mechanic. There is a story that one of the founders of Mercedes-Benz said that there would never be more than a million cars in the world, because there were no more than a million potential chauffeurs.

When you unpack what is really going on, it becomes very hard to think of it as a "plight" at all. It is hard to argue that any class of people in Britain really were impoverished by the replacement of scrubwomen by washing machines. There is thus a certain cognitive dissonance created by judgments of wealth, poverty, and gentility like those of Orwell. He implicitly defines wealth not as the power to get things done but as the power to make other people do them. The twentieth century has seen wealth defined as power over nature increase; but wealth defined as power over people cannot increase. It in fact declines over time as the economy grows because people become less hungry, and so less willing to be bossed around.

This raises an issue: is the purpose of wealth to get things accomplished--to get clothes clean--or is it to demonstrate one's power by bossing the scrubwomen around?

Economists have a strong professional bias--perhaps a professional deformation of our own-- to define it as the first. This is, at bottom, a moral stance: love of domination for domination's sake is not allowed to be an end and a source of utility. The aim must be to get clothes clean, not to show that you are master and she is servant. Your wealth and welfare are defined as the things you can do (or cause to get done) in absolute terms, not by how your pile of commodities stacks up when compared to somebody else's or how many other people you can boss around. You are not impoverished if someone else becomes better off.

The past century has in fact seen the wages of relatively unskilled workers rise at about the same pace as productivity as a whole. Any commodity or service--like restaurant meals, skilled hand-crafted carpentry, or tailoring--that is heavily labor intensive has become, compared to other commodities, more expensive. The rise in material standards of living has necessarily taken the form not of an increase in the ability to acquire commodities that require not predominantly the input of other people's time and skill, but of an increase in the ability to acquire commodities created primarily the application of technology and the use of machines.

The past century has seen households trade cash for leisure. The wholesale city price of raw foodstuffs today amounts to four percent of consumer expenditure. It amounted to 20 percent a century ago. Yet the share of food in household budgets has shrunk not by a factor of five but by a factor of two. The difference is that today much preparation is done outside the household: mixing, chopping, pre-cooking, combining, freeezing, and processing all make cooking a meal a much less time-consuming process today than it was a century ago. Our food bill today seems so large because we count a very large share of the meal production process as a market expenditure. A century ago, much of this process was hidden inside the household and was never registered through a market exchange. To a large extent, Americans today are like rich Edwardian Britons in that they do have cooks. But today the counterparts of the last century's domestic servant cooks work outside the household, for companies like Nabisco, using very capital- and machine-intensive production processes.

A counterpart of the rising price of labor-intensive services has been the falling prices of once luxurious and scarce goods, and the growth of the consumption of "cheap luxuries" on the part of the relatively poor. Once again, this disquiets Orwell: the system is taking advantage of the relatively poor by enabling them to consume commodities that they think are luxuries, but that in fact are no longer so. In Britain during the Depression many among the poor were deprived of steady employment, good housing, nourishing well-balanced diets, and their self-respect as productive and hard-working members of society. Yet there were no revolts and little protest, even though "whole sections of the working clasd...have been plundered of all they really need." Why not? Because they had been "compensatef...by cheap luxuries which mitigate the surface of life": fish and chips, artificial-silk stockings, tinned salmon, cut-price chocolates, movies, radio, tea.

Orwell is profoundly uneasy with these cheap modern "luxuries." His prose shows this uneasiness with words like "palliative," "mitigate," "surface." He is in the last analysis not pleased but upset by the fact that "the youth...for two pounds ten on [installments]...can buy himself a suit which... at a... distance looks... tailored on Saville Row. The girl can look like a fashion place at an even lower price.... [I]n your new clothes you can stand on the corner, indulging in a private daydream of yourself as Clark Gable or Greta Garbo." At some level Orwell believes that this expanded range of choice masks the reality of the situation--which is that the working class has gained little in terms of relative income, relative wealth, or relative power. It makes tolerable what should not be tolerated: that the upper class has too large a share of the pie.

This shows that Orwell does not have the habits of mind of an economist, to whom absolute levels of material prosperity are much more important than relative wealth distinctions. But Orwell may have been right. It may be a mistake to say that the twentieth century has given the shop-girl of this century the same standard of living as a duchess of the nineteenth century, if the key element of being a duchess is being exceptional. To the extent that goods are valued not for the services they provide by themselves but as indices of exclusivity, it is pointless to produce them for more people because then they become less exclusive and so less valuable.

The economist Paul Krugman, for example, is on Orwell's side: he would rather be middle-class in 1950 than working poor in 1990--even though the material standard of living of America's working poor in 1990 is higher than that of America's middle class in 1950. He:

know[s] quite a few academics who have nice hourses, two cars, and enviable working conditions, yet are disappointed and bitter because they have never received a [job] offer from Harvard and will probably not get a Nobel Prize. The live very well... but they judge themselves relative to their reference group, and so they feel deprived. And on the other hand, it is an open secret that the chief payoff from being really rich is, as Tom Wolfe once put it, the pleasure of "seeing 'em jump." Privilege is not merely a means to other ends, it is an end in itself.

It may be a big mistake to think that human happiness is necessarily and significantly increased by piling up larger and larger heaps of material goods. For today we have exceeded the technological capabilities of all previous utopias. Recall Edward Bellamy's Looking Backward, where the limit of human felicity is attained by the ability to dial one of four orchestras and listen to it over a speakerphone.

Yet America today does not see itself as possessing wealth vast beyond dreams. Americans today do still have dreams of avarice. And certainly do not believe that they live in anything like a Utopia. They by and large do not feel as though they have gone far beyond the limits of useful wealth into the realm of sybaritic luxury. And America has not been able to--or has not wished to--distribute this wealth in a way that makes everyone feel that he or she has "enough."

Thus we today do not see ourselves as living in, or even as rapidly approaching, Utopia. Yet dreamers in all previous centuries would have thought that Utopia could be built with much less power over nature and ability to produce material goods than a late twentieth century industrial nation in fact possesses.

I want to stress this contrast between how we regard our prosperity, and how our predecessors would have regarded us. Consider John Maynard Keynes, perhaps the greatest economist of the twentieth century. He was one of the few who did clearly see the power of economic growth in an essay he wrote at the beginning of the Great Depression: "Economic Possibilities for Our Grandchildren." Keynes, correctly, classified the then-current depression as a temporary interruption of a long-run tide of rising prosperity. But what did he see as the result of this rising tide? Keynes concluded that the Economic Problem, that is "the problem of want and poverty and the economic struggle between classes and nations," was in the last analysis "nothing but... a transitory and unnecessary muddle."

Keynes' argument had three steps. First, he--correctly and in fact somewhat pessimistically--expected "...the standard of life in progressive countries one hundred years hence will be between four and eight times as high as it is [in Britain] today." We in the United States only a little more than half a century after his writing have at least met and perhaps far surpassed this expectation. Second, Keynes saw human needs as "fall[ing] into two classes-those needs... absolute in...that we feel them whatever the situation of our fellow[s]... and those which are relative...that we feel... only if their satisfaction... makes us feel superior...." Third, he argued that although "needs of the second class... may indeed be insatiable... this is not so true of the absolute needs."

Keynes' conclusion was that "a point may soon be reached... when these [absolute] needs are satisfied, in the sense that we prefer to devote our further energies to non-economic purposes." In that case:

the day is not far off when the Economic Problem will take the back seat where it belongs, and that the arena of the heart and head will be occupied... by our real problems---the problems of life and of human relations, of creation and behavior and religion.

Then the desire to acquire for the sake of impressing our next door neighbors will fall as well:

When the accumulation of wealth is no longer of high social importance, there will be great changes in... morals.... We shall...rid ourselves of many of the pseudo-moral principles which have hag-ridden us for two hundred years.... We shall...assess...the love of money as a possession--as distinguished from the love of money as a means to the enjoyments and realities of life--for what it is... one of those semi-criminal, semi-pathological propensities which one hands over with a shudder to the specialists in mental disease. All kinds of social customs and economic practices, affecting the distribution of wealth and of economic rewards and penalties, which we now maintain... however distasteful and unjust they may be in themselves, because they are tremendously useful in promoting the accumulation of capital, we shall then... discard.

There are many ways to see that Keynes is mistaken. First, note that much of what Keynes thought of as "necessities" in the mid-1930s would have struck, say, Agamemnon in 1400 B.C. as pointless and decadent luxuries.

More important, Keynes's predictions have not come to pass. He expected society to undergo a profound change as attention shifted from working hard to keep the wolf from the door to living a good life. But we today do not feel that material acquisition is about to go out of style, we do not appear to be on the threshold of converting en masse from full-time to half-time or quarter-time work, and we have not begun to rank and applaud people by how they spend their leisure as opposed to what they do at work. The dividing line between useful necessity and pointless luxury always comes at roughly twice one's current standard of living. After all, Americans could subsist--healthily--off of wheat flour, evaporated milk, cabbage, spinach, and navy beans for less than fifty cents a day. But, as George Stigler wrote:

such a diet would not be to the satisfaction of either the population or the students of nutrition.... Man insists upon luxuries such as meat, and should we somehow fully address his desire (despite his penchant for shifting from sow belly to pheasant), he will no doubt insist upon shifting to another and more expensive food.... [T]he economic system has as its purpose forcing people to find new scarcities... the alteration of a host of circumstances and policies that deprive large numbers of people of eminently desirable things that a more efficiently organized society could afford.

So there is no real reason to expect "satiation" at any level of per capita income that I can foresee. The level of luxury at which people imagine satiation is always three times the value of their current consumption.

It is significantly more pleasant to eat broiled sole at Chez Panisse than to munch on a tuna sandwich while sitting on the concrete wall by the North Gate to the Berkeley Campus. It is more fun to write on a powerful laptop PC, while sitting at a tile table in an air-conditioned cafe and drinking cappucino, than to write on a manual typewriter in a small, hot office while drinking a combination of dishwater and sludge made from instant coffee--or to write with bad ink on parchment by the light of a single candle.

We cannot approach utopia in terms of material welfare because we can always imagine how increased resources could give us a more comfortable and rewarding life. Or perhaps it is better to say that from the standpoint of every previous century we have surpassed utopia, but failed to stop and properly appreciate the accomplishment.

An equally important answer, of course, is that Utopia does not require merely command over nature. It requires command over self, and command over society as well. Command over self is a matter of psychology. But it means that material welfare is not standard of living. Public order and public safety, relative income, one's material consumption relative to one's parents, and so forth all make the standard of living or style of life more complicated than simply the consumption of material goods, of commodities and services. They make relative income as important, in some circumstances, as absolute prosperity. And it is as important to teach people how to choose the ends they want their lives to serve as to give them wealth--power--that can be used to achieve such ends.

The second answer is that we have not achieved utopia--in spite of immense material wealth--because we have approached it as a problem of engineering, and it is in fact a problem of psychology. This leads to a third answer: our collective failure to solve the problems of command over self means that the economy is not just as a means for the satisfaction of wants, but also serves as a social discipline mechanism: a device for compulsion and regulation of behavior through the granting and withdrawal of material rewards for appropriate and inappropriate behavior.

The institutions of the economy and polity never confine themselves just to the administration of things, but becomepart of the government of humans as well.

Yet to use the economy as a social discipline device to control behavior requires that those who do not behave appropriately do not benefit from the fruits of our collective prosperity. And economic forces can only be effective as mechanism of social control if the relative misery generated by the failure to behave appropriately is great: if the economy is to be used as a social discipline mechanism, then some must be disciplined--and live in poverty. This principle was restressed during the right-wing swing of the political pendulum in the 1980s: it was argued that the rich and skilled would not work their hardest and do their best unless they got to keep a very large share of what was produced produced, and that the poor would be idle and unproductive unless the consequences of unproductivity were truly dire--that disability insurance only encouraged more people to remain disabled, and that unemployment insurance only encouraged people to stay unemployed.

Thus the paradox; the carrot of lower taxes to the rich and the stick of a withdrawal of social insurance to the poor are, it is widely agreed, necessary to rev up the engine of rapid economic growth and development. The result is a society that is materially richer than any previously imagined utopia. Yet this society also falls far short of anyone's vision of a shining city on a hill. In the imagination of utopians, their cities on a hill did not have masses of itinerant beggars, or poor mothers working their fingers to the bone because of life-choices they had made in the distant past. Yet our civilization does.

There is a possibly apocryphal story about Lenin in exile in Switzerland. One day he was eating lunch in a hotel. Someone asked him how, after the revolution had been accomplished and the building of utopia had been completed, goods would be distributed. Lenin pointed to the sugar bowl in front of him. In middle class restaurants, he said, sugar and salt are not scarce; everyone takes what they need, and there is enough for all. So will it be for all commodities under socialism.

Now Lenin was not only one of the most brutal but also one of the most clueless political leaders of the twentieth century. He had no understanding of how to create a government that would nurture and protect individual liberty. He had no idea how to order society to create general prosperity. He did understand--to Russia's great misfortune--the institutions of political conspiracy.

But it is not only from Lenin's perspective alone, but from Edward Bellamy's and from John Maynard Keynes's perspective that our present society falls short of the utopia that they had imagined such great material wealth and technological capability would generate. From their perspective, our combination of enormous material wealth on the one hand with the use of economic forces as a social discipline device on the other would appear profoundly weird, and mark a degree of continued enslavement to "avarice, usury, and precaution" that they would have found incredible.

And the answer, of course, is that there is much, much more to be done if we are ever to finish slouching towards utopia.
 

-IV. Genocide-
 

J. Bradford DeLong
University of California at Berkeley and NBER

January 1997
 
 
 
 

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Magnitude of Twentieth Century Genocide
Origins of Twentieth Century Genocide
Communism and Nazism
Economic Ideology and Political Murder
 

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This chapter carries a dark, grim message: the boost to human productive, technological, and organizational powers seen in the twentieth century was truly value-neutral. The century that has seen the fastest economic growth and the richest human societies ever has also seen the greatest--and multiple--genocides. The greatest crimes of human history have been committed, and the greatest criminals of all time have lived, in the past hundred years.

The table below presents a few estimates from R.J. Rummel's Death by Government--a book that undertakes the grim task of attempting to roughly count up the violent death toll of the twentieth century. Rummel excludes from his count of genocide the deaths of soldiers in time of war, and the "incidental" deaths of civilians in time of war (that is, deaths that occurred as a consequence of what could be classified as military operations directed against enemy armed forces or war-making power: military exercises like the British night bombing of German cities during World War II are counted as episodes of genocide). Rummel's estimates of genocide are only of the people whom governments, in time of peace or far from the battlefront, have killed.

Some of the estimates are solid; some are shaky; some are wild guesses. Some are barely estimates at all: we know next to nothing of what has gone on in North Korea over the past fifty years, and Rummel's guess--he doesn't label it an "estimate"--is based on the projection that North Korea has been no better and now worse than similar countries with similar ideologies and similar degrees of self-imposed isolation.

I think some estimates are too high, and some are too low (I suspect Communist China and Nazi Germany should be switched). But Rummel's estimates are not without evidence, and on average I have no reason to believe that they are biased in any systematic way.

Deaths as a result of military operations in this century have been horrific enough: governments and their soldiers have killed perhaps forty million people in war--either soldiers unlucky enough to have been drafted into the mass armies of the twentieth century, or civilians killed in the course of operations that generals could claim were directed at reducing the enemy's war-making potential.
 

But the top twenty regimes have killed--roughly--156,000,000 civilians in this century. Wars have been less than a quarter of this century's violent death toll. Far from the battlefront and in time of peace, governments in this century have bloody hands: class enemies, race enemies, political enemies, economic enemies, imagined enemies--you name it, governments have slaughtered them on a previously unimagined scale.

Let us call those leaders whose regimes have slaughtered more than ten million of their fellow humans "members of the Ten-Million Club." All pre-twentieth century history may (but may not) have seen two members of the Ten-Million Club: Chingis (Ghengis) Khan, the ruler of the twelfth century Mongols, the launcher of tremendously bloody invasions of Central Asia and China, and the founder of China's ruling Yuan Dynasty (Marco Polo's travels were to the court of the Yuan Emperor Kubulai Khan); and Hong Xiuquan, the mid-nineteenth-century Chinese intellectual who declared himself Jesus Christ's younger brother and launched the Taiping Rebellion. No single individual played a significant role in the creation and growth of the early modern Atlantic slave trade, or in the disease-and-exploitation-driven decimation of the pre-Columbian populations of the Americas. The first of these two historical episodes was on a super-genocidal scale; the second is uncertain--it may only have been genocidal.

By contrast, the twentieth century has seen perhaps five members join the Ten Million Club: in alphabetical order, Adolf Hitler, Chiang Kaishek, Vladimir Lenin, Joseph Stalin, and Mao Zedong. Hitler, Stalin, and Mao have credentials that may well make them the charter members of the Thirty Million Club as well--perhaps even the Fifty Million Club: our knowledge of what went on inside China, the Soviet Union, and the Third Reich is very imperfect. A regime whose hands are as bloody as those of the Suharto regime in Indonesia-with the blood on its hands of perhaps 450,000 communists, suspected communists, and others who simply were in the wrong place at the wrong time at its creation in 1965, and perhaps 150,000 inhabitants of East Timor since the Indonesian takeover in the mid-1970s--such a regime barely makes the twentieth century's top twenty list as far as the massacre of civilians is concerned.
 
 

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Origins of Twentieth-Century Genocide

Some have traced the beginnings of the twentieth century's culture of genocide to the overturning of the traditional rules of European war that sharply distinguished combattants from non-combattants. In the Boer War at the turn of the century in South Africa the British army found itself faced with a stubborn guerrilla movement after the defeat of the Boer Republic's conventional armies. The British army responded by inventing the concentration camp as we know it: depopulating the countryside, and crowding civilians together. Disease spread though the camps and mortality was relatively high--although lower than in virtually every other twentieth century concentration camp.

Others trace it to the rhetoric of violence that always accompanied Karl Marx's version of socialism. In Marx's writings, democratic political institutions, individual rights, and public deliberation are always masks and shams in the absence of substantive economic equality--and were to be fought as fiercely as medieval barons who slaughtered peasants for failing to pay feudal rents.

Still others trace it to the great French Revolution of the eighteenth century, to political philosophers like Jean-Jacques Rousseau, and to the idea that whatever political party represents the Nation is engaged in a life-and-death struggle with Enemies, a struggle in which scruples about means are out of place.

Still others say that it was there all along, but that pre-twentieth century governments and religions by and large lacked the organizational capability and certainly lacked a motive to exterminate their fellow human beings by the tens of millions. They could conduct pogroms, purges, and witch-burnings on a retail scale, and only the absence of modern technologies of communication and organization kept them from moving to the same wholesale scale of slaughter as the Khmer Rouge. It was a French Catholic bishop who, when asked how to sort out the heretics from the true believers in a newly captured city, is reported to have said: "Kill them all!--God will recognize his people."

There is some truth to all of these interpretations. For example, the practice of Robespierre's Committee of Public Safety during the French Revolution in executing not just the leaders but also the followers and families of their political opponents (a practice that Robespierre's political opponents turned against him as soon as they could), the practice of using the military to depopulate restive regions like the Vendee of western France, and the practice of using rigged courts to give a thin veneer of "legality" and due process to political murder did have their origin in the French Revolution.

The first two major episodes of genocide in this century, the perhaps one million peasants killed in Russia in the last two decades of the Czarist regime and the perhaps than one million civilians dead in the last year's of President Porfirio Diaz's rule and the years of the Revolution in Mexico, look a lot like the traditional use of violence by an aristocracy to maintain its power and wealth, only writ larger as a result of better technologies of communication and organization.

But the greater power of governments to organize and carry out purges, the sharpening of ethnic conflicts, and the rising power of violent nationalism were, even together, not enough to trigger the genocides of this century. That required two political movements: Communism and Fascism. And both Communism and Fascism were movements that had economic ideology at their core.
 
 

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Communism and Nazism:

Communism as we have known it was born when Vladimir Lenin's fraction of the Russian left--the "Bolshevik" or majority faction of the formerly-unified Russian Social Democratic Party--seized power in a late-1917 coup from the post-Czarist provisional government led by Kerensky. A brutal Civil War followed, as "White" supporters of the Czar, local autocrats seeking effective independence, Lenin's "Red" followers, stray other forces-- including a Czech army that found itself first trapped in and then effective ruler of Siberia, and Japanese regiments (the United States sent both troops to secure base areas for anti-Communist forces, and food to feed Russians in Communist-controlled areas)--fought back and forth over much of Russia for three years.

When the Civil War ended, Lenin's regime was in control. The Czarist generals were dead or in exile in Paris. Any liberal democratic or social democratic center had been purged by the Whites or the Reds in the course of the Civil War. And the relatively small group of socialist agitators that had gathered under Lenin before the revolution found itself with the problem of running a country and building a utopia, with the assistance of those who had declared for the Reds and against the Whites and joined Lenin during the Civil War.

The first imperative facing Lenin's regime was the necessity of eliminating capitalism. According to the Marxist theory that Lenin deeply believed, capitalism--private ownership of businesses and land, and private receipt of profits--was the source of inequality or exploitation. But how do you run industry and economic life in the absence of business owners--of people whose incomes and social standing depend directly on the prosperity of individual enterprises, and who thus have the incentives and the power to try to make and keep individual pieces of the economy productive and functioning?

Lenin's answer was that you organize the economy like an army: top down, planned, hierarchical, with under-managers promoted or fired depending on how well they attained the missions that the high economic command had assigned them. Lenin had been impressed by what he saw of the German centrally-directed war economy of World War I.

The second imperative facing Lenin's regime was to industrialize Russia. Frightened that the powers of the industrial core might decide to overthrow their regime, and desperately aware of their economic weakness, it seemed to Lenin and his followers that military discipline in the service of industrialization was essential.

The third imperative was to survive. As the British historian Eric Hobsbawm has written of Lenin's regime, "as Lenin recognized... all it had going for it was the fact that it was... the established government of the country. It had nothing else. Even so, what actually governed the country was an undergrowth of smaller and larger bureaucrats..." And for a government to survive when there are no powerful social classes or interest groups that have ideological allegiances or substantive reasons to back it requires great ruthlessness.

Great ruthlessness was exercised not only against society outside the Communist Party but against the activists of the Communist Party itself. A "command economy" turned out to require a "command polity" as well. The Communist Party won the Russian Civil War as a one-party dictatorship with a powerful and aggressive secret police, committed to using mass terror to suppress counter-revolutionaries, and banning even internal democracy and discussion of policies and politics. As the German Marxist Rosa Luxemburg had warned, the process begins by ruling in the name of the people, then by substituting the judgment of the Party for the wishes of the people, then by substituting the decisions of the Central Committee for the judgment of the Party, and then by substituting the whim of the Dictator for the decisions of the Central Committee.

And the dictator who won the struggle for power after Lenin's death--Josef Stalin--was a paranoid psychopath to boot. Stalin made Lenin's terror look mild and reasonable.

Peasants were shot, died of famine, and were exiled to Siberian prison labor camps in the millions during the 1930s. Factory workers were shot or exiled to Siberian labor camps for failing to meet production targets assigned from above. Intellectuals were shot or exiled to Siberian labor camps for being insufficiently pro-Stalin, or for being in favor of the policies that Stalin had advocated last year and being too slow to switch.

Communist activists, bureaucrats, and secret policemen fared no better. More than five million government officials and party members were killed or exiled in the Great Purge of the 1930s as well. All of Stalin's one-time peers as Lenin's lieutenants were gone by the late 1930s-save for Leon Trotsky, in exile in Mexico, who survived until one of Stalin's agents put an icepick through his head in 1940.

Of the 1800 delegates to the Communist Party Congress of 1934, less than half were alive by 1939.

We really do not know how many people died at the hands of the Communist regime in Russia. As Basil Kerblay write in his Modern Soviet Society, we know more about how many cows and sheep died in the 1930s than about how many of Stalin's opponents, imagined enemies, and bystanders were killed. R.J. Rummel estimates 62 million dead.

The story of Mao in China is similar to the story of Stalin in Russia: the same ruthless commitment to use any means necessary to remake society and preserve Communist Party rule, the same desire to override all other social forces and centralize economic and social life into a near-military hierarchy, the same delusions of grandeur and paranoia at the top. Mao's lieutenants were perhaps better than Stalin's at attempting to ease him out of power and into symbolic retirement: Liu Shaochi and Deng Xiaoping thought that they had achieved this in the aftermath of the catastrophic economic policies of the 1950s that led to a great famine that killed tens of millions. But Mao's lieutenants' willingness to try to control their paranoid leader triggered the upheaval of the Cultural Revolution, Mao's counterstroke in which he rallied the young and the ideologically pure against the hierarchy of the Communist Party, and may in the end have simply increased the death toll.

The third of the leaders of the most murderous regimes of the twentieth century, Adolf Hitler of Nazi Germany, probably did not match up to his peers Stalin and Mao in length of his tyranny, but surely was their master in evil. He gained a voice in German politics by exploiting nationalist resentment against those who had beaten Germany in World War I and the economic distress of the Great Depression. He took power by outmaneuvering the right-wing politicians who had taken him into the cabinet to boost their popular support.

He quickly turned Gemany into a centralized-totalitarian-dictatorship in which, in theory at least, all social and economic institutions were "co-ordinated" with the Nazi Party. "What need have we to socialize industry or agriculture? We socialize human beings!" Up until the start of World War II the terror was, by twentieth century standards, relatively small: murder, imprisonment, and harassment of Jews, opposition political activists, homosexuals, and some ofthe disabled and mentally ill. After the beginning of World War II, the machine of extermination was put in motion on a large scale. Some were worked to death in slave labor camps at the disposal of German businesses like Krupp and I.G. Farben. Some were shot by mobile extermination teams. Many were shot by the army well behind the fighting lines. Some were left to die in concentration camps. Many others were killed assembly-line fashion in extermination camps.

Stalin and Mao could point to reasons --insane and mistaken reasons, true, but reasons nevertheless--why their actions and killings made sense in terms of ends that we all share of general prosperity and human development, and why they had chosen the path that the poet W.H. Auden wrote of as "the acceptance of guilt in the necessary murder." The Cultural Revolution in China was needed to keep China a socialist country that could someday become a free and equal utopia, to keep it from degenerating into a bureaucratic despotism like the Soviet Union. The mass slaughter of the peasants of the Ukraine was necessary because an agriculture based on private farming and small plots rather than collective farming and industrialized agriculture could never produce the increases in productivity needed to feed the growing cities of the industrializing Soviet Union. These justifications were wrong--insanely wrong--but economic development and the avoidance of bureaucratic despotism are good things.

But Hitler? Killing in concentration camps, extermination camps, and through forced labor, killing six million Jews, two million of scattered nationalities from western Europe, and twelve million or so from eastern Europe in addition to the battle-related deaths of World War II? Why? To diminish the likelihood that the German "race" would be further polluted through intermarriage, and to provide more "living space" for German farmers.

Stalin and Mao still have their defenders: people who admit with one hand that "there is no doubt that under some other leader [than Stalin]... the sufferings of the peoples of the [Union of Soviet Socialist Republics] would have been less, the number of victims smaller"; yet with the other go on to write that:

any policy of rapid modernization in the U.S.S.R... was bound to be ruthless and, because imposed against the bulk of the people and imposing serious sacrifices on them, to some extent coercive... closer to a military operation than to an economic enterprise. On the other hand... the breakneck industrialization of the first Five-Year Plans (1929-41) generated support by the very "blood, toil, tears, and sweat" it imposed on the people.... sacrifice itself can motivate.

Hitler, however, does not have his defenders, has no one to claim that he used perhaps excessive means to good ends. His ultimate goals--the Aryan racial purity of the German people, and sufficient "living space" at the disposal of the German nation to allow it to dominate the world--are far, far outside the admissable bounds.
 
 

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Economic Ideology and Political Murder:

What does this bloody political and secret police history have to do with economic history, with the story of how people produced, distributed, and consumed the commodities needed and desired for their material well-being? First, the possibility that the secret police will knock at your door and drag you off for torture and death is a serious threat to your material well-being. The seventeenth-century political philosopher Thomas Hobbes wrote that people are motivated by sticks and carrots: "the fear of violent death, and the desire for commodious living." In a century where the chance that a randomly-selected person will be shot or starved to death by the government approached five percent, the fact of large scale political murder becomes a very important aspect of everyday life and material well being.

Second, the twentieth century is unique in that its wars, purges, massacres, and executions were part of struggles over economics. Before the twentieth century people killed each other over theology: eternal paradise or damnation. Before the twentieth century people killed each other over power: who gets to be top dog, and to command the material resources of society. These motives are, to some extent, comprehensible.

But only in the twentieth century have people killed each other on a large scale in disputes over the economic organization of society.

Communism saw itself as a utopian mode of social and economic organization, engaged in a death struggle with the other modes of "Capitalism" and "Feudalism." Opponents of regimes had to die because their very existence was "objectively" reinforcing the strength of the opposing modes of organization, and preventing the achievement of universal prosperity and utopia.

Naziism was, in its origins, National Socialism: the National Socialist German Workers' Party. Those Nazis who took the "socialism" as implying a serious desire on the part of a Nazi government to level the distribution of income died in the 1934 purge, a year and a half after Hitler took power. But anti-capitalist rhetoric remained--a stock-in-trade of Nazi propaganda was always the contrast between good hard-working German technicians and bad blood-sucking Jewish financiers. And the Nazi justification for taking power was rooted both in the desire to reverse the shame of Germany's defeat in World War I (and the unequal treaty settlement imposed by the victors) and in the desperate poverty of the Great Depression, which demonstrated the political bankruptcy of the liberal Weimar Republic.

The economic ideologies of the Communists and the Nazis did not play a significant role in boosting or maintaining their power. The Communist Party chief of a Ukrainian village is and remains boss whether the cattle are owned by individual farmers or by the village collective. Lenin and his successors had little trouble maintaining political control during the 1920s, the decade of the "New Economic Policy" that saw the party allow the revival of private enterprise. And the flaws in trying to run economic life through nationwide central planning were obvious early in the regime. The Nazi government's power depended on its use of the police and of terror. The expropriation of Jewish enterprises, the gathering of much industry into the hands of second-in-command Hermann Goering, and the attempt to impose central planning for military purposes did not aid the Nazi regime: its success at mobilizing national economic resources for World War II was less than that of Stalin's Russia, Churchill's Britain, or Roosevelt's Ameria.

But these economic ideologies played an enormous role in creating and energizing the movements, and in directing their actions while they were in power.

Fidel Castro rules in Havana whether or not farmers are allowed to sell their crops in roadside stands. Deng Xiaoping's control over China was not impaired by his decision to be pragmatic: to announce that a good cat was one that catches mice-not one that was the ideologically-correct color. Power, personal status, and eternal salvation had little to do with the Soviet collectivization of agriculture, the Cuban suppression of small-scale markets, or the disaster of Mao's Great Leap Forward. These were in large part and certainly appeared on the surface to be attempts to guide and shift the economy in order to meet the requirements that some ideology claimed were necessary.

Other twentieth century disasters had equally strong roots in economic ideas: it is hard to see World War II in the absence of Adolf Hitler's idee fixe that the Germans needed a better land-labor ratio-more "living space", more lebensraum-if they were to be a strong nation; beliefs that overseas colonies provided powerful economic advantages fueled great power rivalries before World War I.

Imperial Japan drew from its own and to a much lesser extent the German militarist traditions. But its wave of conquest drew inspiration from the European pattern of colonial empires, and from economic theories that a country could not maintain full employment and rapid growth without the "vent for surplus" production and investment provided by a colonial empire. By 1936 Japan had a colonial empire consisting of many Pacific islands, Taiwan, Korea, and Manchuria. Then the army decided to add much of China to the colonial empire; the far eastern phase of World War II began; and perhaps five million Chinese civilians died.

So a very important part of twentieth century history is the fact that the causes of the bloodshed were in large part economic ideologies: beliefs about how the world worked, and how the economy should be organized.

V. First and Third World-
 

J. Bradford DeLong
University of California at Berkeley and NBER

January 1997; DRAFT 1.0
 
 
 

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The Iron Curtain
"Convergence"?
Determinants of Relative Economic Growth
 

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Those nations and economies that were relatively rich at the start of the twentieth century have by and large seen their material wealth and prosperity explode. Those nations and economies that were relatively poor have grown richer, but for the most part slowly. And the relative gulf between rich and poor economis has grown steadily. Today this relative gulf is larger than at any time in humanity's previous experience, or at least larger than at any time since there were some tribes that had discovered how to use fire and other tribes that had not.

This particular glass can be viewed either as half empty or as half full. Half empty: we live today in the most unequal, in terms of the divergence in the life prospects of children born into different economies, world ever. Half full: most of the world has already made the transition to sustained economic growth; most people live in economies that, while far poorer than the leading-edge post-industrial nations of the world's economic core, have successfully climbed onto the escalator of economic growth and thus the escalator to modernity. The economic transformation of most of the world is less than a century behind the economic transformation of the leading-edge economies-only an eyeblink behind, from a millennial perspective.

On the other hand, one and a half billion people live in economies that have not made the transition to intensive economic growth, and have not climbed onto the escalator to modernity. It is very hard to argue that the median inhabitant of Africa is any better off in material terms than his or her counterpart of a generation ago.
 
 

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The Iron Curtain:

Begin by looking at the snaky geographic line across Eurasia that used to be called the "Iron Curtain," a name coined by Winston Churchill in a famous speech given in Missouri in 1947. On one side were regimes that owed their allegiance to Karl Marx and to Marx's viceroys on earth. On the other side were regimes that claimed during the 1946-1989 Cold War between Communism and Liberalism to be of the "free world"--and that were, if not good, at least less-worse guys: only two of the twenty most genocidal twentieth-century regimes fall on "our" side of the Iron Curtain in the post-World War II era. By the standards of the twentieth century that is not a bad score.
 
 

Walk along this geographical line from Poland to Korea, and then hop over to the only western hemisphere Communist satellite--Cuba--looking first left at the level of material welfare in the Communist country, and then right at the level of material welfare in the non-Communist country. Before Communism regions adjacent to the Iron Curtain were seen as having similar economic destinies. And the location of the Iron Curtain is a historical accident: it is where Stalin's Russian armies stopped after World War II, where Mao's Chinese armies stopped in the early 1950s, and where Giap's Vietnamese armies stopped in the mid 1970s.

Notice as you walk that to your right, outside the Iron Curtain, the countries are far better off in terms of GDP per capita. They are not necessarily better off in education, or health care, or in the degree of income inequality: if you were in the poorer half of the population--and if you were not homosexual, if you kept your mouth shut, and if you were not swept up in one of the anti-profiteer drives--you probably received a better education and had access to better medical care in Cuba than in Mexico until the collapse of the Soviet Union, and the end of Russian subsidies to Cuba at the end of the 1980s.

But the countries fortunate enought to lie outside what was the Iron Curtain are vastly more prosperous. Mexico today is, we think, some eight times as wealthy as Cuba, which few if any would have predicted in the mid-1950s before Castro seized power. Greece today is some six and a half times as well off as Bulgaria. Even the Philippines are five times as well off as Vietnam. And Taiwan--where the Chinese Nationalist Kuomintang Party retreated after losing the final late-1940s phase of their Civil War to Mao--is some nineteen times as well off as the Chinese mainland.

Depending on how you count, between two-thirds and seven-eighths of the potential material production and prosperity of a country has been annihilated if it fell under Communist rule. Communism was not only a source of genocide, it was also a source of economic stagnation and decline: not one of the brighter lights on humanity's tree of good ideas.

The fact that a large part of the globe fell under Communist rule in the twentieth century is the first major factor making for enormous disparities in the world's distribution of economic wealth across nations. Moreover, figuring out how to move from a stagnant, ex-Communist economy to a dynamic, growing one is proving very difficult. It looks as if the "economies in transition" closest to the European Union will successfully become growing economies and democratic polities: Slovenia, Hungary, the Czech Republic, Poland, Lithuania, Latvia, and Estonia all appear to be making a success of their transitions from Communism. What will happen elsewhere is still uncertain.
 
 

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"Convergence"?

The nineteenth-century British philosopher and economist John Stuart Mill hoped and believed that he would live to see the world economy's distribution of income and wealth draw closer together. Cruel and inefficient tyrannies had always left countries impoverished, but--with the spread of democracy, liberty, education, and liberalism--Mill thought that cruel and inefficient tyrannies would soon be a thing of the past.

Resource and population pressure--too many mouths to feed given limited arable land and limited agricultural technology--had kept many other countries at the edge of famine. The amount of bread that the wage of a bricklayer would buy fell by a third, back to the level of 1300, during the glorious reign in England of Queen Elizabeth I. No matter what went on in high politics and courtly luxury, the mass of humanity was close to the edge of want. Life was nasty, brutish, and short.

But Mill was optimistic; Mill thought that the spread of birth control and the advance of technology would remove hunger from the world.

Mill looked out at a world where the industrial revolution, concentrated in northwest Europe, had as yet raised the standard of living of only a small proportion of the world's population. The advance of European living standards accompanied by stagnation elsewhere had opened huge relative wealth gaps between Europe and the rest of the world. Mill hoped and expected this wealth inequality to be transitory.

Democracy and literacy were spreading across the globe. The modern technologies of the industrial revolution were not the private property of any one man or group of men; instead, they were "public goods," open to all. Anyone who could read and observe could learn what were the key technologies that had made the industrial west so rich. And the material benefits from tapping the storehouse of industrial technologies were so great that businessmen and governments outside of Europe would strain every nerve to do so, and would bring their countries into the modern industrial age.

When they did so, the world's nations would draw together in terms of standards of living, and then human command over nature would continue to rise and the burden of labor to fall. For the industrial revolution was not a once-and-for-all jump in the level of technology alone, but a once-and-for-all jump in the level accompanied by a permanent upward shift in the rate of change.

In many ways, Mill was correct. The successive technological waves of the Industrial Revolution, roads and canals first, then textiles, then steam power in mining, then ironworking and railroads, and so forth, did permanently change the material conditions of human life. As technologies became more sophisticated, children became net consumers of household resources rather than net producers of resources for the household. Fertility dropped. Thus rates of population growth remained low while technology and available natural resources expanded. The industrial revolution was an enormous shock to the world economic order. It did gave Europe, and especially northwestern Europe, and especially Great Britain, an enormous edge in terms of productivity and technology. And the technologies of the industrial revolution did begin to diffuse.

In spite of stringent laws restricting the export of technologies and of skilled workers adopted by Britain, its technology leaked out to other countries. When the Lowells, Cabots, and Appletons of Boston wished to build a textile factory they hired a managing engineer, Paul Moody, from England. They gave him a substantial equity stake in the Waltham-based Boston Manufacturing Company that they had started and had based on Francis Cabot Lowell's hurried and secret sketches of British textile machinery. Industrialization spread from old England to New England, and into Belgium, Germany, northern France, and beyond in Mill's lifetime.

Yet thereafter the process of diffusion did not live up to Mill's hopes. On the eve of the twenty-first century, the world is much richer than it was in J.S. Mill's day. But the distribution of the world's wealth between nations is more unequal than when J.S. Mill wrote. The economic history of the past century and a quarter is a history not of "convergence" but of "divergence": the different countries and peoples of the world have not drawn closer together in relative living standards, but have drifted further apart.

The figure below shows the distribution of world real GDP per capita--by percentage of world population, not by nation-state--in 1993 and in 1870, as best as it can be estimated. The estimates are the standard ones from Historical Statistics: those that show merely a seven-fold multiple of material prosperity at the top end of the world income distribution over the past century. In actual fact, as I argued above, people living in the richest countries of the world today have between twenty and two-hundred times the material standard of living as their counterparts of a century ago.
 
 
 
 

Question: Does this mean that the world's poorest people today are between three and thirty times as well off as their counterparts of a century ago? Are the underestimates of economic growth as significant at the low as at the high end of the world's income distribution?

Answer: There are underestimates, but they are probably not as large. This is not to say that the world's poorest today are as poorly off as the world's poorest of a century ago. First of all consider life expectancy: even in the poorest countries today, life expectancy at birth is fifty years, twice what it was a century ago. Even the imperfect penetration of modern medical technologies into the poorest parts of the third world have done marvels for human well-being.

But the benefits that the world's poor have gotten from the invention of new goods and new types of commodities are almost surely smaller than the benefits that the rich have received from the past century's waves of innovation. Suppose that the prices of a set of commodities that take up fifty percent of your budget fall in half: the increase in your real standard of living is approximately twenty-five percent. Suppose that the prices of a set of commodities that take up five percent of your budget fall in half: the increase in your real standard of living is approximately five percent. The rich today are in the first, and the poor today are in the second, category: it truly is the case that the material standard of living of the rich today is vastly greater than the calculations of Historical Statistics suggests relative to their counterparts of a century ago, and that the material standard of living of the world's poor today is somewhat greater than the calculations of Historical Statistics suggests, relative to their counterparts of a century ago.

If the underestimate of economic growth over the past century is greater at the high end and less at the low end of the world's income distribution, doesn't that mean that standard calculations greatly underestimate how unequal the world income distribution is? Perhaps. Here we run into the limits of index numbers. We have been trying to summarize the complicated, multi-faceted considerations that make up the standard of living in a single number--real GDP per capita. We should not expect that we will be able to do this unambiguously and without distortion: we cannot even projet a map of the world onto a flat piece of paper without distortion. It might well be that different sets of "real income" measures are better for different comparisons.

But in this case correcting for possible distortions would simply amplify the message of the figure above: the world is a much, much more unequal place in relative incomes than it was a century ago.

Now there are a large number of additional caveats attached to these estimates. To mention two:

The 1993 measurements are of low quality; the 1870 GDP per capita estimates are of abysmal quality.
The figure suppresses all variability in productivity and real GDP per capita inside of nation-states: everyone in China is assumed to have the 1993 purchasing-power-parity concept real GDP per capita of $2,330.
Nevertheless the major conclusion is sound: the world is, in relative terms, a much more unequal place than it was a century ago. There has been no "convergence."

Moreover, the failure of convergence is not just a failure of the diffusion of technology to reach the world's poorest nations. Some of the richest nations at the turn of the twentieth century have grown very slowly since; some of the poorest have grown very rapidly. Consider the pairs of nations Argentina and Norway, Chile and Finland, the Philippines and Japan, and Pakistan and Taiwan. Within each pair, the nations appear on the best available estimates to have begun the twentieth century at about the same levels of national product per capita. Yet today the second member of each pair has between three and eight times the material prosperity of the first member of each pair. Over the twentieth century, some of the poorest economies grew very rapidly and caught up or are rapidly catching up to the world's industrial leaders; some of the richest economies grew very slowly and fell far behind the productivity levels of the world's industrial leaders.

Growth and Non-Convergence, 1900-1987
 
 

This is not to say that the slowly-growing countries have necessarily stagnated. Many of them have not. For example, cnsider Argentina, one of the world's most disappointing performers in terms of economic growth in the twentieth century. Argentina has experienced substantial economic growth. Officially measured labor productivity or national product per capita in Argentina today is perhaps three times what it was in 1900. True productivity, taking adequate account of the value of new commodities, is higher.

But the much more smoothly-running engine of capitalist development in Norway--no more, and probably less, rich and productive than Argentina in 1900--has multiplied measured national product per capita there by a factor of nine. In 1900 Argentina was a rich First World nation: in 1913 Buenos Aires ranked thirteenth among the cities of the world in density of telephones per capita. Even as late as 1929 Argentina ranked fifth in the world in automobiles per capita, ahead of every nation save the U.S., Canada, France, and Britain. In 1900 Argentina ranked fourteenth richest out of the twenty-seven nations plotted in figure 1; in 1987 it ranked twentieth. Over the course of the twentieth century it has been overtaken by Finland, Japan, Korea, Norway, and Taiwan; and perhaps by Brazil and Chile.

For these 27 countries, for which the data are on a not-as-unsound basis as for many others, some countries have improved their standing substantially in relative wealth compared to other nations, while other countries have fallen behind. Fifteen nations have gained ground relative to the U.S. over the century. 11 nations have lost ground relative to the U.S., and have fallen behind-or fallen further behind.

Even more horrifying than the long-run failure of "convergence" to take hold is the economic performance of sub-Saharan Africa since independence. There is little good reason to believe that sub-Saharan Africa (excluding South Africa) has experienced any improvement in standards of living or national product per worker over the past third of a century. From the perspective of material wealth the years since the attainment of African independence from European colonial powers have, taken together, been a false start. This is a tremendous disappointment given the signs of increasing wealth and development seen in the colonial period, and given the high hopes that existed at the time of decolonization.

False starts and misdirected patterns of political economy appear to have extraordinarily severe consequences: the descendants of those who migrated from Sicily to New York or to Milan in the last years of the nineteenth century are today more than four times as well off as the descendants of those who migrated from Sicily to Buenos Aires. Relative economic decline is not confined to those nations that began the century far behind the industrial core in productivity. Great Britain, which in the nineteenth century played the same role in the world economy that the United States has played in the twentieth, has today a level of per capita national product perhaps two-thirds that of the United States, and noticeably below that of most western European nations.

Too great a focus on winners and losers in a relative economic growth race tends to eclipse the fact that the world economy is a positive-sum game. In the long run all are enriched by and benefit from the early success of a few.

Nevertheless, even a pattern of productivity growth that is rapid in very long-run historical perspective, like Argentina's, can appear heartbreakingly slow when compared to what, reasonably, might have been and was achieved by the world's industrial leaders. What is bad about falling behind, or falling further behind, is not that second place is a bad place to be-it is false to think that the only thing that matters is to be "top nation," and that it is better to be poor but first than rich but second. What is bad about falling behind is that the world's industrial leaders provide an easily viewable benchmark of how things might have been different, and of how much better things might have been. There was no destiny keeping Buenos Aires today from looking like Paris, Toronto, or Sidney. It was, but is no longer, a first world city--and it could have remained one.

Such enormous disparities in relative growth spring from patterns of mistakes generated by patterns of rule and of political influence. The principal producers of material wealth are an economy's workers, and not its natural resources. The presence or absence of a "culture of entrepreneurship" is not usually a deciding factor, for entrepreneurship can be found in many places. Consider the Chinese diaspora. Throughout South Asia emigrants from China play key roles in trading and manufacturing, while China proper remains one of the poorest countries on earth. It is hard to imagine that any force other than China's governors--from the Chien Lung Emperor to Mao Zedong and Deng Xiaoping--who have kept China so poor.
 
 
 

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Determinants of Relative Economic Growth:

Three factors appear to be most important in accounting for how a country has done in relative terms in its productivity growth over the past century:

The productivity gap vis-a-vis the world's best practice. The further a country is behind the world's industrial leaders, the more scope there is for successful technology transfer. Poor countries that successfully industrialize can grow very fast indeed.

The rate of investment. High private sector investment has two benefits. First, high investment means that the average worker has a better and more productive work environment: more structures investment means better work spaces, and more equipment investment means more machines to amplify productivity. Second, high investment--especially high machinery investment--is essential to use better technologies. A very large chunk of new and better technological knoweldge is embodied in the machines that are the principal creation of the industrial revolution, in the sense that new and more productive technologies are impossible to utilize without the appropriate capital equipment. Many factors affect the rate of investment, including:

national savings rates
foreign investment rates
tax systems
the extent of "kleptocracy"--the extent to which the government is best described as "rule by the thieves"
the real rate of interest
the economy's relative price structure--are the goods that make up investment relatively cheap or relatively dear
the degree of free trade
But many of these appear to affect economic growth primarily through their effects on the rate at which the stock of capital goods is built up, and not to have an independent effect working through other channels than the rate of investment.

Whether market forces or bureaucractic commands govern resource allocation. Market forces exert pressure to allocate resources to their most productive uses. Bureaucratic commands exert pressure to allocate resources following other logics. A country like the Soviet Union or like Zambia can have a very large technology gap and a high measured rate of investment. But if investment is allocated and industries grow not by the profitability of its use but by the political power of its users, it will not do nearly as much good for productivity and economic growth.

The post-World War II period shows a clear and strong relationship between relative backwardness and productivity growth. Each one percentage point gap in productivity in 1960 carries with it an increase in the rate of productivity growth of between 0.02 and 0.03 percentage points per year over 1960-85. A country like Hong Kong-with an initial GDP per worker gap of some 70%-should "catch up" because of this factor alone and close of the gap from 70% to some 50-58%-between 1/6 and 1/4 of the total initial gap-over 1960-85.

Yet of all the factors associated with rapid growth, perhaps the most important is the rate of investment.

Why should investment play such a key role? It is, of course, no accident that the era in which European economic growth took off is called the Industrial Revolution. Blanqui, first to use the phrase industrial revolution in print, identified its beginnings in the invention and spread of those "two machines, henceforth immortal, the steam engine and the cotton-spinning [water frame]." Ever since, qualitative historical discussions of growth have emphasized the role of machinery investment in augmenting labor power. Historians of technology have long argued that the capital goods industries are uniquely well suited to serve as centers for technological diffusion to other sectors of the economy where such knowledge had practical applications.

This suggests a role for government intervention to advance industrial development: the government should step in because private investors do not face the right incentives to develop and invest early and heavily in modern machinery and equipment.

Of course that governments can does not mean that governments will. Over the past two decades, many have argued that the typical systems of regulation introduced in developing countries to accelerate development were in fact retarding development. First, they were preventing the economy from responding to international price signals by shifting resources to activities in which the country had a long-run comparative advantage. Second, they were inducing firms and entrepreneurs to devote their energies to seeking rents by lobbying governments instead of seeking profits by lowering costs.

When taken as a group, poor countries have not closed any of the gap relative to the world's industrial leaders over the post-World War II period. Poor countries have relatively low shares of investment in national product: capital goods are relatively expensive, meaning that even a hefty savings effort translates into little increase in the capital stock; savings rates are relatively low; and taxes are siphoned off to maintain the incomes of politically powerful groups rather than to support public investment projects.

The general conclusion is one that either Adam Smith or Karl Marx would have found natural: market economies prosper and grow when they are managed in the interests of the business class. When governments intervene to shift prices and quantities in order to distribute income away from the productive and entrepreneurial classes-both current and prospective future members of the bourgeoisie--and toward others, whether urban consumers, bureaucrats, or small-scale inefficient rice farmers--economic growth and development suffers.

Poor countries could grow rapidly if their governments took a long-run view of their people's interest and followed appropriate policies. But what pressures are there to push governments-especially unelected, non-legitimate modern dictatorships-to take a public-spirited long-run view? W.W. Rostow recounts a visit by President Kennedy to Indonesia in the early 1960s; Kennedy talked about economic development, and a South Asian development bank to provide capital for Indonesia's economic growth. The Indonesian dictator Sukarno's response? "Mr. President, development takes too long. Give me West Irian [province to annex] instead." Sukarno got West Irian to annex; under Sukarno Indonesia's economy stagnated.
 

-VI. Policy and Prosperity-

J. Bradford DeLong
University of California at Berkeley and NBER

January 1997; DRAFT 1.0
 
 
 

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Social Democracy
Race
Governing the Economy
The Age of Keynes
 

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From one perspective, governments have been a major obstacle to economic growth in this century. Communism was a century-long economic disaster that has retarded the economic development of half the human race. Nazism and its tamer fascist cousins were nearly as inept as Communism at nurturing economic growth--and were worse than Communism in creating war.

But that is not all. The twentieth century has also seen governments--from Herbert Hoover's to Jimmy Carter's--that proved themselves singularly inept at managing market economies: inept at coping with the economic shocks that threatened to and did cause mass unemployment or raging inflation.

Among the developing countries, especially, a large number of governments appear to have possessed the inverse of the Midas touch: everything they tied turned to lead.

Some failures came about because economists did not know what to prescribe: the history of economic policy reads like alchemy, not chemistry. Proposed remedies made economic problems worse: consider Herbert Hoover's insistence--applauded by the eminent among economists of the time--on slashing government spending during the slide into the Great Depression. Some of it is that politicians did not like to follow their economists' advice, or at least sought for a more complaisant set of economists who would give advice that would be more politically pleasing and palatable to follow.

The net result was a set of economic policies and policymakers that have, taken all in all, done a lousy job at managing the business cycle--and a widely varied job (some excellent, some horrible) at encouraging long-run economic growth.
 
 

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Social Democracy:

Yet there is one sphere of activity in which the governments of modern industrial economies have been extraordinarily successful. Call this "social democracy"--the construction of the infrastructure necessary for the private economy to flourish, the provision of "rules of the road" that have kept the economy a positive-sum enterprise, and the construction of systems of "social insurance" to greatly diminish the vulnerability of individuals and families to the individual and collective economic catastrophes that might befall them.

In the United States today social democracy includes the interstate highway system, airport construction, air traffic control, the Coast Guard, the National Parks, government support for direct research and development through agencies like the National Institute of Standards and Technology, the National Oceanic and Atmospheric Administation, and the National Institutes of Health. It includes the antitrust lawyers of the Department of Justice and the Federal Trade Commission, the financial regulators in the Securities and Exchange Commission, the Office of the Comptroller of the Currency, the Federal Reserve, and the Pension Benefit Guarantee Corporation. It includes the National Labor Relations Board to regulate and guide the bargaining between workers and employers. It includes the promise by the federal government to insure small bank depositors against bank failures. It includes Social Security and all of its means-tested and non-means-tested cousins--Supplemental Security Income, Food Stamps, Aid to Families with Dependent Children, and Head Start. It includes (with much less success) farm subsidy programs.

None of these programs would be seen as a proper use of the government by even a moderate liberatarian. None of them fit under the definition of the "night watchman" state.

Yet these programs--together with local provision of policy and fire protection, and of public schools--are the government, or at least that part of the government that is not natioanl defense. And over the twentieth century as a whole these government programs and their analogues in other advanced industrial countries have been remarkably successful.

They have been remarkably successful in two ways. First, they have been politically successful. Voters distrust politicians who seek to cut back on the major programs of the social insurance state. Voters find taxes earmarked to support social insurance programs less distasteful than taxes that flow into general revenues.

Second, the developed social insurance state has proven remarkably successful at providing social insurance, and reducing poverty in this century. The "safety net" has provided the middle class with substantial insurance that economic or personal disasters will not leave them wholly impoverished.

Whether called "mixed economy," "social democracy," or "social market economy," the major business of government has become social insurance: progressive tax systems, income support, and benefit provision programs to partially counterbalance the extremes of economic inequality produced by the market distribution of income, and to create countries that are more middle-class societies--even though its redistributions of wealth have been primarily within the middle class, rather than to the relatively poor.

The existence of social democracy has played a large part in drawing the fangs of potential revolutionary movements. A standard nineteenth-century fear among the elite was that the possible arrival of universal suffrage would see the end of economic growth: redistributive and confiscatory taxation would destroy enterprise and provide "bread and circuses" to the working class--which would then succumb to the flattery of ruthless demagogues. Dire anaologies with the Roman Empire were drawn. When the French dictator Napoleon III reviewed the army, the cavalry cried "Viva the sausages!", for Napoleon III had staged banquets for the army--he got credit for the banquets, but the taxpayers had paid for them.

Yet the social democratic regimes found in industrial economies in the second half of the twentieth century have exhibited remarkable stability in democratic institutions, and remarkable success in preserving incentives for entrepreneurship, investment, and enterprise. With the social insurance state in place, the risk of penury and destitution has been sufficiently diminished that further drives toward the confiscation of the wealth of the risk have not been on the political agenda. The ability of social democracy to deliver more-or-ess constant economic growth has created a powerful consensus in favor of the status quo.

Thus the past fifty years in the industrial, democratic west marks one of the few eras in history in which the distribution of wealth and economic power has been to a degree the result of political choice, instead of the distribution of economic power largely determining political organization. Opposing pressures have balanced: populist calls for taking "unearned increment" from the rich balanced by an admiration for entrepreneurs and savers, and a realization that economic life is a positive sum game; compassion toward the poor balanced by resentment of those seen as trying to get something for nothing--even if the something is small by middle-class standards.

Pressures from the left that existing inequalities are "savage" have been balanced by pressures from the right that the mechanisms of the social insurance state are economically "inefficient" and have slowed growth. From my perspective the consensus is too far to the right--we tolerate much more poverty than we should in the name of "incentives" and "entrepreneurship". But even on the right there has been for more than half a century solid recognition that social democracy is politically necessary to maintain democratic support for the market economy.
 
 

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Race

At the start of the twentieth century governments--governments that ruled practically everywhere, for Africa and Asia save China and Japan were colonies of European empires--were white men's governments. Australian and Californian voters alike overwhelmingly agreed that a principal function of government was to keep Asians out. In the United States the federal government had long since withdrawn from its immediate post-Civil War commitment to "reconstruction", and more than acquiesced in the principle that state governments existed to keep African-Americans down. Segregated schools for African-Americans in the early years of this century met for fewer than one-third the hours that schools for whites met.

The principles of equal opportunity and meritocracy stopped at the color line. And the line separating those who were white from those who were not was very tightly drawn. Were people from southern Italy white? Maybe. Were people from Slovakia white? Probably not. Inhabitants of Calcutta or Bombay who wished to sit for examinatons requied for high office in the British administration of India could do so--but only if they travelled to London to take the exams.

At the turn of the century racial attitudes had taken several steps backward from what they had been half a century before. In the late 1850s Abraham Lincoln--debating Senator Stephen Douglas--could call, and find it politically popular to call, for equality of opportunity across racial lines: that while he, Lincoln, did not think that the Negro slave was Lincoln's intellectual equal, in the slave's right to earn his own bread by the sweat of his brow, "he is my equal, and the equal of all that have ever lived."

In 1900 few if any American politicians would have said that the government ought to be neutral between citizens of European-American and of African-American descent.

Yet by the 1960s everything had changed. In the United States, at least, and at the level of political rhetoric, at least, the commitment to color-blind equality of opportunity was absolute; and there was even some recognition that "affirmative action" would be needed to create a truly level playing field. And as President Lyndon Johnson recognized, true equality of opportunity would require affirmative action to repair deficiencies and gaps that had been generated by previous oppression and discrimination.

The--incomplete--creation of a multi-ethnic and multi-racial society in the United States, and the hesitant steps toward a truly multi-national Europe, are enormous--albeit partial--achievements. To some degree we owe them to the Cold War: it is difficult for a society practicing explicit racial apartheid to claim to be the "free world", and this tension undermined support among conservatives in the United States: fear of the Communists outweighed distaste for Africa-Americans. To some degree we owe them to the working-out of liberal principles: government by the people means universal suffrage; government for the people means equality of opportunity. To some degree we owe them to the political machines of America's northern cities, which had much experience at taking politically-unsophisticated migranst to the city and turning them into powerful and directed political forces by block-by-block organization: African-Americans in the southern United States were disenfranchised, but African-Americans who migrated to the northern cities in the twentieth century could rapidly become part of a political coalition to elect mayors and representatives.

But most of it we owe to political courage. Slavery proved compatible with America's democratic and republican values for ninety years (and would have proven compatible for much longer had not the defense of slavery become attached to the dissolution of the nation). Racial apartheit proved compatible with America's democratic and republican values for a hundred years. A few less brave leaders in the 1950s and 1960s, and American race relations today might well still be frozen in their 1950s pattern.
 
 

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Governing the Economy:

The political and economic balancing act of social democracy appears possible only when economic growth continues. And the record of the twentieth century is that modern mixed economies are not stable, and require the most delicate management to avoid economic chaos. Much of post-World War II discussion among economists has been consumed by sterile debate over whether the market economy is "naturally" "stable" or not. The answer is obvious: that if the government acts properly to reinforce the stabilizing factors and counteract the destabilizing ones, then the market economy is stable. But if government policy is improperly tuned, then it is unstable. The proof of the pudding lies in what policies are stabilizing and what policies are destabilizing--not in whether the economy is stable "by nature", whatever that might mean.

Go to Wall Street. Look around. Wall Street is, in a very real sense, the investment planning department of the human race. Power to purchase commodities that owners of property have earmarked for savings flow into Wall Street and, in a complicated social and economic dance, are distributed to enterprises and bureaucracies seeking permission to invest, develop new enterprises, or expand old ones.

The future becomes visible only slowly: one day at a time. Our technological capabilities, individuals' preferences for spending and saving, and natural resources change very slowly. Thus Wall Street should be a quiet place. Financial prices are the shorthand that Wall Street-considered-as-investment-planning-department uses to assess the desirability of investment projects. They should move glacially, as an extra day's information causes forecasters to revise so very slightly their image of the economy's bottlenecks twenty years down the road.

But this is not how Wall Street works.

Today, for example, Mexico is fifty percent off: it has been fifty percent off since the end of 1994. The valuation of all things Mexican, whether the cost of employing a worker, the value of a house, the worth of Mexico's currency, or the long-term profits to be gained from investment in a Mexican enterprise, is today fifty percent less than what it was in the late summer of 1994. If you had wanted to buy insurance against a fall in the peso in the late summer of 1994, you could have done so extremely cheaply. Few saw a peso collapse of the magnitude seen in the winter of 1994-1995 as possible; no one saw it as likely.

What has caused such a change? In part, financiers now believe that they were overoptimistic about the economic future of Mexico. In large part, however, financiers concluded that other financiers' downgrading of Mexico meant that Mexico would be starved of capital and short of international means of payment, and that as a result of this shift in mood the Mexican economy would perform more poorly.

This is an old story: a regime that bet a large chunk of its chips on rapid industrial development financed by capital inflow from world financial markets finds itself suddenly subject to a panic. In the United States, 1873 saw British investors lose confidence that American railroads and infrastructure were that day's equivalent of investments in the Pacific Rim. The largest investment house in the United States-that of Jay Cooke, politically well-connected industrial visionary who financed Abraham Lincoln's armies, and whose picture the Treasury Department's antique custodians will not release for me to hang in my office-went bankrupt.

Then there was no International Monetary Fund, no Bank for International Settlements, no Exchange Stabilization Fund, no one willing to guarantee the liquidity of the financial system that had funneled capital to America from Europe. As a result of the collapse of Jay Cooke and Company the City of London sneezed. The U.S. economy caught pneumonia. The share of America's non-agricultural labor force building railroads fell from perhaps one in ten in 1872 to perhaps one in forty by 1877-a seven percentage point boost to non-agricultural sector unemployment from this source alone.

Now we have a keen awareness of what is lost when a crisis of confidence is allowed to lead to the unraveling of a financial network. We have governments and institutions willing to take action. Unlike the United States in the 1870s, Mexico in the 1990s will not undergo anything near to a great depression.

Nevertheless, for at least three centuries capitalist financial markets have been working their erratic will. No one has a preferable alternative to allowing financial markets to do our collective investment planning: Wall Street's vision of where investment capital should be directed is infinitely better than the vision any group of planners. All would agree that financial markets require the most delicate political regulation and management.

But it is rare that you find any two agreeing on exactly what form that political regulation and management should take. Moreover, the entire system can lose forward motion completely. It is possible to mismanage a capitalist economy so badly as to bring a halt to essentially all economic growth. Consider Argentina, on a par with France and ahead of Italy in GDP per worker, agricultural productivity, and some areas of industry in 1950. Yet Argentina today may have no higher a standard of living than it had in the aftermath of World War II. Consider the Great Depression, when U.S. unemployment hit 25 percent of the labor force, and stayed above ten percent for a full decade.

The world economic system is more fragile than anyone would wish and has gone completely off its rails once in this century.
 
 

Note: incorporates revisions to pre-Great Depression unemployment estimates suggested and calculated by Christina Romer.

Source: Historical Statistics (Lebergott unemployment series), Economic Report of the President 1994, Bureau of Labor Statistics January 1995 Monthly Employment Release, Christina Romer.

Governments balance conflicting goals: high investment to boost productivity growth, stable prices so that private economic planning decisions focus on productivity rather than on exploiting quirks in the price-adjustment process, and high employment. The terms of the tradeoff are lousy. Election cycles tend to emphasize short-term as opposed to long-term performance, removing incentives for irresponsible and diminishing the ability of responsible politicians to adopt policies that advance the long-run interests of the human race.
 
 

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The Age of Keynes

In the 1920s British economist John Maynard Keynes wrote a Tract on Monetary Reform, in which he distinguished two different macroeconomic dangers. The first was deflation-the possibility of a sharp fall in the price level and in the volume of total spending. The second was inflation-the possibility of a sharp rise in the price level and in the volume of total spending.

Consider the first danger, deflation. A fall in the overall level of prices and in the nominal flow of spending, Keynes argued, ought not to affect what is produced or how much is produced: for such "a fluctuation in the measuring-rod of value does not alter in the least the wealth of the world, the needs of the world, or the productive capacity of the world." However, Keynes went on to argue, such a fluctuation does have important and destructive consequences because of the "peculiarities of the existing economic organization of society": because investors can always refuse to invest and store their wealth in cash, entrepreneurs must always pay a positive nominal interest rate for the capital they need; thus a fall in the price level carries with it very high ex post real interest rates that entrepreneurs must pay, leaving them potentially bankrupt. Because:

the fact of falling prices injures entrepreneurs... the fear of falling prices causes [entrepreneurs] to protect themselves by curtailing their operations; yet it is upon the aggregate... willingness to run... risk[s], that the activity of production and of employment mainly depends.

Falling prices (and spending) or the fear of falling prices (and spending) are the principal sources of mass unemployment, idle capacity, and destroyed economic wealth. This was written nearly a decade before the nadir of the Great Depression. Yet its relevance to the Great Depression is complete, and the world is a worse place because those making policy in the 1930s did not keep this principle in mind and take steps to avoid deflation.

The second danger, inflation, is in Keynes's view a subtler--although not necessarily a less serious--threat. Inflation redistributes income away from savers who do not have the financial sophistication to invest in equities or indexed financial instruments. Inflation redistributes income away from anyone with a fixed income who has already exercised and used up his or her bargaining power in the market. Inflation redistributes income toward entrepreneurs, and toward those fortunate enough to owe fixed sums. Keynes sees three things wrong with inflation. The first is that it is "Injustice": an essentially random redistribution of income and wealth that causes more misery and want to those who lose than it gains happiness for those who win. The second is that of those groups harmed by inflation the one harmed most seriously is the class of rentiers: those who earn their income by loaning out their capital, the class of savers. Inflation thus discourages many kinds of saving; Keynes is a strong believer in the power of compound interest in the form of saving to eventually bring the human race to utopia; and inflation tends to delay the accumulation of capital and the process of compound interest.

The third danger that Keynes sees in inflation is the most serious, and shows Keynes at his most prescient. He wrote in 1919 that:

there is no subtler, no surer means of overturning the existing basis of Society than to debauch the currency [through inflation]. The process engages all the hidden forces of economic law on the side of destruction, and does so in a manner which not one man in a million is able to diagnose.

In Keynes's mind, the first danger was that inflation confiscated wealth arbitrarily, thus not only undermining everyone's belief in their economic security but also providing a powerful object lesson that there was no justice or equity of any sort to be found in the existing distribution of wealth. Moreover, the class that lost the most from inflation was the class of small savers who did not have the financial sophistication to guard against the depreciation of the currency. Such people are usually the firmest supporters of limited governments and pronounced opponents of arbitrary power: after all, they have done well under a constitutional order, and any left or right wing revolutionary regime is not likely to be in their interest.

Keynes concluded in 1919 that the European governments which had resorted and were resorting to inflation were "fast rendering impossible a continuation of the social and economic order of the nineteenth century. But they have no plan for replacing it." He was right: the confiscation of the wealth of Germany's upper middle class by the hyperinflation of 1923 is usually listed as a principal cause of the at best lukewarm support offered to the constitutional Weimar Republic in interwar Germany. Through the inflation of the early 1920s, the democratic government of this Weimar Republic did its natural supporters, the prosperous relatively small-scale savers of Germany in the professional and mercantile classes, a most grievous economic injury by confiscating most of their savings. The social democratic and Christian democratic politicians of the Weimar Republic did lack a plan for replacing the nineteenth century capitalist social and economic order. And in Germany the replacement turned out to be Adolf Hitler.

Which danger was most on Keynes's mind at any particular date depended on which danger was the greatest threat. In the immediate aftermath of World War I and through the mid-1920s, the principal danger was inflation as governments filled the gap between their revenues and spending expanded first by war and then by postwar reconstruction through the printing of money. From 1925 on-after the more-or-less complete restoration of the gold standard, and especially after the beginnings of the Great Depression-deflation, mass unemployment, and the fear of falling prices were the great enemy.

In either case the cure was much the same:

The best way to cure... must be to provide that there shall never exist any confident expectation either that prices generally are going to fall or that they are going to rise; and also... that a movement, if it dose occur, will [not] be a big one.

The agent that is to provide this cure is sometimes the central bank (stabilizing price) and sometimes the treasury (stabilizing total spending) so that "whenever something occurred which, left to itself, would create an expectation of a change in the general level of prices, the controlling authority should... set... in motion some factor of a contrary tendency."

Politicians remember Keynes as a foe of unemployment and deflation, because unemployment and deflation were the principal problems in the times when he had greatest influence. It may be that he had a slight bias toward fearing unemployment more--he did write that "of the two [inflation and deflation] perhaps deflation is... the worse; because it is worse, in an impoverished world, to provoke unemployment [by allowing deflation] than to disappoint the rentier [by allowing inflation]." But he went on immediately to write that:

it is not necessary that we should weigh one evil against the other. It is easier to agree that both are evils to be shunned. The Individualistic Capitalism of to-day, precisely because it entrusts saving to the individual investor and production to the individual employer, presumes a stable measuring-rod of value, and cannot be efficient-perhaps cannot survive-without one.

If you want to seek the legacy of Keynes it is in the willingness to accept that macroeconomic management is an important task of the government: "the regulation of the standard of value [must] be the subject of deliberate decision. We can no longer afford to leave it in the category [of]... matters which are settled by natural causes, or are the resultant of the separate action of many individuals acting independently."

There is some sign that there have been improvements in economic knowledge, or improvements in the structural resilience of the economy, that have moderated the destructive impact of the business cycle in the second half of the twentieth century. Christina Romer has constructed a consistent chronology of business cycles for the past century in the United States. According to her chronology, recessions have become rarer (although not shorter). There has been a clear and significant improvement in the share of the time that the economy is in recession compared to the 1916-45 interwar period. There may have been some--smaller--improvement comparing the post-World War II period to the pre-World War I years.

However, even if the government accepts its responsibility to stabilize the overall economy, and to avoid inflation or deflation, the story of economic policy and economic reality is not necessarily a happy one. Governments can prove themselves incompetent at the task of macroeconomic management.

And even the best macroeconomic management is no guarantee that on average the business cycle will produce the levels of employment or of income distribution that you want. Structural policies to level out the income distribution and maintain a high average level of employment face their own tradeoffs. Structural labor market policies are expensive; if you try to do them on the cheap you wind up with an unfavorable distribution of income, or a high level of employment; if you commit the appropriate level of resources to education and training, to job search assistance and employment subsidies, you will surely hear complaints-sometimes justified-that taxes are too high to sustain growth and investment.

There are a number of rules-of-thumb for economic management: Run a government surplus to keep the government's hunger for resources from draining the pool of resources for society's non-governmental investments. Use "automatic stabilizers"-decreases in tax collections and increases in social welfare spending in recessions-to cushion declines in employment and increases in poverty that occur when financial market shifts trigger depressions. Guarantee the safety and soundness of the credit system as a whole in emergencies, even though it rescues many who made overrash bets and provides some encouragement for future overrash and overspeculative investments. Guarantee not just the domestic but the international credit system. Stabilize prices to the extent that the pursuit of price stability does not endanger more important ends, for price stability is a means to low unemployment, high saving, fast growth, and an equitable distribution of income.

But these remain mere rules of thumb. For the "science" of macroeconomic management has advanced surprisingly little beyond its level in the 1920s. There is very little that we could say about how to manage an economy that would surprise those who wrote about economic policy in the aftermath of World War I.

-VII. From the British to the American Century-
 

J. Bradford DeLong

University of California at Berkeley and NBER
 
 

August 1996
 
 
 

Great Britain's Relative Economic Decline:
 

But the United States became the world's leading-edge nation-the richest, the most prosperous, the most modern, and the highest technologied-only because Great Britain, the nineteenth-century "workshop of the world" seemed to falter in it economic growth. The story of America's rise to economic preeminence is in many ways simply the reverse of the story of Great Britain's rapid turn of the century relative economic decline.
 

Great Britain had been the first industrial nation. Its commercial dominance of the seventeenth and eighteenth centuries, coupled with its established sheepherding industry, its plentiful supplies of water power, coal, and iron, and a relatively large pool of wage-workers without traditional rights to occupy the land gave it crucial economic advantages at the start of the industrial revolution. In textiles, steam power, iron production, and canal building Great Britain led the way throughout the 18th and nineteenth centuries. The last years of the nineteenth century saw Great Britain the richest country in the world (save for Australia, the late nineteenth century sheep-raising equivalent of OPEC), with the heaviest industrial base, the most comprehensive railroad network, and ruling over the largest Empire the world had ever seen.
 

The United States surpassed Britain in productivity at the turn of the century. Yet British productivity has grown more rapidly in the twentieth century than it did in the nineteenth. Britain's relative decline springs from its inability to partake fully of the acceleration of growth in productivity that the twentieth century saw. And American economic preeminence sprang from the American economy's ability to create and ride the wave of this growth acceleration.
 

Perhaps Britain's advance contained the seeds of its inability to lead the productivity revolutions of the twentieth century. Britain's relative prosperity had been based on a set of technologies that greatly multiplied the productivity of unskilled workers. The poor British educational system, its weak corps of technical engineers, and the easy availability of unskilled Irish and rural British workers were no great handicap as long as the most dynamic edge of the economy intensively used both machines and unskilled workers, but not skilled workers. But technologies that made heavy use of skilled workers would be the locus of industrial development in the twentieth century.
 

In the last years of the nineteenth and the first years of the twentieth century Britain lost its leading position in new, modern industry after new, modern industry. Organic chemicals became German (and American), British railroads became smaller and slower than those on the continent, the development of the automobile lagged behind France and the United States, the electric power grid was put into place slowly, the telephone network was rudimentary, and so on. Even in textiles, Britain began to be excluded from foreign markets on the basis of too high a price. British levels of productivity remained high. They just failed to grow at the same rate as in the rest of the leading edge of the industrial world. And British companies lost, or failed to develop, market position in what were going to become the leading industries of the first half of the twentieth century.
 

Britain's loss of market position in the most technologically advanced industries is surprising, for in those industries lies the most natural comparative advantage of the leading industrial nation. The leading industrial nation is the richest, has the most experience with modern technology, and would seem to be the best set up to train and mobilize labor and capital to take advantage of new opportunities. Yet British firms and workers did not do so. In fact, in the thirty years before World War I factors of production behaved as if there was something pernicious about locating in Britain. On net both British capital and British labor left the island for better opportunities elsewhere. As U.C. David economist Gregory Clark puts it, by 1910 you could combine British labor and British capital in the textile city of Fall River, Massachusetts, and obtain 50 percent more output per worker hour and 20 percent more output per machine hour than back in the textile city of Manchester, in England.
 

In 1903, the British economist Alfred Marshall-John Maynard Keynes' teacher-wrote that "[s]ixty years ago England had…leadership in most branches of industry.…It was inevitable that she should cede much.…It was not inevitable that she should lose so much of it as she has done." While it is not surprising that in the end "…half a continent should raise more coal and make more steel than one small Island," it is surprising that Britain should first lose market share in the highest of high technology industries. Even when Britain did move into the "new" industries of the late nineteenth century, it wound up drawing on foreign expertise to do so. The first public power station in England, in 1881, was built by Siemens. On the eve of World War I, the German electrical manufacturing industry was more than twice as big as Britain's.
 

Clearly many factors contributed to Britain's relative decline. One of the key factors was Britain's anemic rate of investment in industry. This occurred in spite of a very healthy rate of national savings. It was just that the share of national savings invested at home was small, especially in the years before World War I. Almost as large a share of British savings was invested abroad as was invested at home. And without ample investment in the machines that embody industrial technology, British workers did not acquire skills necessary to utilize and British firms did not acquire the skills necessary to create advanced industrial technologies.
 

Why was domestic machinery investment so low? There are four candidate reasons: a deficiency in natural resources, the British labor relations system, and the British educational system, and a banking system that failed to mobilize capital for large-scale industrial firms. Of these, resource-based explanations for British relative decline are unsatisfactory. Germany and the United States had superior natural resources. Yet water transportation was very cheap. Britain grew no cotton, yet had no trouble dominating the world cotton spinning and weaving industry for a century. Japan today produces steel in large quantities from Australian iron ore and Brazilian and American coal.
 

Right-wing analysts have tended to blame Britain's industrial decline on the bloody-mindedness of British unions, unwilling to see firms earn profits or to allow economic readjustment and change to take place. Left-wing analysts have tended to blame Britain's industrial decline on its class structure and deficient educational system. These are not separate causes, but a single interlinked system: unions were bloody-minded and the educational system was deficient because Britain had strong class distinctions. And the deficient educational system and poor labor relations reinforced class distinctions.
 

Those who governed Britain did not see an educated population as a high priority. As economic historian David Landes wrote, in Britain:
 

For every idealist or visionary who saw in education … an enlightened citizenry, there were several 'practical' men who felt that instruction was a super_uous baggage for farm labourers and industrial workers. These people, after all, had been ploughing fields or weaving cloth for time out of mind without knowing how to read or write…all they would learn in school was discontent.…Under the circumstances, Britain did well to have roughly half of her [elementary] school-age children receiving some kind of elementary education around 1860.
 

This was a far lower percentage than found in the United States or in Germany. What was true of elementary education was even more true of technical and engineering education. In Britain, technical education was the business of private firms. But why should they train workers who might well go elsewhere for jobs? And why should they train workers if such training only upped the bargaining power of British unions? Meanwhile, in the United States institutes of technology were founded.
 

The year 1914 saw close to 40 percent of Britain's national capital stock-of its produced means of production-located overseas. No other country has matched Britain's high proportion of savings channeled to other countries. Britain's overseas investments were concentrated in government debt, in infrastructure projects like railroads, streetcars, and utilities, and in securities guaranteed by the local government.
 

Britain did not do well out of its overseas investments. In the forty years before World War I, British investors in overseas assets earned low returns, ranging as low to perhaps 2% per year in in_ation-adjusted pounds on loans to dominion governments. Such returns were far below what presumably could have earned by devoting the same resources to the expansion of domestic industry. British industry in 1914, and British infrastructure, were not as capital intensive as American industry and infrastructure were to become by 1929. It is difficult to argue that Britain's savings could not have found productive uses at home if only they could be challenged appropriately and managed productively.
 

The difference in rates of return between home and foreign investments cannot be attributed to risk: overseas investments were at least as, if not more exposed to risk than were domestic investments. In the final analysis, British investments in Argentina or Australia yield dividends by the export of Argentinian or Australian goods to Britain. In a depression at home-the major risk facing investors in domestic industry-exports to Britain from the periphery of the world economy drop far in both quantity and price. It is difficult to believe that government guarantees would be worth much in a severe depression, and thus difficult to believe that overseas investments-even if guaranteed by the Argentinian government-were in any sense less risky than domestic investments. Overseas investments were thus no safer than domestic investments.
 

Why, then, did British investors commit their wealth overseas? One possibility is that the high rates of return presumably available at home were not really there: the absence of British engineering skill, and the aggressive wage demands of British unionized workers would have prevented home investments from earning even the small profits earned abroad. A second possibility is that British investors did not understand the framework in which they were embedded. Perhaps they imagined that home investments-even a diversified portfolio of industrial, railroad, and utility corporations-were risky, while overseas investments guaranteed by the local government were safe.
 

Certainly a contributing factor was the failure of Britain to develop institutions for channeling the savings of thousands into the capital stock of one giant enterprise. How is an individual saver, in an age where the efficient size of an operating corporation is vast beyond his means, to evaluate which industries and companies have good prospects, monitor the management to which he has committed his capital, and control and replace the management when it does not do its job? Such tasks require the growth of financial intermediaries-investment banks of one form or another.
 

German analysts, especially, criticized the pre-WWI British banking system because of the lack of such a monitoring system: the "complete divorce between stock exchange and deposits...causes another great evil, namely, that the banks have never shown any interest in the newly founded companies or in the securities issued by these companies, while it is a distinct advantage of the German system, that the German banks, even if only in the interests of their own issue credit, have been keeping a continuous watch over the development of the companies, which they founded."
 

In Britain, without powerful investment banks, no one could expect large, modern companies to be effectively watched and kept from running off the rails. And so few were willing to invest in companies that might become large organizations that contributed to the rapid advance of productivity. Landes, for example, notes that the scarcity of British engineering talent was matched by a scarcity of venture capital-there was plenty of capital for infrastructure or for government debts, but little for the progressive entrepreneur.
 

In the U.S., in Germany, and in Japan such institutions did develop. And the existence of "finance capitalist" institutions played a significant role in the expansion of managerial capitalism. Investment banker willingness to choose and monitor managers aided founding families that were attempting to withdraw from active management of their businesses and to diversify their holdings. Such investment banks played a key role in transforming corporations into the professionally managed organizations with diversified stock ownership that were to dominate the twentieth century. Chandler's accounts of the slow growth of managerial capitalism in Great Britain stress how long firms remained held together by webs of personal ties of clientage and patronage, and how loath were top executives-even the top executives of would-be conglomerates-to take seriously the problem of choosing appropriate managers.
 

Thus economic preeminence in the twentieth century appears to have required much more than an initially-rich country and a laissez-faire economic policy. It also required a skilled labor force, a solid corps of technologically-trained engineers, financial institutions to channel savings into the domestic accumulation of the machines that embody industrial technology, a labor movement eager to share in and not to block economic reorganization and technological change, and modern business enterprises to take advantage of economies of scale and to translate scientific knowledge into productive engineering applications. In all of these Britain was deficient. In all of these the United States was-mostly by luck-abundant.

-VIII. The Pre-World War I Gold Standard-

J. Bradford DeLong
University of California at Berkeley and NBER
 

January 1997; DRAFT 1.00
 
 

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International Finance
The Pre-WWI Business Cycle
 

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International Finance

What made the upward leap in international trade, the creation of an integrated world economy--a world economy where for the first time trade was not confined to luxuries and intoxicants but extended to staples and necessities--possible in the years before World War I? Falling costs of ocean transportation was one major factor. The development and extension of the international political and economic order called the gold standard was another.

The gold standard was in its origins a very simple thing: governments and central banks all over the world declared that their currencies were as good as gold-show up with £100 note, or a $100 bill, at the British Bank of England or the U.S. Treasury and the man behind the counter would give you a specified, fixed, unchanging quantity of gold: about 4.5 (troy) ounces in the case of the $100 bill, and about 22 (troy) ounces in the case of the £100 pound note.

Why did this matter? It mattered because as long as the gold standard stood entrepreneurs could make their plans for and build their factories engaged in international trade without having to worry about what we today call foreign exchange risk. Consider the plight of an American manufacturer deciding in 1980-when one British pound sterling sells for $2.32-to compete with British producers by exporting to London; spending the early 1980s building factories to expand capacity, and then finding in 1985 that one pound sterling sells not for $2.32 but for $1.30 on the foreign exchange market. The simple movement in exchange rates since 1980 has raised the manufacturer's costs relative to those of British competitors by 80 percent. You can bet that a very large number of productive operations and markets that looked profitable to American businesses in 1980 no longer looked profitable in 1985.

This is foreign exchange risk: the risk that governments following sensible or nonsensical policies or international currency speculators responding to their own "animal spirits" will cause exchange rates to shift in a way that destroys a particular line of trade or bankrupts importers and exporters. This foreign exchange risk is in large part avoided under a gold standard. And this near-absence of foreign exchange risk was one powerful factor driving the expansion of international trade and finance in the years before World War I.

How did the gold standard reduce foreign exchange risk-and close to eliminate the risk that a country would embark on a policy of inflation that would endanger established wealth? In its idealized form, the gold standard carried out these tasks by virtue of its working as an automatic equilibrating mechanism.

If ever a central bank or a Treasury printed "too many" banknotes under a gold standard, the first thing that would happen would be that those excess bank notes would be returned to the Treasury by individuals demanding gold in exchange. Thus each country's domestic supply of money was linked directly to its domestic reserves of gold.

Suppose a country under the gold standard ran a trade deficit in excess of foreigners' desired investments. It, too, would find those who had sold goods to its citizens lining up outside the Treasury looking to exchange banknotes for gold. And these foreign suppliers of imports would then ship the gold back to their countries. The money stock at home would fall as gold reserves fell. And with a falling money stock would come falling prices, falling production, and falling demand for imports.

So balance of payments equilibrium would be restored, and countries' price levels kept in roughly appropriate competitive alignment, by the gold standard as sources of disequilibrium were removed by shipments of gold, or threatened shipments of gold, that raised and lowered nations' reserves. Monetary authorities would find themselves restrained from pursuing over-inflationary policies by fears of the gold drains that would result. And since central bankers in every country were all working under the same gold standard system, they would all find their policies in rough harmony without explicit meetings of G-7 finance ministers or explicit international policy coordination.

The pre-World War I gold standard was not invented. It just grew, starting in the 1870s when Germany joined Britain, which had defined its currency primarily in terms of gold since 1717, when Sir Isaac Newton was Master of the Mint. Increased German demand for gold pushed up its price; increased American mining of silver pushed down its price. Countries that had long tried to keep both gold and silver coins legal tender found their gold reserves falling, as people would buy cheap silver on the world market, exchange it for currency, and then bring the currency into the Treasury for gold. By the end of the 1870s nearly the whole world was on the gold standard.

That exchange rates were stable under the pre-World War I gold standard is indisputible. Devaluations were few among the industril powers, and rare. Exchange rate risk was rarely a factor in economic decisions.

It is important to recognize that the gold standard was a historically-specific institution. The cornerstone of the gold standard was the commitment by all industrial-economy governments and central banks to maintaining convertibility of their currency. The pressure that twentieth-century--democratic--governments would feel to abandon currency convertibility and the stable exchange rate peg in order to boot employment or attain other economic objectives was simply absent. The credibility of the government's commitment to the gold standard rested on the denial of the franchise to the working class. As long as the right to vote was still limited to middle and upper-class males, those rendered unemployed when the central bank raised is discount rate and tightened monetary policy had little voice in politics. As long as union movements remained relatively weak, the flexibility of wages and prices that would allow the gold-standard system to quickly readjust to equilibrium was present.

Later on these two preconditions for the functioning of the gold standard would erode, and the gold standard would cease to be a politically and economically-feasible institution.

At the periphery of the world economy, the gold standard functioned with less success. Primary product-producing econmies were subject to large economic shocks as the prices of their exports rose and fell. Countries at the periphery were also subject to large shocks as British investors' willingness to loan capital abroad went through its own less-than-rationally-based cycles. Latin countries were repeated forced off of the gold standard and into devaluation by financial crises.

Not only did trade expand under the gold standard, but international capital markets expanded in the years before World War I as well. It became a commonplace for rich people in Europe or North America to have their money invested in far-flung enterprises on other continents. This outflow of capital from the industrial core to the industrializing, mineral-rich periphery was greatly assisted by the gold standard.

Later, the British economist John Maynard Keynes was to look back on this era of free trade and free capital flows as a golden age:

...for [the middle and upper classes] life offered, at a low cost and with the least trouble, conveniences, comforts, and amenities beyond the compass of the richest and most powerful monarchs of other ages. The inhabitant of London could order by telephone, sipping his morning tea in be, the various products of the whole earth... he could at the same moment and by the same means adventure his wealth in the natural resources and new enterprises of any quarter of the world, and share, without exertion or even trouble, in their prospective fruits and advantages.... He could secure... cheap and comfortable means of transit to any country or climate without passport or other formality.... But, most important of all, he regarded this state of affairs as normal, certain, and permanent, except in the dierction of further improvement, and any deviation from it as aberrant, scandalous, and avoidable.

Certainly free trade, free capital flows, and free migration helped greatly enrich the world in the generations before World War I. And certainly those economies that received inflows of capital before World War I benefitted enormously. It is not so clear that the free flow of capital was beneficial to those in the capital-exporting countries. France subsidized the pre-World War I industrialization of Czarist Russia (and the pre-World War I luxury of the court and expansion of the military) by making investments in Russian government and railroad bonds a test of one's French patriotism. A constant of French pre-World War I politics was that someday there would be another war with Germany, during which France would conquer and re-annex the provinces of Alsace and Lorraine that Germany had annexed as part of the settlement of the Franco-Prussian War of 1870-71. (And that France had taken from the feeble and oddly-named Holy Roman Empire of the German Nation as part of the settlements of the Thirty Years' War of 1618-48 and the Wars of Louis XIV of 1667-1715.) French military strategy depended on a large, active, allied Russian army in Poland threatening Berlin and forcing Germany to divide its armies while the French marched to the Rhine. Hence boosting the power of the Czar by buying Russian bonds became a test of French patriotism.

But after World War I there was no Czar ruling from Moscow. There was Lenin ruling from Petrograd-subsequently renamed Leningrad-subsequently returned to its original name of St. Petersburg. And Lenin had no interest at all in repaying creditors from whom money had been borrowed by the Czar.

British investors did better from their overseas investments, but they still did not do very well The year 1914 saw close to 40 percent of Britain's national capital invested overseas. No other country has ever matched Britain's high proportion of savings channeled to other countries. Britain's overseas investments were concentrated in government debt, in infrastructure projects like railroads, streetcars, and utilities, and in securities guaranteed by the local governments.

However, in the forty years before World War I, British investors in overseas assets earned low returns, ranging as low to perhaps 2% per year in inflation-adjusted pounds on loans to dominion governments. Such returns were far below what presumably could have earned by devoting the same resources to the expansion of domestic industry. British industry in 1914, and British infrastructure, were not as capital intensive as American industry and infrastructure were to become by 1929. It is difficult to argue that Britain's savings could not have found productive uses at home, if only British firms could have been challenged appropriately and managed productively. And the difference in rates of return cannot be attributed to risk: overseas investments were in the last analysis more exposed to risk than were domestic investments.

But for capital importing countries, like the U.S., Canada, Australia, and others like India and Argentina, the availability of large amounts of British-financed capital to speed development of industry and infrastructure was a godsend. It allowed for earlier construction of railroads and other infrastructure. It allowed for the more rapid development of industry.

Of course, the actual, real-world gold standard did not work as smoothly as the idealizations of economic theorists. But it did provide a stable underpinning to the growth of the world economy in the years before World War I.
 
 

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The Pre-World War I Business Cycle

However, there is a negative side to the gold standard. The gold standard was good not only at encouraging international trade expansion and boosting international capital flows, but also at quickly transmitting business cycles and financial panics around the world as fast as the telegraph wire could carry them. So borrowing foreign capital from Britain had costs as well: it tied the borrower's economy to the financial and employment cycles of Great Britain. "When London sneezes," the saying went, "Argentina [or Canada, or the U.S.] catches pneumonia."

How did this work? Look in some detail at the industrialization of the United States to see how the typical pre-1929 depression had its origin in the gold-standard links with the London-centered world economy.

The years between the Civil War and the 1890s saw the great railway booms. In 1870 and 1871 U.S. railroad construction reached its first post-Civil War peak. The number of miles of operated railroad in the U.S., then around 50,000, grew at about twelve percent per year. The construction of 6,000 miles of railroad track each year employed perhaps one-tenth of America's non-farm paid labor force and half of the production of America's metal industries.

Four years later, railroad construction had collapsed. In 1875, railroad mileage grew at only three percent. Railroad construction employed less than three percent of America's non-farm paid labor force, and required perhaps fifteen percent of the production of America's metal industries.

The depression of 1873 had its origins in British investors loss of confidence that American railroads and infrastructure-that day's equivalent of investments in the Pacific Rim. The largest investment house in the United States-that of Jay Cooke, politically well-connected industrial visionary who financed Abraham Lincoln's armies, and whose picture hangs in the Treasury Department's antique collection in the General Counsel's office-went bankrupt.

As a result of the collapse of Jay Cooke and Company the City of London sneezed. The U.S. economy caught pneumonia. The share of America's non-agricultural labor force building railroads fell from perhaps one in ten in 1872 to perhaps one in forty by 1877-a seven percentage point boost to non-agricultural sector unemployment from this source alone.

Such a wave-first of expanded railroad construction as capital flowed in, and then of contraction as capital flowed out-must have been difficult to absorb just as the Mexican recession of 1995 proved very painful. Each wave of railroad building required an expansion of capacity in iron and steel for rails, timber for ties, equipment for locomotives and cars, furniture to equip the cars to carry passengers on the new lines, and most important the redirection of one million workers to railroad construction. As the wave passed, suppliers and workers would have to find new markets and new jobs. The dislocation generated may well have been extreme and severe. But we know little about how it was accomplished, or about what workers who built railroads in 1871 were doing in 1875.
 
 
 
 

It is hard to attribute such spasms of construction to independent disturbances in finance: railroad finance was then more-or-less the sole business of Wall Street. By default such depressions appear to have been driven by waves of optimism about future growth, followed by recognition of overbuilding and contraction until the economy had grown enough that it seemed that shipping by rail was a railroad's and not a farmer's market.

The gold standard appears also in the depression of the 1890's. The possibility that "free silver" might sweep American politics made investors and financiers uneasy. Relative to what they would earn if they kept their cash, investments, and capital in London, a free-silver victory and subsequent devaluation might well have cost them a third of their wealth as measured by the international yardstick of the gold standard. Perhaps the free-silver movement was powerful enough to cause capital flight, investment shortfall, and depression, but not strong enough to secure devaluation and monetary expansion to reduce the debt burdens of farmers and create a booming labor market for urban workers. The U.S. thus got the worst of both worlds: it suffered the disadvantages of being on the gold standard without reaping the gold standard advantage of keeping financiers confident and investing. Moreover, the panic of 1907 followed a recession in Great Britain. As a result of the recession, the Bank of England raised interest rates to pull gold to London to boost its reserves. This left the United States short of currency to be paid out to farmers and middlemen during the fall shipment of the harvest to the East. Financial panic followed, and recession followed the financial panic.

It is very clear that depressions before 1929 were more painful than depressions today. Those who lost their jobs had no welfare state to cushion them. Individual states had sketches of a future welfare system, but such embryonic systems did not have the resources to cope with episodes of widespread unemployment. Extended families, friends, and local benevolent associations must have provided support for those who lost their jobs to remain, for the most part, fed and housed. American cities during depressions at the turn of the century were centers of poverty and want, but apparently not of mass near-starvation.

-IX. How the Pre-World War I World Economy Worked: International Finance, the Gold Standard, and Politics-
 

J. Bradford DeLong

University of California at Berkeley and NBER
 
 

August 1996
 
 

The Gold Standard before World War I:
 

What made the upward leap in international trade, the creation of an integrated world economy-a world economy where for the first time trade was not confined to luxuries and intoxicants but extended to staples and necessities-possible in the years before World War I? Falling costs of ocean transportation was one major factor. The development and extension of the international political and economic order called the gold standard was another.
 

The gold standard was in its origins a very simple thing: governments and central banks all over the world declared that their currencies were as good as gold-show up with £100 note, or a $100 bill, at the British Bank of England or the U.S. Treasury and the man behind the counter would give you a specified, fixed, unchanging quantity of gold: about 4.5 (troy) ounces in the case of the $100 bill, and about 22 (troy) ounces in the case of the £100 pound note.
 

Why did this matter? It mattered because as long as the gold standard stood entrepreneurs could make their plans for and build their factories engaged in international trade without having to worry about what we today call foreign exchange risk. Consider the plight of an American manufacturer deciding in 1980-when one British pound sterling sells for $2.32-to compete with British producers by exporting to London; spending the early 1980s building factories to expand capacity, and then finding in 1985 that one pound sterling sells not for $2.32 but for $1.30 on the foreign exchange market. The simple movement in exchange rates since 1980 has raised the manufacturer's costs relative to those of British competitors by 80 percent. You can bet that a very large number of productive operations and markets that looked profitable to American businesses in 1980 no longer looked profitable in 1985.
 

This is foreign exchange risk: the risk that governments following sensible or nonsensical policies or international currency speculators responding to their own "animal spirits" will cause exchange rates to shift in a way that destroys a particular line of trade or bankrupts importers and exporters. This foreign exchange risk is in large part avoided under a gold standard. And this near-absence of foreign exchange risk was one powerful factor driving the expansion of international trade and finance in the years before World War I.
 

How did the gold standard reduce foreign exchange risk-and close to eliminate the risk that a country would embark on a policy of in_ation that would endanger established wealth? In its idealized form, the gold standard carried out these tasks by virtue of its working as an automatic equilibrating mechanism.
 

If ever a central bank or a Treasury printed "too many" banknotes under a gold standard, the first thing that would happen would be that those excess bank notes would be returned to the Treasury by individuals demanding gold in exchange. Thus each country's domestic supply of money was linked directly to its domestic reserves of gold.
 

Suppose a country under the gold standard ran a trade deficit in excess of foreigners' desired investments. It, too, would find those who had sold goods to its citizens lining up outside the Treasury looking to exchange banknotes for gold. And these foreign suppliers of imports would then ship the gold back to their countries. The money stock at home would fall as gold reserves fell. And with a falling money stock would come falling prices, falling production, and falling demand for imports.
 

So balance of payments equilibrium would be restored, and countries' price levels kept in roughly appropriate competitive alignment, by the gold standard as sources of disequilibrium were removed by shipments of gold, or threatened shipments of gold, that raised and lowered nations' reserves. Monetary authorities would find themselves restrained from pursuing over-in_ationary policies by fears of the gold drains that would result.
 

And since central bankers in every country were all working under the same gold standard system, they would all find their policies in rough harmony without explicit meetings of G-7 finance ministers or explicit international policy coordination.
 

The pre-World War I gold standard was not invented. It just grew, starting in the 1870s when Germany joined Britain, which had defined its currency primarily in terms of gold since 1717, when Sir Isaac Newton was Master of the Mint. Increased German demand for gold pushed up its price; increased American mining of silver pushed down its price. Countries that had long tried to keep both gold and silver coins legal tender found their gold reserves falling, as people would buy cheap silver on the world market, exchange it for currency, and then bring the currency into the Treasury for gold. By the end of the 1870s nearly the whole world was on the gold standard.
 

That exchange rates were stable under the pre-World War I gold standard is indisputible. Devaluations were few, and rare. Exchange rate risk was rarely a factor in economi decisions.
 

Thus not only did trade expand under the gold standard, but international capital markets expanded in the years before World War I as well. It became a commonplace for rich people in Europe or North America to have their money invested in far-_ung enterprises on other continents. This out_ow of capital from the industrial core to the industrializing, mineral-rich periphery was also greatly assisted by the gold standard.
 

Certainly those economies that received in_ows of capital before World War I benefitted enormously. It is not so clear that the free _ow of capital was beneficial to those in the capital -exporting countries. France subsidized the pre-World War I industrialization of Czarist Russia (and the pre-World War I luxury of the court and expansion of the military) by making investments in Russian government and railroad bonds a test of one's French patriotism. A constant of French pre-World War I politics was that someday there would be another war with Germany, during which France would conquer and re-annex the provinces of Alsace and Lorraine that Germany had annexed as part of the settlement of the Franco-Prussian War of 1870-71. (And that France had taken from the feeble and oddly-named Holy Roman Empire of the German Nation as part of the settlements of the Thirty Years' War of 1618-48 and the Wars of Louis XIV of 1667-1715.) French military strategy depended on a large, active, allied Russian army in Poland threatening Berlin and forcing Germany to divide its armies while the French marched to the Rhine. Hence boosting the power of the Czar by buying Russian bonds became a test of French patriotism.
 

But after World War I there was no Czar ruling from Moscow. There was Lenin ruling from Petrograd-subsequently renamed Leningrad-subsequently returned to its original name of St. Petersburg. And Lenin had no interest at all in repaying creditors from whom money had been borrowed by the Czar.
 

British investors did better from their overseas investments, but they still did not do very well The year 1914 saw close to 40 percent of Britain's national capital invested overseas. No other country has ever matched Britain's high proportion of savings channeled to other countries. Britain's overseas investments were concentrated in government debt, in infrastructure projects like railroads, streetcars, and utilities, and in securities guaranteed by the local governments.
 

However, in the forty years before World War I, British investors in overseas assets earned low returns, ranging as low to perhaps 2% per year in in_ation-adjusted pounds on loans to dominion governments. Such returns were far below what presumably could have earned by devoting the same resources to the expansion of domestic industry. British industry in 1914, and British infrastructure, were not as capital intensive as American industry and infrastructure were to become by 1929. It is difficult to argue that Britain's savings could not have found productive uses at home, if only British firms could have been challenged appropriately and managed productively. And the difference in rates of return cannot be attributed to risk: overseas investments were in the last analysis more exposed to risk than were domestic investments.
 

But for capital importing countries, like the U.S., Canada, Australia, and others like India and Argentina, the availability of large amounts of British-financed capital to speed development of industry and infrastructure was a godsend. It allowed for earlier construction of railroads and other infrastructure. It allowed for the more rapid development of industry.
 

Of course, the actual, real-world gold standard did not work as smoothly as the idealizations of economic theorists. Butit did provide a stable underpinning to the growth of the world economy in the years before World War I.

The Business Cycle Under the Gold Standard:
 

However, there is a negative side to the gold standard. The gold standard was good not only at encouraging international trade expansion and boosting international capital _ows, but also at quickly transmitting business cycles and financial panics around the world as fast as the telegraph wire could carry them. So borrowing foreign capital from Britain had costs as well: it tied the borrower's economy to the financial and employment cycles of Great Britain. "When London sneezes," the saying went, "Argentina [or Canada, or the U.S.] catches pneumonia."
 

How did this work? Look in some detail at the industrialization of the United States to see how the typical pre-1929 depression had its origin in the United States' gold-standard links with the London-centered world economy.
 

The years between the Civil War and the 1890's saw the great railway booms. In 1870 and 1871 U.S. railroad construction reached its first post-Civil War peak. The number of miles of operated railroad in the U.S., then around 50,000, grew at about twelve percent per year. The construction of 6,000 miles of railroad track each year employed perhaps one-tenth of America's non-farm paid labor force and half of the production of America's metal industries.
 
 
 
 

Four years later, railroad construction had collapsed. In 1875, railroad mileage grew at only three percent. Railroad construction employed less than three percent of America's non-farm paid labor force, and required perhaps fifteen percent of the production of America's metal industries.
 

The depression of 1873 had its origins in British investors loss of confidence that American railroads and infrastructure-that day's equivalent of investments in the Pacific Rim. The largest investment house in the United States-that of Jay Cooke, politically well-connected industrial visionary who financed Abraham Lincoln's armies, and whose picture hangs in the Treasury Department's antique collection in the General Counsel's office-went bankrupt.
 

As a result of the collapse of Jay Cooke and Company the City of London sneezed. The U.S. economy caught pneumonia. The share of America's non-agricultural labor force building railroads fell from perhaps one in ten in 1872 to perhaps one in forty by 1877-a seven percentage point boost to non-agricultural sector unemployment from this source alone.
 

Such a wave-first of expanded railroad construction as capital _owed in, and then of contraction as capital _owed out-must have been difficult to absorb just as the Mexican recession of 1995 proved very painful. Each wave of railroad building required an expansion of capacity in iron and steel for rails, timber for ties, equipment for locomotives and cars, furniture to equip the cars to carry passengers on the new lines, and most important the redirection of one million workers to railroad construction. As the wave passed, suppliers and workers would have to find new markets and new jobs. The dislocation generated may well have been extreme and severe. But we know little about how it was accomplished, or about what workers who built railroads in 1871 were doing in 1875.
 
 
 
 
 

It is hard to attribute such spasms of construction to independent disturbances in finance: railroad finance was then more-or-less the sole business of Wall Street. By default such depressions appear to have been driven by waves of optimism about future growth, followed by recognition of overbuilding and contraction until the economy had grown enough that it seemed that shipping by rail was a railroad's and not a farmer's market.
 

The gold standard appears also in the depression of the 1890's. The possibility that "free silver" might sweep American politics made investors and financiers uneasy. Relative to what they would earn if they kept their cash, investments, and capital in London, a free-silver victory and subsequent devaluation might well have cost them a third of their wealth as measured by the international yardstick of the gold standard. Perhaps the free-silver movement was powerful enough to cause capital _ight, investment shortfall, and depression, but not strong enough to secure devaluation and monetary expansion to reduce the debt burdens of farmers and create a booming labor market for urban workers. The U.S. thus got the worst of both worlds: it suffered the disadvantages of being on the gold standard without reaping the gold standard advantage of keeping financiers confident and investing.
 

And the panic of 1907 and depression of 1908 followed a recession in Great Britain. As a result of the recession, the Bank of England raised interest rates to pull gold to London to boost its reserves. This left the United States short of currency to be paid out to farmers and middlemen during the fall shipment of the harvest to the East. Financial panic followed, and recession followed the financial panic
 

Whether the depressions that did occur were worse back before the Great Depression than they have been since World War II remains disputed; given our limited quantitative knowledge, it is likely to remain so.
 

That depressions before 1929 were more painful is, however, very clear. Those who lost their jobs had no welfare state to cushion them. Individual states had sketches of a future welfare system, but such embryonic systems did not have the resources to cope with episodes of widespread unemployment. Extended families, friends, and local benevolent associations must have provided support for those who lost their jobs to remain, for the most part, fed and housed. American cities during depressions at the turn of the century were centers of poverty and want, but apparently not of mass near-starvation.
 

All in all, the balance for the pre-World War I gold standard was probably positive: the boost it gave to world economic growth through making trade expansion easier and capital _ows larger probably outweighed any costs from tieing the whole world to Great Britain's business cycle. However, it is hard to argue that the post-World War I attempted restoration of the gold standard was beneficial, as we will see below.
 
 

Empires:
 

Europe's sixteenth century overseas empires, in Latin America, in the Philippines, and in the spice islands of Indonesia, had firm economic rationales: in the wrods of the chronicler of the Spanish Conquistadores, Spain's warriors conquered the New World "to spread the word of God, and to get rich." Control over the high-value low-weight luxury goods of East Asia, or over the precious metals of Latin America, could make individuals' fortunes and provide a healthy boost to any early modern European royal treasury.
 

Europe's seventeenth and eighteenth century overseas empires also had an economic component: obtaining a near-monopoly of the tobacco or the slave trade, or conquering the sugar-growing islands of the Caribbean, could boost mercantile prosperity.
 

But by the nineteenth century little was needed in the way of luxuries that could not be made more cheaply in the industrial core of the world economy, and little was to be found in raw materials from further extensions of European empires. Yet the nineteenth century saw the European great powers complete their conquest of the world.
 

In the last years before World War I, only Ethiopia, Siam, Persia, Afghanistan, the Ottoman Empire (the core of which is now Turkey), China, and Japan could claim to be neither a colony nor an ex-colony of Europe's great powers. And the independence of all those save Ethiopia (which had slaughtered an invading Italian army) and Japan (with its junior empire of Taiwan, Korea, and scattered Pacific islands, along with large chunks of Manchuria) was heavily compromised.

Democracy and Plutocracy:
 

"They control the people with the people's own money." So Louis Brandeis, strong Democratic political activist, wrote of the turn of the century financiers who he saw as controlling the American economy through their domination of the commanding heights of finance. The answer that Brandeis saw was simple: separate ownership from control, so that the bankers who collected the savings of the people through the acceptance of deposits would be unable to use those savings to increase their bargaining power vis-a-vis the managers of American enterprise.
 

It is doubtful that Louis Brandeis's proposed solution was any solution at all. Large-scale businesses borrow from banks, true. But remove some power to control and in_uence the managers of large-scale enterprises that borrow from the bankers, and where does it go? It _ows to the managers of the oligopolies and the monopolies that no longer have to look over their shoulders to make sure that Wall Street is satisfied; it does not _ow to the "people."
 

But if Brandeis's cure-to destroy the "money trust"-was false cure, it was a response to a real disease. For the United States as of the turn of the twentieth century was a much more economically and socially unequal place than it had been even thirty years before.
 
 
 
 

On the eve of the American Revolution, the United States-to-be had been a relatively egalitarian society. The richest one percent of households owned perhaps fifteen percent of the total wealth in the economy-a very low value for such an inequality statistic. Even by the immediae aftermath of the Civil War wealth was still not that concentrated: the top one percent of households appear to have had a little more than a quarter of the wealth of the country.
 

By 1900, however, the U.S. had become the Gilded Age country of industrial princes and immigrants living in tenements of our political memory. On the one hand, Andrew Carnegie building the largest mansion in Newport, Rhode Island with gold water faucets. On the other hand, 146 largely-immigrant workers dying in the 1911 Triangle Shirtwaist Factory fire in Manhattan because the exits had been locked to keep workers from taking fabric out of the building for their own clothes.
 

Surveys suggest that in 1929 the richest one percent of U.S. households held something like 45 percent of national wealth, and that the concentration of wealth had been sharply rising in the 1920s. We strongly suspect that World War I had seen substantial deconcentration, as in_ation eroded the value of bondholders' wealth and as high demand for labor boosted workers' earnings. It is my guess that the second was stronger than the first; that the concentration of wealth was eroded more during World War I than it was boosted in the 1920s, and that the concentration of wealth in the United States peaked sometime in the twenty years before World War I, with the richest one percent of households owning some 50% or so of total national wealth.
 

Attempts to count the wealth of the merchant princes themselves reinforce the suspicion that the pre-World War I U.S. was more unequal than at any time before or since.
 

A country of immigrants and plutocrats is very different from the country of yeoman farmers that the United States had been in its Founding Fathers' imagination, and in large part in reality, in the late eighteenth century.
 

Alexis de Tocqueville, a keen-eyed commentator on American society in the first half of the nineteenth century, had feared the growth of such a class of plutocrats, such an "aristocracy of manufacturers":
 

The territorial aristocracy of past ages was obliged by law, or thought itself obliged by cutom, to come to the help of its servants and relieve their distress. But the industrial aristocracy of our day, when it has impoverished and brutalized the men it uses, abandons them in time of crisis to public charity to feed them.... Between workman and master there are frequent relations but no true association.
 

I think that, generally speaking, the manufacturing aristocracy which we see rising before our eyes is one of the hardest that have appeared on the earth....
 

In the United States the rising concentration of wealth provoked a widespread feeling that something had gone wrong with the country's development. The rich (and many of the native-born not-so-rich) blamed foreigners: aliens born in China, Japan, Italy, Spain, Poland, and Russia who were incapable of speaking English, or understanding American values, or contributing to American society. Many of the middle class, especially the farmers, blamed the rich, the easterners, and the bankers.
 

Populism in America
 

Progressivism in America
 

European politics were very different. In Europe the trend was not toward greater inequality but toward greater equality, as rising wealth and incomes submerged the wealth of the descendants of old aristocracies in a deeper pool, and as a competing elite of manufacturers and bankers grew up alongside the older elite of landlords, ministers, royal favorites, and successful generals.
 

The fear of socialism
 

The spread of reform

G.H.M.'s views as to what is a "living wage" for a college professor are a mark of a profound shift in the American economy over the past century, a profound compression (even taking account of the widening of real wage differentials and the growth of inequality in the 1980's) in the U.S. relative wage structure. There is a strong sense in which America today is a much more egalitarian country than it was a century ago. The boast has always been that America is a country of independent middle-class people, lacking both a proletariat (although we have always had a "rural poor" and now have an "underclass") and an aristocracy. This was not true around the turn of the twentieth century. It has been much more true in the era after World War II.
-IX. Empires and Economic Leadership-

J. Bradford DeLong
University of California at Berkeley and NBER
 

January 1997; DRAFT 1.00
 
 

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Empires
Asia
The Meiji "Restoration" in Japan
Britain's (Relative) Economic Decline
American Exceptionalism
 

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Empires

Europe's sixteenth century overseas empires, in Latin America, in the Philippines, and in the spice islands of Indonesia, had firm economic rationales: in the words of the chronicler of the Spanish Conquistadores, Spain's warriors conquered the New World "to spread the word of God, and to get rich." Control over the high-value low-weight luxury goods of East Asia, or over the precious metals of Latin America, could make individuals' fortunes and provide a healthy boost to any early modern European royal treasury. Europe's seventeenth and eighteenth century overseas empires also had an economic component: obtaining a near-monopoly of the tobacco or the slave trade, or conquering the sugar-growing islands of the Caribbean, could boost mercantile prosperity.

But by the nineteenth century little was needed in the way of luxuries that could not be made more cheaply in the industrial core of the world economy, and little was to be found in raw materials from further extensions of European empires. Yet the nineteenth century saw the European great powers complete their conquest of the world.

In the last years before World War I, only Ethiopia, Siam, Persia, Afghanistan, the Ottoman Empire (the core of which is now Turkey), China, and Japan could claim to be neither a colony nor an ex-colony of Europe's great powers. The independence of all those save Ethiopia (which had slaughtered an invading Italian army) and Japan (with its junior empire of Taiwan, Korea, and scattered Pacific islands, along with large chunks of Manchuria) was heavily compromised. For in the second half of the nineteenth century it became clear that there was no part of the world in which Europeans could not--if they wished--impose their will by armed force without anything like total mobilization.

To give just example: at the battle of Omdurman in the Sudan in 1898, 10,000 soldiers of the Mahdist Sudanese regime died; only 48 British and Egyptian soldiers died. The difference was not entirely due to superior European military technology. After all, the Mahdist regime did have machine-guns, telegraphs, and mines--all bought from European suppliers. What it did not the have was the organizational capacity and discipline to make effective use of them.

The outcome was integration into the European dominated world economy, political submission--either formal or informal--to rule by European proconsuls, and what we might call "cultural contamination": the spread of European languges and European views of life around the globe. Missionaries brought European religions. Proconsuls interested in uplift brought European-style schools. Europe-originated culture, methods of administration, science, and technology began to percolate down through non-European societies as the children of the past and the members of the future elite were taught--in European languages--how "our ancestors the Gauls" had fought the Romans in the fist century B.C. European technologies percolated up through non-European societies as international investments paved the way for world trade: harbors, railroads, factories, and (most important) plantations sprung up from Bali in what is now Indonesia to Accra in what is now Ghana.

In Latin America, the U.S. helped the continent avoid a second round of recolonization. The "Munroe Doctrine" declared that the U.S. would oppose any attempt to impose European rule on the former Spanish colonies, and it served Britain's interest to use the British navy to support the formal independence of Latin America. (During the U.S. Civil War of 1861-1865, however, the French did attempt to set up a Mexican empire under a client Austrian prince). But toward the end of the nineteenth century United States politicians began to exert U.S. influence in Latin America, not just to bar potentially-hostile European powers from having American colonies. The aim was "to teach the Mexicans [and others] to elect good men," in the words of President Woodrow Wilson. Steamships and the rise of American interest in Asia made the United States government much more sensitive to central America: one consequence was U.S. intervention in Colombia, triggering the secession of a piece of the country, the establishment of the independent republic of Panama, and the Panama Canal.

After a brief aggressive war against Spain, Puerto Rico and the Phillippines became U.S. possessions at the turn of the century. Cuba gained an "independence" that guaranteed the U.S. a right of intervention. The U.S. provoked the break-up of Colombia in order to create an independent Panama in which to build a canal, established a protectorate over panama, and placed the canal zone itself under U.S. administration. U.S. interventions in Cuba and the Dominican Republic were frequent; the marines landed in Nicaragua in 1912, at Vera Cruz in Mexico in 1914, and in Haiti in 1915.

The expansion of european empires was coupled with a willingness to hand over power over local affairs to locals--to white locals. Canada gained its substantive independence from Britain with the granting of "Dominion status" in 1867, nearly two decades before the completion of the Canadian Pacific Railroad in 1885 made "Canada" as an economic unit even possible. The various British colonies in Australia were gathered into the self-governing Commonwealth of Australia in 1901. Self-government for New Zealand followed in 1907. And the Union of South Africa was established with Dominion status in 1910, even though the majority of the white population of the newly-established Union had been at war with the British Empire only a decade before.

South Africa is of special interest as the point of closest contact between the first and the third world--a region that was half settler colony (like Canada or Australia) and half colonial possession (like Nigeria or India). After the end in 1815 of the Napoleonic Wars that began the nineteenth century , Great Britain retained as a strategic asset the former Dutch colony at the southern tip of Africa, the Cape of Good Hope. The British navy saw control of the Cape of Good Hope as an important safeguard for communications with British-ruled India. The Dutch monarchy did not mind--or at least did not object. The Orange dynasty was being returned to power in a much stronger position (as Kings of the Netherlands rather than as "stadtholders" of each of the individual provinces), was protected from future French interference by a British and Prussian alliance--and was allowed to annex what is now Belgium as well.

After 1815 British colonists began to arrive in the Cape Colony. The response of the Dutch-descended Boers to this gorwing influx of foreigners who could talk to the rulers sent out from London was to leave: to move north across the Orange River outside of the British Empire in 1835, to found the Orange Free State. Once in South Africa, the British began to expand: their annexation of the neighboring Natal triggered another exodus of Boers to the Transvaal north of the Vaal River. Zulu kingdom of Shaka. Attempted annexation of the Transvaal Republic in the late 1870s. The Xhosa, the Zulu, and other kingdoms on the ground and in the way of the British expansion put up some resistence: the Zulu kingdom even annihilated a British battalion and mauled a second at the battles of Rourke's Drift and Islandhwana, thus doing even better against the advance of European settlers and their armies than the Souix at the Little Bighorn. An attempt to annex the Transvaal in the 1870s was abandoned when London contemplated the difficulties of maintaining effective rule over a hostile population of European-descended and European-armed farmers.

But the calculus changed when gold was discovered in large quantity in the Transvaal in 1886. The result was a huge influx of miners and speculators. Johannesburg grew in a few years to a city of 100,000--the largest city in Africa south of the Sahara. Railroads were built to transport gold to the coast, powerful pneumatic tools were installed to crush gold-bearing rock, a complicated high-technology advanced chemicals industry was built to extract gold from the rock, for although South African gold deposits were vast they were too low-quality for mining to be possible without the most advanced chemisry of the late nineteenth century. Gold made the interior of South Africa important to Europeans, the swallowing-up of the rest of Africa by European colonial powers made British geopoliticians anxious to cement control over the Cape.

British officials on the spot in South Africa provoked the Boer War in 1899. A quarter of a million British soldiers were sent to South Africa. Defeated in open battle, the Boers turned to guerrilla warfare. The British responded with the twentieth century's first concentration camps. Mao Zedong was to remark that a successful guerrilla army is like a school of fish: they must learn to swim in the sea of the people. The British at the turn of the century knew how to fight such a guerrilla army: dry up the sea in which they swim by bringing the population into "concentration camps" where they can be monitored and watched. It is effective--even though the "concentrated" civilian population dies of disease at a relatively rapid rate, and even though it impoverishes the country.

The possibility of a British defeat simply did not exist. A peace treaty ending the war was signed in 1902, annexing the two Boer republics to the British Empire. But control over the newly-conquered South Africa by proconsuls set by London or by British-speaking colonists was relatively brief. By 1906 Boer-centered political parties had won control over the Transvaal provincial legislature. 1910 saw the establishment of the Union of South Africa as a self-governing dominion, with equality for Afrikaans and English as official languages.

A millennium from now, historians are likely to judge the British and Dutch-descended colonists of South Africa less harshly than the settlers of North America, of the Argentine pampas, or of Australia. They will be struck by the--relatively only--mercy shown by settlers in South Africa to the indigenous population. In North America the standard treatment of the Cherokee, the Souix, the Pequot, and many others was to expel them by force from land that white settlers might want, to concentrate them on reservations, and to give them smallpox-infected blankets. In Australia the standard treatment of the Aborgines was to massacre them. There are no survivors from the indigenous population of Tasmania. What the Boers and English colonists of South Africa did was first to fight, and then to employ the Xhosa, Zulu, Swazi, Matabele, Basuto, and others.

Perhaps the difference was that the aborigines in Australia and the Indians in the United States were simply not very useful as employees in the land-intensive, capital-intensive agriculture of the New World or of Australia, while African employees were very useful indeed in the mine- and transport-based relatively industrialized gold-centered South African economy of the turn of the century. Perhaps the difference was that Africa was always connected by land to Eurasia, and so the coming of Europeans bearing their diseases did not have the catastrophic consequences for indigenous populations that it had in the Americas or Australia. Perhaps the difference was that the Boers who settled South Africa were a more moral people than the American or the Australian settlers.

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Asia

From the beginning of the nineteenth century, the British had effective control of India. The conquests (largely with Indian armies) that made the British the dominant power in India in the eighteenth century had been carried out on a shoestring, under the formal authority of a trading company: the British East India Company. Yet from that base British military operations in the nineteenth century were largely mopping-up operations: small wars against Indian powers that had no chance of assembling the resources to match the British-controlled forces in India.

Possession of India gave the British an immense interest in Egypt. Control over Egypt, and the link between the Mediterranean and the Red Sea, could cut several months off of the time needed to travel to or communicate from London to the centers of British influence at Calcutta or Bombay. The coming of the steamship, and the completion of the Suez Canal in 1869 brought India much closer to Britain--and made British interests in Egypt much stronger.

Egypt in the mid-nineteenth century was ruled by a "khedive." The Mamluk warrior-slave aristocracy that had ruled Egypt (under pledge of formal obedience to the Istanbul-centered Ottoman Empire) had been broken by Napoleon during his campaign of conquest. The viceroys established in Egypt afterwards by the Ottoman Empire had established their substantive independence within a generation.

In 1863, six years before the completion of the Suez Canal, the relatively young khedive Ismail took the throne. Ismail had been educated in France: he was open to European influences, eager to modernize his country, and eager to play the role of the open-handed Eastern ruler. He became ruler of Egypt in 1863, in the middle of the "cotton famine" created by the American Civil War and the consequent temporary disappearance of the U.S. South from the world's cotton supply. The consequence was a cotton boom everywhere else in the world: the factories of the industrial revolution needed cotton to run on, and they were willing to pay almost any price for it. Egypt grew cotton. And so for a few years it seemed as though Egypt's economic resources and wealth were growing rapidly and were inexhaustible.

More over, the khedive Ismail was more than extravagant. The Egyptian national debt was 7 million British pounds or so at Ismail's accession. It had swelled to 100 million British pounds 13 years later--and interest charges on the debt amounted to 5 million a year.

In 1876 the Egyptian government declared bankruptcy, and the creditors of the khedive became the rulers of the country. Ismail abdicated. Two financial controllers--one British, one Frence, for the bankers who had loaned to Ismail came overwhelmingly from those two counties--were appointed with substantial control over taxes and expenditures. Their task was to make sure that Egypt was governed by Ismail's son to keep up revenue and pay off the debt.

The Egyptians wondered why they were being highly-taxed to pay off debts run up by their extravagant ex-khedive. If Ismail had borrowed more than he could repay, wasn't that a problem for the bankers? Why was it a problem for the Egyptian people--and why should they be taxed and ruled by foreigners as a result? Discontent led to attempted revolution against foreign domination and high taxation. And British troops restored order and suppressed the uprising in 1882. Thereafter the khedive was a British puppet: the strategic importance of the Suez Canal for communications with India meant that British troops were to stay in Egypt on varying pretexts and for various reasons until 1956.

The opening of the Suez Canal cut the travel time to Egypt by a third. The coming of the steamship cut travel time by another third. Travelling to India from London after 1870 or so took perhaps two months, compared to six months around 1800. As India came closer, more Britons began to go there for at least a part of their career. The British presence was transformed from long-term expatriates willing to make substantial and semi-permanent adjustments in their culture and style of life to shorter-term visitors anxious to reproduce as much of Britain as possible and keep their lives as close to the British pattern as possible. And as India came closer to Britain, British institutions began to penetrate the country. The old eighteenth-century East India Company had no interest in Christianizing India. But missionaries began to appear from 1813; the first railroads were started in 1853; and universities to educate young Indians in European styles of learning started in 1857.

The drawing-nearer of India to Britain helped create a class of British officials with little sympathy for old Indian patterns: reform minded officials saw a culture in which female infanticide and the incineration of widows were common customs, in which religion served to keep the poor submissive and unambitious by convincing them that meekness now would allow them to inherit the earth in a future reincarnation, and in which caste distinctions and monopolies blocked any possibility of efficient production. Earlier conquerors had all been absorbed by Indian society in greater or lesser measure. The Victorian British with their modern technology, confidence in their intellectual and religious superiority, and continuously-renewed contacts with their homeland maintained their own caste distinctiveness.

India came surprisingly close to evicting the British in the great mutiny of 1857. Suppression of the mutiny also led to the rationalization of the institutions of British rule, and to the creation of the post of Viceroy of India, directly responsible to the British government. The Indian National Congress--with its demands first for self-government and later for independence--was founded in 1885.

Before 1800 or so there was very little that European traders could offer to sell that Chinese consumers would wish to buy. For more than two thousand years China had been one of the leading, if not the leading civilization on the planet. It was not that the average standard of living was higher in China: Malthusian population pressures roughly equalized standards of living around the world. But China had a higher population density because more efficient technologies allowed a given plot of arable land to generate more food, better craftswork in most industries, a larger class of literati interested in high culture, and--quite probably--a higher standard of living for the landed and ruling elite. Before 1800 European trade for Chinese goods was by and large trade of silver for China-made luxuries. And the transfer of technology flowed from east to west: it is still unclear to what degree the European development of items like gunpowder, printing, the compass, and noodles owed to the Chinese example. It is clear that all of these were known in China before they were known in Europe.

Even after the voyages of European discovery it was not clear that Europe was in any sense the "dominant" culture. China had long had the capability of launching its own "voyages of discovery"--and its governments had chosen not to. The one exception came under the early Ming dynasty: the fifteenth-century imperial court funded its own series of voyages of discovery commanded by the politically-powerful eunuch admiral Cheng Ho. The fleet reached Zanzibar, and touched the east coast of Africa several times. Annoyed at their treatment by a Sri Lankan king, they captured him and brought him back to China to make his apology to the emperor. But the political balance in the Ming court changed, the follow-up expeditions were cancelled, and the exploration program abandoned.

After 1800 British merchants did discover one commodity besides silver that Indian producers could supply and that Chinese consumers were eager to buy: opium. By the end of the 1830s the Chinese government was beginning to worry about the consequences of opium addiction on the country, and the exchange of European silver for Chinese goods had turned around: the bulk of the China trade was the exchange of Chinese silver for Indian-grown opium. The Chinese government attempted to suppress the opium trade and opium smuggling. The result was the 1839-1842 "Opium War," in which the British fleet intervened on the side of free trade, the sale of opium, and drug addiction. The British Empire acquired the then nearly barren island of Hong Kong as a base, European influence was established in a substantial number of "treaty ports" along the Chinese coast, and the division of China not into European colonies but into regions in the "spheres of influence" of different European powers began.

The fact that the coming of the European powers to the western Pacific coincided with the decay into bureaucracy and impotence of the Ching dynasty (which had ruled China since 1648) did not make China's lot any easier in the nineteenth century. The normal Chinese pattern of peasant revolts against corrupt rulers during the decay of a dynasty combined with European influence to produce a catastrophe: the Tai-Ping rebellion of 1850-1864. Hung Hsiu-ch'uan, a would-be bureaucrat who failed him Chinese examinations several times, had visions that convinced him that he was the younger brother of Jesus Christ: The armies of "God's Chinese Son" dedicated to overthrowing the ruling dynasty and to the coming of the kingdom of "Great Peace" ravaged central China for fifteen years, aided by the fact that the imperial court feared successful generals (as potential usurpers) at least as much as it feared the rebels.

In the late nineteenth century some industrialization took place along the coast, within the European-influenced and -ruled enclaves. In the interior agricultural production jumped as farming technologies improved, but population kept pace: there was little improvement in the standard of living, and no sign of an approaching demographic transition. Attempt to learn European technologies and organizational attitudes--to replicate what was simultaneously going on in Japan--soon ran into the problem that the ruling dynasty feared economic reform and the consequent social change as a greater threat to its power than the European navies off the coast. The loss of the Japanese-Chinese War in 1895 brought matters somewhat to a head. The "hundred days of reform" in 1898 came to an ignomious end with the political victory inside the imperial palace of the dowager empress over the pro-reform faction (and the emperor). Reaction--the use of anti-European sentiment to support the regime and the subsequent "harmonious fist" rebellion in 1900--failed as well: an all-European expeditionary force relieved the beseiged European embassies in Beijing and burned the Ching dynasty's summer palace.

With both reform and reaction having failed, the only remaining option was revolution. In 1905 Sun Yat-sen formed--in Japan--China's first revolutionary party: to overthrow the Ching dynasty, reform land ownership, and establish a republic. The dynasty fell in 1911 when the most important of its military commanders, Yuan Shih-kai, turned on the regime rather than suppress local revolts. On 12 February 1912 the six-year-old Manchu emperor abdicated. But the new Chinese republic's president was not Sun Yat-sen but Yuan Shih-kai. China descended into anarchy with local military commanders and successful bandits exercising whatever civil authority there was in a civil war of all against all.
 
 

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The Meiji "Restoration" in Japan

In the early seventeenth century the Tokugawa clan of samurai decisively defeated its opponents at the battle of Sekigahara, and won effective control over Japan. Tokugawa Ieyasu petitioned the--secluded--Priest-Emperor to grant him the title of
Shogun, the Priest-Emperor's viceroy in all civil and military matters. From its capital, Edo--now Tokyo--the Tokugawa Shogunate ruled Japan for two and a half centuries.

Early in the seventeenth century the Tokugawa Shogunate took a look to the south, at the Philippines. Only a century before, the Philippines had been independent kingdoms. Then the Europeans landed. Merchants had been followed by missionaries. Converts had proved an effective base of popular support for European influence. Missionaries had been followed by soldiers. And by 1600 Spain ruled the Philippines. The Tokugawa Shogunate was confident that it could control its potential rivals and subjects in Jpan. It was not confident that it could resist the technology, military, and religious power of the Europeans. he country was closed: trade restricted to a very small number of ships allowed access to the port of Nagasaki only, Japanese subjects returning from abroad were executed, foreigners discovered outside of their restricted zone were executed, and Christianity was suppressed. The Tokugawa Shoguns did adopt one more foreign practice: crucifixion--which they saw as a fitting punishment for those who refused to abjure the foreign religion of Christianity. For two and a half centuries the Tokugawa ruled a largely peaceful Japan. Population few. Rice-growing productivity increased. The arts and crafts flourished. rade flourished. The military skills of the samurai warrior class atrophied, Japan's technology fell further and further behind tht of Europe, but the country did not become a European colony.

In 1851 the President of the United States commissioned Commodore Perry to open relations with Japan. American warships enter Tokyo Bay in 1853. There argument for why the Tokugawa Shogunate should change its policy and open up trade was simple: if they did not, the U.S. fleet would burn Tokyo. The Tokugawa Shogunate submitted, and began trying to grasp how to deal with a world in which European powers would no longer permit isolation as an option.

For fifteen years the Tokugawa Shogunate muddled along. Then in 1868 it was overthown by the coup termed the "Meiji restoration." The shogunate was abolished. Theoretically, at least, the Priest- Emperor Meiji resumed the direct rule that his ancestors had turned over to the first Shoguns more than a thousand years before--hence "restoration." In fact Japan was ruled by a shifting coalition of notables interested in absorbing European technology while maintaining Japanese civilization and independence: "western learning with Japanese spirit" in the interest of creating a "rich country with a strong army."

The Priest-Emperors with their imperial court moved to Tokyo, took over the palace of the Tokugawa Shguns, and changed the name of Edo to Tokyo--"the Eastern Capital." There followed the rapid adoption of western organization: prefects, bureaucratic jobs, newspapers, an education ministry, military conscription, railways, and the Gregorian calendar were all in place by 1873. The samurai class's right to receive rents from the peasanst were transformed into bonds--debt owed by the central government. Within a generation inflation had expropriated the samurai. Representative local government was in place by 1879, and a bicameral parliament (with a newly-created peerage) was in place by 1889.

Even as early as 1876 Japan was flexing its muscles as a junior colonial power by putting pressure on Korea. A successful war with China in 1895 made Korea a Japanese protectorate. In 1899 the Japanese government abolished extra-territoriality--the immunity of Europeans from Japanese justice and law. Japan allied with Britain, seeking the role of Britain's viceroy in the North Pacific, in 1902. Disputes with Russia over spheres of influence in Manchuria led to the Russo-Japanese War in 1905. The Japanese were eager to escalate to test their armed forces; the Russians were eager to escalate as well, Czarist ministers believing that a "short victorious war" would solidify support for the Czar. The Japanese won decisively, bringing Manchuria into their sphere of influence. Formal annexation of Korea followed in 1910. And Japan's declaration of war against Germany in World War I brought it rule over all Pacific islands that had been German colonies.
 
 

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Britain's (Relative) Decline

The United States became the world's leading-edge nation--the richest, the most prosperous, the most modern, and the highest technologied--only because Great Britain, the nineteenth-century "workshop of the world" seemed to falter in its economic growth. The story of America's rise to economic preeminence is in many ways simply the reverse of the story of Great Britain's rapid turn of the century relative economic decline.

Great Britain had been the first industrial nation. Its commercial dominance of the seventeenth and eighteenth centuries, coupled with its established sheepherding industry, its plentiful supplies of water power, coal, and iron, and a relatively large pool of wage-workers without traditional rights to occupy the land gave it crucial economic advantages at the start of the industrial revolution. In textiles, steam power, iron production, and canal building Great Britain led the way throughout the eighteenth and nineteenth centuries. The last years of the nineteenth century saw Great Britain the richest country in the world (save for Australia, the late nineteenth century sheep-raising equivalent of OPEC), with the heaviest industrial base, the most comprehensive railroad network, and ruling over the largest Empire the world had ever seen.

British productivity has grown more rapidly in the twentieth century than it did in the nineteenth. Britain's relative decline springs from its inability to partake fully of the acceleration of growth in productivity that the twentieth century saw. And American economic preeminence sprang from the American economy's ability to create and ride the wave of this growth acceleration.

Perhaps Britain's advance contained the seeds of its inability to lead the productivity revolutions of the twentieth century. Britain's relative prosperity had been based on a set of technologies that greatly multiplied the productivity of unskilled workers. The poor British educational system, its weak corps of technical engineers, and the easy availability of unskilled Irish and rural British workers were no great handicap as long as the most dynamic edge of the economy intensively used both machines and unskilled workers, but not skilled workers. But technologies that made heavy use of skilled workers would be the locus of industrial development in the twentieth century.

In the last years of the nineteenth and the first years of the twentieth century Britain lost its leading position in new, modern industry after new, modern industry. Organic chemicals became German (and American), British railroads became smaller and slower than those on the continent, the development of the automobile lagged behind France and the United States, the electric power grid was put into place slowly, the telephone network was rudimentary, and so on.

Even in textiles, Britain began to be excluded from foreign markets on the basis of too high a price. British levels of productivity remained high. They just failed to grow at the same rate as in the rest of the leading edge of the industrial world. And British companies lost, or failed to develop, market position in what were going to become the leading industries of the first half of the twentieth century.

Britain's loss of market position in the most technologically advanced industries is surprising, for in those industries lies the most natural comparative advantage of the leading industrial nation. The leading industrial nation is the richest, has the most experience with modern technology, and would seem to be the best set up to train and mobilize labor and capital to take advantage of new opportunities. Yet British firms and workers did not do so.

In fact, in the thirty years before World War I factors of production behaved as if there was something pernicious about locating in Britain. On net both British capital and British labor left the island for better opportunities elsewhere. As U.C. David economist Gregory Clark puts it, by 1910 you could combine British labor and British capital in the textile city of Fall River, Massachusetts, and obtain 50 percent more output per worker hour and 20 percent more output per machine hour than back in the textile city of Manchester, in England. The first public power station in England, in 1881, was built by the German firm of Siemens. On the eve of World War I, the German electrical manufacturing industry was more than twice as big as Britain's.

Alfred Chandler describes the rise of German dye firms to market dominance, in spite of the fact that the largest markets for dyes were in Britain until World War I. Starting in the 1880s, the major German firms--Bayer, Hoechst, and company--decided to build mammoth plants along the Rhine river, which would produce some ten times as many kinds of dyes as previous plants. To distribute the products the German firms for the first time integrated distributors into the manufacturing firms, rather than relying on wholesalers. And by the turn of the twentieth century the German dye manufacturers--relying on low costs made possible by economies of scale, and expanded distribution through sales forces that would push dye out the door and teach customers how to use it. By 1913 some 85% of textile dyes were produced in Germany; some 3% were produced in Britain.

One reason for Britain's slower growth than the other industrial powers is that its rate of investment was low. There have always been four candidate reasons: a deficiency in natural resources, the British labor relations system, and the British educational system, and a banking system that failed to mobilize capital for large-scale industrial firms. Of these, resource-based explanations for British relative decline are unsatisfactory. Germany and the United States had superior natural resources. Yet water transportation was very cheap. Britain grew no cotton, yet had no trouble dominating the world cotton spinning and weaving industry for a century. Japan today produces steel in large quantities from Australian iron ore and Brazilian and American coal.

Right-wing analysts have tended to blame Britain's industrial decline on the bloody-mindedness of British unions, unwilling to see firms earn profits or to allow economic readjustment and change to take place. Left-wing analysts have tended to blame Britain's industrial decline on its class structure and deficient educational system. These are not separate causes, but a single interlinked system: unions were bloody-minded and the educational system was deficient because Britain had strong class distinctions. And the deficient educational system and poor labor relations reinforced class distinctions. For those who governed Britain did not see an educated population as a high priority. As economic historian David Landes wrote, in Britain:

For every idealist or visionary who saw in education an enlightened citizenry, there were several 'practical' men who felt that instruction was a superfluous baggage for farm labourers and industrial workers. These people, after all, had been ploughing fields or weaving cloth for time out of mind without knowing how to read or write all they would learn in school was discontent. Under the circumstances, Britain did well to have roughly half of her [elementary] school-age children receiving some kind of elementary education around 1860.

This was a far lower percentage than found in the United States or in Germany. What was true of elementary education was even more true of technical and engineering education. In Britain, technical education was the business of private firms. Why should they train workers who might well go elsewhere for jobs? And why should they train workers if such training only upped the bargaining power of British unions?

Thus the year 1914 saw close to 40 percent of Britain's national capital stock-of its produced means of production-located overseas. No other country has matched Britain's high proportion of savings channeled to other countries. Britain's overseas investments were concentrated in government debt, in infrastructure projects like railroads, streetcars, and utilities, and in securities guaranteed by the local government.

Britain did not do well out of its overseas investments. In the forty years before World War I, British investors in overseas assets earned low returns, ranging as low to perhaps 2% per year in inflation-adjusted pounds on loans to dominion governments. Such returns were far below what presumably could have earned by devoting the same resources to the expansion of domestic industry. British industry in 1914, and British infrastructure, were not as capital intensive as American industry and infrastructure were to become by 1929. It is difficult to argue that Britain's savings could not have found productive uses at home if only they could be challenged appropriately and managed productively. And it is difficult to argue that foreign investments were more secure. In a depression at home--the major risk facing investors in British industry--exports to Britain drop far in both quantity and price, and firms and governments across the oceans declare bankruptcy.

Why, then, did British investors commit their wealth overseas? One possibility is that the high rates of return presumably available at home were not really there: the absence of British engineering skill, and the aggressive wage demands of British unionized workers would have prevented home investments from earning even the small profits earned abroad. A second possibility is that British investors did not understand the framework in which they were embedded. Perhaps they imagined that home investments--even a diversified portfolio of industrial, railroad, and utility corporations--were risky, while overseas investments guaranteed by the local government were safe.

Certainly a contributing factor was the failure of Britain to develop institutions for channeling the savings of thousands into the capital stock of one giant enterprise. How is an individual saver, in an age where the efficient size of an operating corporation is vast beyond his means, to evaluate which industries and companies have good prospects, monitor the management to which he has committed his capital, and control and replace the management when it does not do its job? Such tasks require the growth of financial intermediaries: investment banks of one form or another. German analysts, especially, criticized the pre-WWI British banking system because of the lack of such a monitoring system:

the complete divorce between stock exchange and deposits...causes another great evil, namely, that the banks have never shown any interest in the newly founded companies or in the securities issued by these companies, while it is a distinct advantage of the German system, that the German banks, even if only in the interests of their own issue credit, have been keeping a continuous watch over the development of the companies, which they founded.

And so few were willing to invest in companies that might become large organizations that contributed to the rapid advance of productivity. The scarcity of British engineering talent was matched by a scarcity of venture capital: there was plenty of capital for infrastructure or for government debts, but little for the progressive entrepreneur.

Britain's relative economic decline should have given libertarians much more cause to pause and take stock than they have. For turn-of-the-century Britain was, from a libertarian point of view, a laissez-faire utopia in which the government did little and the private market system did everything. Yet economic preeminence in the twentieth century appears to have required much more than an initially-rich country and a laissez-faire economic policy. It also required a government willing to invest in education to create a skilled labor force and a solid corps of technologically-trained engineers, it required financial institutions to channel savings into the domestic accumulation of the machines that embody industrial technology, it required a labor movement eager to share in and not to block economic reorganization and technological change, and modern business enterprises to take advantage of economies of scale and to translate scientific knowledge into productive engineering applications. In all of these Britain was deficient. In all of these the United States was--by luck--abundant.
 
 

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American Exceptionalism: The Furnace Where the Future Was Being Forged

Because it was in relative terms so prosperous and so technologically advanced, the United States in the twentieth century was the country where people looked to see the shape of the future, just as Holland in the seventeenth and Britain in the nineteenth centuries had been the focuses of institutional and economic innovation and the balance wheels of world economics and politics. For much of the twentieth century, the United States seemed to observers from Europe and elsewhere to be a qualitatively different civilization: it lacked the burden of the past that constrained the politics and oppressed the peoples of the nations of Europe, and freed from the burden of the past it could look toward the future.

We can see some of this admiration and wonder by gazing at the early twentieth century United States through the eyes of a 1916 transitory immigrant who, later, recorded his experiences in his autobiography. Unlike the bulk of the people who had left the Old World for the New in the previous half century, Lev Bronstein did not want to be there. He was a political exile: one of those feared by Czars and policemen, and hunted and exiled because they were feared. But once he and his family had landed in New York, he and his family made the best of it. The Bronsteins:

rented an apartment in a workers' district, and furnished it on the installment plan. That apartment, at eighteen dollars a month, was equipped with all sorts of conveniences that we Europeans were quite unused to: electric lights, gas cooking-range, bath, telephone, automatic service-elevator, and even a chute for the garbage.These things completely won the boys over to New York. For a time the telephone was their main interest; we had not had this mysterious instrument either in Vienna or Paris...

They--particularly the children--were overwhelmed by the prosperity of the United States, and by the technological marvels that they saw in use everyday:

...the children had new friends. The closest was the chauffeur of Dr. M. The doctor's wife took my wife and the boys out driving... the chauffeur was a magician, a titan, a superman! With a wave of his hand, he made the machine obey his slightest command. To sit beside him was the supreme delight.

He stayed in the United States for less than a year. The Russian Revolution came, and he returned to the city of St. Petersburg (whose name was changed, first to Petrograd, then to Leningrad, and now back to St. Petersburg). As Leon Trotsky (an alias taken from one of his former Czarist jailers in Odessa in order to evade the police) he became Lenin's right-hand, the organizer of Bolshevik victory in the Civil War, the first of the losers to Stalin in the subsequent power struggle, and finally the victim of the Soviet secret police, assassinated with an ice-pick in his head outside Mexico City in 1940.

Trotsky was never allowed back into the United States. He had no time to more than "catch the general life-rhythm of the monster known as New York." But on his departure Trotsky felt--or at least he later wrote in exile that he had felt--as if he was leaving the future for the past: "I was leaving for Europe, with the feeling of a man who has had only a peek into the furnace where the future is being forged...."

X. World War I-
J. Bradford DeLong
University of California at Berkeley and NBER

February 1997
 
 
 
 

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The Outbreak
The War Effort
The Aftermath
A Land Fit for Heroes?
 

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The Outbreak:

To much of the industrial world--especially to those engaged in commerce, trade, and enterprise--World War I seemed impossible to imagine beforehand, and like a bad dream as it happened. The British economist John Maynard Keynes, one of those who saw the war as a previously-unimaginable horror, was afterwards to write of the pre-World War I inhabitant of London "for whom life offered, at a low cost and with the least trouble, conveniences, comforts, and amenities beyond the compass of the richest and most powerful monarchs of other ages," who saw:

...this state of affairs as normal, certain, and permanent, except in the direction of further improvement, and any deviation from it as aberrant, scandalous, and avoidable. The projects and politics of militarism and imperialism, of racial and cultural rivalries, of monopolies, restrictions, and exclusion, which were to play the serpent to this paradise, were little more than the amusements of his daily newspaper, and appeared to exercise almost no influence at all on the ordinary course of economic and social life, the internationalization of which was nearly complete in practice.

In the summer of 1914, a Bosnian terrorist seeking Bosnian independence from the Austro-Hungarian Empire and union with Serbia assassinated the heir to the throne of the Austro-Hungarian Empire, the Archduke Franz Ferdinand (brother of the ruling Emperor Franz Josef), and his wife. The terrorists had received some assistance from the secret police of the Kingdom of Serbia--although almost surely not with the active knowledge of the King of Serbia: no ruler, monarchical or otherwise, has an interest in the declaration of an open hunting season against heads of state and their near relatives.

The rulers of Austria-Hungary had for a long time been worried about Serbian nationalism, or rather the extension of Serbian nationalism northward as ideologues argued that Serbs, Bosnians, Croats, Slovenes, and others were really one nation--"Yugoslavs"--and that only alien rule by Turks from Istanbul and Germans from Vienna had prevented the previous emergence of a glorious south-slav nation.

From our perspective it is easy to be very, very cynical: less than 80 years separate the time when Serbs and Croats were blood-brothers (so much so that the Serbs would risk bloody war with Europe's great powers to rescue the Croats from oppressive foreign despotism) and our time, when Serbs and Croats cannot live in the same village or province without the political leaders of at least one side calling for the extermination and exile of the other. To fight one set of wars at the start of the twentieth century to unify Serbs and Croats and to fight another set of wars at the end to dissolve the union and "ethnically cleanse" the region seems among the sickest of the jokes History plays on human populations.

From our perspective a semi-democratic, constitutional monarchy like that of the Habsburg-ruled Austro-Hungarian Empire, ruling over various nationalities, a monarchy that respected (most) local customs, kept the peace, and allowed freedom of commerce, belief, and speech (within limits), seems much more than halfway up the list of desirable regimes. The heir of Emperor Franz Josef is now the President pro tempore of the European Parliament in Strasbourg. How much better to have achieved this by peaceful evolution than by war.

But a large number of European statesmen wished to see--or at least were willing to risk the chance of--a war in the summer of 1914.

For the old emperor Franz Josef in Vienna and his advisors, the outrageous murder of his nephew--with help from within the Serbian government--seemed to call for action to chase and punish the guilty, humble and shame Serbia, and make it plain that Austria was the great power in the Balkans. Thereafter Serbian foreign policy had better trim its sails to the Austrian wind. To establish this seemed worth a small risk of a large war.

For the not-so-old emperor in St. Petersburg, Czar Nicholas II, and his advisors, possible involvement of Serbian government officials and agencies in the assassination of his distant cousin Franz Ferdinand was beside the point. Russia, not Austria, was to be the dominant great power in the Balkans. Russia was to be the protector of Slavic-speaking states that had previously been part of Turkey's decaying Ottoman Empire. Russia needed to make it plain that it would fulfill its promises to protect other Slav-speaking states--and especially to protect them against the imperialism of German-speaking Berlin and Vienna. To establish this seemed worth a small risk of a large war.

For the not-so-old German Emperor, the Kaiser Wilhelm II, and his advisors, the decision to back Austria to the hilt in whatever action it chose to take in response to the assassination of Franz Ferdinand-up to and including war-was nearly automatic. For the German government by and large viewed a large war not as a risk but as an opportunity. The rulers of Germany felt that their country deserved a larger place in international affairs: more influence, more respect, and more colonies. They looked back at a nineteenth century in which the standing and power of the core of the turn of the century German Empire, the Kingdom of Prussia, had been radically enhanced by short victorious wars provoked and managed by the so-called Iron Chancellor, Prince Otto von Bismarck, a German politician whose best-remembered sentence is that: "It is not by speeches and debates that the great issues of the day will be decided, but by Blood and Iron."

Bismarck's shoes were hard to fill. His legend was hard to live up to. But attempting to live up to it seemed to involve an eagerness to court and welcome the risks of war. No one remembered that Bismarck had sought war against isolatedpowers without allies--Denmark in 1864, Austria in 1866, and France i 1870--adn only when he had stacked the deck to make rapid victory all but certain. And no one remembered that Bismarck had never had any desire to escalate political conflict in the Balkans. Perhaps his second-best-remembered sentence is that: "There is nothing at stake [in the Balkans] that is worth the bones of a single Pomeranian grenadier."

Complicating German decision-making further--and this is hard to believe--was that the civilian politicians in Germany and the emperor did not know that the German army understood "mobilization" to be "war." For the chancellor of the German Empire and the emperor, mobilization was the final threat before war. But for the army, it was the first tep of the war: German "mobilization" called for troops to assemble and concentrate in Belgium and Luxemburg, outside of Germany's borders. The Belgian border fortress of Liege was to be occupied on the third day of mobilization; the Luxemburg railways were to be seized on the first day. Thus Germany went to war--attacked Belgian fortresses, and occupied Luxemburg--in a fit of absence of mind. The first German acts of war were undertaken by the military high command on the authority of the (political) order to mobilize. The political leadership did not declare war, they realized they were at war.

For the politicians and journalists of the French Third Republic in Paris, as well, war was viewed not as a risk but as an opportunity. The newly-formed German Empire had ripped the provinces of Alsace and Lorraine from France as part of the treaty that ended the Franco-Prussian War of 1870-1871. (The justification was that these provinces had been previously ripped away from Germany by French aggression-but their incorporation into France had taken place more than two centuries before, Alsace in the first half and Lorraine in the second half of the seventeenth century.) And for more than forty years the French army and French politicians had been getting ready for a rematch. So from the perspective of France's politicians and generals, a war with Germany was to be welcomed-as long as France's allies were securely on board as well. A war would restore French predominance in Europe, and dominance over Germany.

For the politicians of the British Empire in London, risks of war were worth running if they were necessary to preserve the European balance of power. In the early twentieth century, preserving the European balance of power was seen mostly as requiring the containment of Germany. Why the containment of Germany rather than France? Britain had been at war with France for more than half of the millennium before 1914, after all. Because Germany had built a modern navy strong enough to challenge and-possibly, if they were lucky-beat the British navy. Such a naval defeat would leave food-importing Britain helpless, with no choice but to surrender.

Why had the Germans built such a fleet? Because the admirals convinced the Emperor Wilhelm II that the British would never respect Germany unless it did have a fleet strong enough to challenge the British navy. It is not clear that the British respected pre-World War I Germany; it is clear that they feared it, and armed against it. As Winston Churchill said,when the magnitude of the German naval construction program became clear, "the politicians proposed [to build] four, the admirals demanded six, and we compromised on eight [new battleships built every year]." Thus Britain allied with France, which showed no signs of wanting to build a fleet large neough to challenge the British navy.

It is worth stepping back, and noting that all of these politicians and military officers were at best badly mistaken, and at worst criminally insane. Nearly ten million people would die in World War I. All of the continental European emperors whose ministers made war would lose their thrones as a direct result of the war, the British monarch alone surviving (the kings of Italy and Belgium also survived: their countries joined the winning Anglo-French side). The not-so-old Czar Nicholas II in St. Petersburg did not demonstrate that Russia was the great power in the Balkans, and that slavic-speaking small nations could count on it to protect them from Viennese hegemony. Instead he lost his throne, his life, and his country. Russia lost a generation of young men dead or mutilated, and lost its chance to have a less-than-totally-unhappy twentieth century. The not-so-old German Emperor Wilhelm II in Berlin did not secure for Germany a dominant "place in the sun" among the great powers of Europe. He lost his throne; his country lost its political and military autonomy, a generation of young men, and took the first steps along the road to Hitler's Third Reich, a regime that will blacken the name of Germany for millennia. The old Emperor Franz Josef in Vienna would die while World War I was still going on; but his Habsburg dynasty would lose its throne, and his empire would be chopped up and handed out to no fewer than seven nation-states (today between thirteen and fifteen, depending on whether you count Bosnia-Herzegovina as one or three).

The French would lose a generation of young men dead or mutilated. And it would take more than thirty more years before French politicians would realize that trying to contain Germany by using your army simply did not work, and that perhaps a better way to try to contain German power would be to integrate it economically into a wider Europe. The British would lose a generation of young men. And the post-World War I British Empire would be much weaker, and eventually find itself in a worse strategic position, than even a pre-World War I Britain facing a German-dominated Europe would have possessed.

The Princeton historian Arno Mayer has attributed the collossal misjudgments and underlying bloodthirstyness of those who started World War I to the persistence of the Old Regime. Europe in 1914 was a Europe of national populations, of industrialists and socialists, of factory workers and technicians. But Europe's governments in 1914--especially the defense and foreign affairs ministries--were populated by aristocrats, ex-aristocrats, and would-be aristocrats who had no social function in the absence of war, and who could look forward only to continued erosion of their influence and status, erosion of their relative wealth, and erosion of their self-respect in the absence of war.

So they rolled the dice, Arno Mayer believes more-or-less understanding that in the losing country the political and social order that had given them influence and wealth would be destroyed. But they believed that the risk was worth the potential gain, with the gain coming from the strengthening of power and influence that would come from victory and resulting international political domination. And--surprising as it may seem--the people responded: they truly saw the world as made up of nations in conflict, so that they should be willing to risk death to recover Alsace for the French Republic. The mass armies were made up of the universally conscripted 18-21 year olds of Europe, augmented by the reserves: those who had gone through the military in the previous decade or two and who did not hold civilian jobs judged "essential" to the war effort. The mass armies marched off to war enthusiastically, singing, taking the causes of the emperors and the generals for their own.

Much of the enthusiasm for war was fueled by a belief that the war would be short. Within memory, most European wars had been short. The Franco-Prussian War of 1870, the Austro-Prussian War of 1866, the Prusso-Danish War of 1864, the Franco-Austrian War of 1859, and the Balkan Wars of the early twentieth century had all seen armies assemble, armies march, a pitched battle or two, one army in retreat or dissolution, and a peace treaty signed. Many thought that the war would be over before the leaves finished falling. Few looked at the bloody trench warfare of the Russo-Japanese War of 1905 or at the slaughter of the American Civil War of 1861-65, or thought what they might mean for World War I.

Some looked forward to the war with more fear. Edward Grey, the British Foreign Secretary who committed the British Empire to the war, is reputed to have looked out his window one evening at dusk in the last days before the shooting, and said: "The lights are going out all over Europe. I do not think we shall see them lit again in our lifetime."
 
 

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The War Effort

Mobilizing economic resources for total war turned out to be suprisingly difficult. Military plans had all been based on the assumption of a short war: one in which decisive victory would be won or lost in a matter of months, in a single battle or two. And at first it did seem as though victory would be quick, and would go to Germany and its allies, the so-called central powers. The first-mobilized vanguard of the Russian army was decimated in the forests of eastern Germany. The first battles between the French and the Germans saw the French take much heavier casualties, and retreat almost to Paris before the Germans outran their supply lines. But thereafter the front line settled down into a fixed line of trenches in which soldiers hid from flying death. And offensives degenerated into episode of machine-gun target practice in which the attackers always took far heavier casualties, and invariably gained little ground of no strategic value.

As the war settled into stalemate, generals called for greater and greater commitments of resources to the front: if battles could not be won by strategy, perhaps they could be won by the sheer weight of men, metal, and explosives committed to the front. The share of each belligerent's resources devoted to the war effort rose.
 
 

In Britain--which attained the highest degree of mobilization--the government was sucking up more than one-third of national product (plus the time of conscripted soldiers) for the war effort by 1916. Production became much more that dictated by the representatives of industry's largest customer, the military, than by market forces. The example of the German war economy made some, like Vladimir Lenin, believe that a "command economy" was possible: that you could run a socialist economy not through the market but by using the government as a command-and-control bureaucracy.

In the end, the weight of men and metal arranged against Germany and its allies did tell. First, however, Russia disappeared from the war in 1917, with the fall of the Czar in March 1917 and the seizure of power by Lenin and the Communists in November 1917. But the United States entered the war in 1917. Final victory was achieved at the end of 1918, when the Austro-Hungarian Empire's army collapsed and the German army in France, facing defeat, sought an armistice.
 
 

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The Aftermath

When the guns fell silent after fifty months of World War I, the world of relatively rapid growth and progressing civilization of nineteenth century Europe had been shattered. The optimism of the nineteenth century would never be fully restored. Some 65 million men had been mobilized for military service (out of total populations of perhaps 400 million). Of these, perhaps ten million were killed and 21 million wounded, not counting the casualties of the Russian Civil War that erupted at the end of 1917. Civilian casualties were relatively light: less than ten percent of military casualties.

Things were to be different in World War II. Then civilian deaths would exceed military deaths.

In World War I total cumulated war budgets of the combattants amounted to perhaps $200 billion, with total property damage of perhaps $40 billion additional (and lost production that those turned into soldiers would otherwise created of perhaps $65 billion more), all in an era where the gross national product of the United States was $50 billion. In France, which had seen the principal western front battles of World War I, more than 2.5 million people had been driven from their homes by the war-nearly all of whose houses were destroyed or badly damaged. Poor nutrition and refugee movements set the stage for the last great worldwide epidemic, the flu epidemic that followed World War I, which itself killed perhaps fifteen million people.

The victorious allies did not think that they should bear the cost of having been the battlefield in World War I. The peace settlement--the Treaty of Versailles--demanded "reparations." Allied claims for reparations after the war amounted in total to $33 billion, a sum equivalent to two years' worth of German national product. It would have required all of Germany's pre-World War I export earnings in order to amortize this reparations burden over a third of a century. Such reparations were never paid. In fact, transfers from the United States to Germany in the form of post-World War I loans that were never repaid dwarfed actual reparations payments.

Other countries lost as well from default. Perhaps a fifth of a year's GNP for France disappeared with the Bolshevik repudiation of the Czarist debt. But even the notional imposition on Germany of a reparations burden--never mind that it was never paid--weakened the middle class and, perhaps more important, weakened the Social Democratic Party which had signed the allied peace terms. Since the weakness of the social democrats was key to the failure to stop the rise of Hitler, the imposition on Germany of the post-World War I reparations burden turned out to be the most costly political decision of the entire World War I era.

The pattern of international trade was permanently altered by the war. Wartime stimulus to industry expanded the export capacity of North and South America. After the war, the British found themselves exposed to American, Latin American, and Japanese competition in their export markets in ways that had been inconceivable before the war. The interruption of wartime exports from Britain stimulated textile and iron production in Asia and in Latin America.

The final stages of World War I saw the end of three dynasties and three empires, and the first seizure of power by disciples of what was to become the most murderous of the totalitarian ideologies of the twentieth century--Communism. The German Emperor Wilhelm II abdicated in November 1918. A republic was proclaimed, with Social Democratic Party leader Friedrich Ebert as its provisional president. The German army high command agreed to support and defend the republic if the political leaders of the republic would suppress any social revolution that would expropriate and nationalize property and redistribute wealth. The Austro-Hungarian Emperor likewise abdicated in November 1918, and his regime was carved into individual nation-states very roughly following ethno-linguistic borders. The Czar Nicholas II abdicated in March 1917, and after eight months of provisional government Lenin's radical wing of the Russian socialists--the "Bolshevik" or "majority" faction--seized power and claimed to be establishing a working-class dictatorship in November 1917.

Lenin and his comrades confidently expected their revolution in Russia to be followed by other, similar Communist revolutions in the more advanced, industrial countries of western Europe. And he might have been correct had more of the leaders of the left, "violent action" wings of western European socialist movements been like Lenin. A Communist republic briefly held power in Hungary. Another briefly held power in Germany. The "Spartakists"--the left wing of German socialism under Karl Liebnecht and Rosa Luxemburg--called for an uprising in Berlin, declared that the provisional republican government under mainstream social democratic politician Friedrich Ebert was deposed, but did curiously little to attempt to seize power or control over the government.

The flavor of the Spartakist uprising is well-captured by the Spartakist attempt to seize the German Ministry of War:

Karl Liebnecht... ordered a certain Petty Officer Lemmgen to occupy the red-brick edifice of the Ministry of War on behalf of the Revolutionary Council.... But when Lemmgen arrived at the Ministry, he found a young lieutenant, Bruno Hamburger... as duty officer. Lieutenant Hambuger challenged Lemmgen's authority and demanded to be shown his credentials.... Lemmgen produced a typed document with the following text: "Comrades and Workers! The Ebert-Scheidemann government have made themselves impossible.... The undersigned Revolutionary Council has provisionally assumed power."

Lieutenant Hamburger inspected the document and became properly indignant. "But where are the signatures?' he demanded. The documment had none. "Before I can comply with this order, you'll have to go back and get it properly signed. Otherwise any little shorthand typist could declare the government deposed."

Petty Officer Lemmgen... saw the logic of the lieutenant's request. So he and his men saluted... and made their way back to the Revolutionary Council to obtain the necessary signatures.... But by the time he had obtained the signatures, Lemmgen had learned that the People's Naval Division had declared itself neutral. So he did not return to the Ministry of War...

The "revisionist" mainstream social democrats were more ruthless and more Leninist than the left-wing socialists who called for a social revolution to redistribute and nationalize wealth as well as a political revolution to remove the monarchy and institute democracy. The Spartakist demonstrations were suppressed by ex-soldiers hastily organized into a militia. Karl Liebnecht and Rosa Luxemburg were arrested, and "shot while attempting to escape."
 
 

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A Land Fit for Heroes?

World War I permanently changed European politics. The returning soldiers were heroes: they deserved a land fit for heroes. Working class soldiers who had died in enormous numbers for the state could not be deprived of the vote. The electorate was greatly expanded during and after the war. Women were enfranchised. Property tests restricting voters to the middle and upper classes, or giving more influence to upper-class voters, were eliminated. The result was the rise of the political left. In Britain, for example, where less than half of adult males could vote before World War I, the socialist Labour Party multiplied its vote sevenfold in the election of 1918.

Barry Eichengreen sees the rise of proportional representation as an electoral mechanism in Europe as another result of World War I. The war had arisen because of the suppression of nationalities by the old empires, therefore a just post-war system had to protect minority rights. Proportional representation meant that candidates did not have to receive a majority in a particular constituency, but just a sizable enough proportion of the total national vote. Proportional representation encouraged the multiplication of parties: the principal incentive for politicians to group together into parties was always that if you did not combine you stood no chance of winning an office, and proportional representation greatly reduced this incentive. Non proportional systems encourage the growth of two grand coalitions--one just to the right and the other just to the left of center. Proportional systems encourage the growth of many parties, each one finely calibrated to a particular voter mass point on the ideological spectrum.

The rise of proportional representation reinforced currents hostile to political democracy: "we vote and vote, but nothing changes," critics charged, because the only outcome of elections was a small shift in seats in parliament, and a small reshuffle of portfolios among centrist ministers. It was much easier to make the argument that the democratic franchise had real meaning in non-proportional systems, where an election often led to a change of the entire government and not just a reshuffling of portfolios.

But land fit for heroes required more than giving the working class the franchise. It required governmental policies that would recognize the gift that the people had made the nation during the war. Disability insurance for war veterans, unemployment insurance so that returning soldiers did not have to beg in the street because postwar readjustment was slow, mammoth government expenditures to repair war damage, plus mammoth government expenditures to pay off the war debt--all these placed stresses on and required action from governments orders of magnitude greater than had been seen before.

XI. Restoring the Pre-World War I Economy-
J. Bradford DeLong

University of California at Berkeley and NBER

February 1997
 
 
 
 

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Finance and Inflation
Hyperinflation
The Economic Consequences of Mr. Churchill
The Restored Gold Standard
Labor Parties, Welfare States, and the Interwar Gold Standard
 

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In the immediate aftermath of World War I, central Europe and Russia were near starvation. One of the principal weapons with which the western allies had fought the war had been a naval blockade enforced by the British fleet: deprive the cities of central Europe of the food that they had imported, and deprive the farms of central Europe of as many of the raw materials to boost agricultural productivity as possible. And during the war the German army made sure that Germany's chemical factories used nitrogen to produce explosives, not fertilizer.

The first task of reconstruction was thus to bring food to the peoples of Europe, mostly under the auspices of the Herbert Hoover-led American Relief Administration. Something like three percent of a year's American national product was spent on relief. Most relief deliveries were financed through loans, not through aid grants. But the loans were added to war debts that countries owed to the United States government, and were in almost all cases not repaid.

In the immediate aftermath of the war, many feared that the reconversion from war to peace would be difficult. Would there be jobs in the civilian economy for all of the ex-draftees? But fears of an immediate postwar depression were unfounded: 1919 and early 1920 saw a strong worldwide inflationary boom. Governments were still maintaining expenditure at high levels. Governments were anxious to keep nominal interest rates low so that they could refinance their massive war debts on favorable terms. Purchasing power had accumulated during the war, had not been spent because of wartime rationing and shortages, and was unleashed in a surge of business and household inventory-replenishment spending in the year and a half after the end of the war. By the end of 1919 central bankers were worried at the prospect of rapid further inflation. They took steps to restrict credit, and to drive up interest rates. The post-World War I boom cracked, and was followed by a depression, which further complicated the task of restoring the world economy.

The war, moreover, had brought about a substantial shift in the balance of world competitive advantage. Everyone now had steel industries, chemical industries, and shipping fleets. South American countries that had imported manufactures from Britain for most of a century had found their own industries growing up rapidly during the war, while British capacity was devoted to making uniforms and artillery shells. The European belligerants had similarly built up their heavy, militarily-useful industries. The pattern of world relative prices that would produce net trade flows in balance with desired long-run capital flows had changed. And desired long-run capital flows had changed as well. Inflation--even in terms of the gold prices of commodities--had taught investors that bonds were not safe investments. The Russian Revolution had taught investors that the losses on even government-guaranteed loans could be total.
 
 

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Finance and Inflation

For the half-century before World War I, international trade and finance had operated according to the so-called gold standard. Countries had committed themselves to maintaining a fixed parity for their currencies in terms of gold. This meant that (a) international trade was not exposed to significant exchange rate fluctuations, for exchange rates did not fluctuate, and (b) that national monetary policies were very tightly constrained, for any tendency toward inflation would generate, through capital flight or high import demand, a line of bankers at the central bank trying to turn the country's currency into gold. Faced with an erosion of its gold reserves, central banks were forced to deflate--to raise interest rates, reduce investment, reduce employment, and so reduce imports--in order to avoid the faux pas of devaluation.

During World War I, European finance ministers discovered the benefits of inflation, and indeed its necessity given governments' unwillingness to raise taxes sufficiently to fight the Great War on a balanced-budget basis. On average, the world price level in 1920 was twice what it had been in 1914-thus, if countries were to return to gold at their pre-war parities, the world's gold cover ratio would be only half of what it had been before the war. Think of the gold reserves of the world as a shock absorber, for shipments of gold (and speculation based on the expectation of such shipments) were what covered temporary imbalances in trade: the postwar world had only half as good a shock absorber as the prewar world. Different countries had inflated to different degrees. If they restored the prewar system of exchange rates, some countries would have had exchange rates that were much too high and other countries would have had exchange rates that were much too low. So the need for shock absorbers would be greater.

Thus the financial side effects of World War I were such as to place the international economic system, and the gold standard as it was to be restored, under more strain than ever before.

During the war different European countries had inflated to different degrees. The structural changes that shifted world trade had altered "equilibrium" balanced-trade real exchange rates. And the end of the era in which foreign investments were seen as near-riskless had altered desired capital flows as well. Thus when the war ended no one knew what exchange rates should be. After March 1919, the British government let the market decide: it prohibited the export of gold, and let the exchange rate of the pound be determined by supply and demand, with an eye toward an eventual restoration of the pre-war gold parity of the pound. By the end of 1919 the pound sterling was worth only $3.81, some twenty-five percent less than its pre-World War I parity of $4.86.

Why was the gold standard not restored immediately after the end of the war? Because of the enormous debts that had been run up during the war. The chief problem of European governments was debt management: how to rollover and, hopefully, someday retire the wartime debt. Thus central banks came under enormous pressure from treasuries to keep interest rates low, but low interest rates could only be obtained by a rapidly-expanding money supply--and hence inflation. Different rates of inflation in different countries made early restoration of a fixed exchange rate system impossible until the debt management problems of the ex-belligerents had been resolved. Yet in many European counties the problems seemed unresolvable: retiring debt required a government surplus, but government spending must not be reduced below levels consistent with the wartime promises made to the ex-servicemen. No democratic government could hope to survive such a breach of promise.

How about creating a surplus by raising taxes? The wealthy insisted that emergency wartime taxes on the rich be reduced. The working classes insisted that capital be taxed to create a more equal society and to punish war profiteers. If the electoral balance between the middle and the working classes had been less even, then either government promises on spending would have been scaled back (pleasing the rich) or capital would have been taxed (pleasing the working classes), in either event resolving the debt funding problem. But because political and electoral power in post-war Europe was finely balanced, centrist politicians hesitated: they did nothing, hoping either (i) that reparations payments from the Germans would solve their problem for them, or (ii) that something would make it clear whether the road to electoral success was to tax the rich or to cut back on the nascent social insurance state.

While they hesitated central banks continued to keep interest rates low, the money supply continued to grow, demand outran supply, and inflation continued at varying speeds in different countries. In the end inflation eroded the real value of the government's wartime debt enough to make its fiscal problems manageable: the rich were not taxed, government spending was not cut, but holders of government bonds were expropriated by inflation. And afterwards governments could once again turn their attention to restoring the pre-war international economy.
 
 

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Hyperinflation

Thus in the aftermath of the war, most European economies resorted--or central banks found themselves forced to resort--to still further bursts of high inflation to meet the post-World War I demand for government spending, in the context of a weakened tax base and the crushing burden of wartime borrowing and reparations demands. The people demand government aid? There are no tax revenues available? Then print money, or create it within the banking system by a stroke of the central bank's pen. And the result is inflation. The result can turn into hyperinflation if the government does not quickly take steps to restore its finances.

The first hyperinflations took place in the successor states to the old Austro-Hungarian empire, Germany's ally during the war that had shattered at the end of 1918 under the pressures of military defeat and southeastern European nationalism. A small chunk of the empire was added to the territory of the allied power Italy. A large chunk was merged with Serbia into the Kingdom of Yugoslavia. The province of Transylvania was annexed by Romania. A small slice of the former Austro-Hungarian province of Galicia wound up as part of Poland. The Czech and Slovak lands formed a new republic of Czechoslovakia. And the largely Magyar, Hungarian-speaking regions downstream the Danube from Vienna became the fully-independent country of Hungary.

Austria was what was left over.

The Austro-Hungarian empire had been a single economic unit. Now it was split among seven countries, each with its own different currency and its own high tariffs. Industries in one part of the empire had depended on raw materials from another. Now provinces rich in raw materials tried to encourage their own resource-based manufacturing industries, and restricted raw mterial exports.

The Austrian economy collapsed first. Its capital, Vienna, had been the administrative of a great central and southeastern European empire. After the end of World War I, it had many too many civil servants to govern the small state that was left. The government sought to pay its civil servants, provide relief to the unemployed, and establish its legitimacy. Unable to balance the budget the Austrian government printed paper money. Before World War I, the Austrian crown had been worth a little less than twenty cents. By the late summer of 1922 the crown was worth 1/100 of a cent. The League of Nations--an international organization established at the end of World War I as one of the provisions of the Treaty of Versailles--provided a hard-currency loan on the condition that the Austrian government surrender control over its own currency and finances. The Austrian government was willing: after all, it could no longer print money fast enough to make an appreciable difference in how much it could spend, it could not borrow, and so control over its own currency was useless.

The Austrian currency was pegged to gold. The budget was balanced by severe cuts in expenditures and higher taxes. Unemployment remained high after stabilization. But by the mid-1920s currency stability had been maintained for long enough that the League of Nations withdrew. There were other hyperinflations as well: in Austria prices had risen 14,000-fold during the inflation. In Hungary prices rose 23,000-fold. in Poland prices rose 2.5 million-fold. In Russia prices rose four billion-fold.

And in Germany prices rose one trillion-fold.

A truly runaway hyperinflation has two sources. First, it arises through a fall in the foreign exchange value of the currency-when an adverse balance of payments or capital flight reduces foreign investors' and speculators' relative demand for the currency in question. A falling exchange rate raises the cost of imports, and thus the cost of living. Wages rise as workers try to maintain their standard of living, especially if previous institutional arrangements have linked wages to living costs. Firms paying higher wages raise the prices of the goods they sell, prices rise still further, the foreign exchange value of the currency falls still more, and the cycle continues.

Second, it arises through a large budget deficit that no one believes will be closed in the future. Faced with the prospect of budget deficits for as far ahead as the eye can see, the usual sources of credit to the government dry up: it can no longer borrow to cover the gap between revenues and expenditures. The only alternative is to print more and more banknotes. As government workers and suppliers present their bills to the Treasury, it pays them off with newly-printed pieces of paper.

But what do the workers and suppliers do with these pieces of paper? They hold onto banknotes not because they are a good investment (after all, they pay no interest) but as a convenient, readily-spendable form in which to hold purchasing power. So put more banknotes in the hands of the public and they will spend them. Call "M" the total (nominal) value of readily-spendable purchasing power; call "Y" the total value of production; call "P" the overall level of prices. And let the letter "V" stand for the average individual's propensity to spend out of his or her holdings of money, M: V thus stands for the "velocity" of money.

Then the quantity theory of money is the simple statement that:

(1) M x V = P x Y

If the government prints enough new banknotes to double the supply of money, M, and if the propensity to spend cash, V, remains unchanged, then total nominal spending P x Y will double as well. And if production Y does not rise--if the economy is already near full employment, say--then prices P will double as "too much" money chases "too few" goods.

As the government continues to print money, inflation continues. And as the consciousness that your cash will be worth less tomorrow than it is today penetrates the minds of the public, the situation further deteriorates. If cash loses value the longer you hold it, you should spend it as fast as possible. Thus the propensity to spend rises. The velocity of money V is not a constant of nature, but rises alongside past and present inflation. Thus the paradox noted by the Austrian economist Joseph Schumpeter, who served as Austria's finance minister, briefly, and failed to stop Austria's hyperinflation: the central bank is printing money faster than ever before, the volume of currency--measured in nominal terms--far outstrips even the most fevered imaginings of previous eras, yet no one has any cash: no one has any cash. Because to fail to spend cash is to waste its purchasing power, the velocity of money rises, price rises outstrip the rate of money creation, and the real balances held fall.

The fall in "real balances"--in the money supply divided by the price level--is a very damaging consequence of hyperinflation. For real balances are the grease that keeps the money-based market economy operating. Thus the chaos caused by rapid inflation breaks down the established links between firms and industries-for someone's prices are always ahead or behind theh average pace of the inflation-and so the productive potential of the economy, Y, drops as well. Unemployment may or may not increase.

With V rising, and Y falling, the quantity theory of money rearranged:

(2) P = M x (V/Y)

tells us that in the later stages of the hyperinflation prices rise faster than the government can print money. And in the end the hyperinflation loses whatever point it might have had. For the government's ability to spend more than it collects in revenue depends on its ability to print and deliver money as fast as prices rise, and is roughly proportional to M/P, to the real stock of readily spendable purchasing power in the hands of the public. But as the "velocity," the propensity to spend V, rises and as Y, production, falls, the public's holdings of spendable purchasing power in the form of money M/P fall as well.

In the limit the power to boost government spending by printing money almost vanishes. And when the government no longer gains even in the short-term budgetary sense from the inflation, the situation is ripe for a stabilization: a currency board, a new finance minister, a link to the gold standard, whatever-and then reform can be successfully accomplished as long as the government's post-hyperinflation revenue sources are in line with its post-hyperinflation spending level, and as long as foreign investors and exchange speculators believe in the stabilization.

The German hyperinflation of 1921 to 1924 has long served as the classic example of this process. The German government began to print money during the war. After the war the budget deficits were greater than ever, prices rose faster, and the fact that prices were rising further widened the budget deficit: revenues were by and large based on what income had been received six months ago; spending depended on the price level now. So six months' worth of inflation was built into the budget deficit. And the faster inflation proceeded, the further revenues fell behind expenditures.

To make matters worse, there was a substantial balance-of-trade deficit, and a widespread fear that anyone to whom German citizens owed debts would find themselves standing in line behind reparations-demanding allied governments whenever payment began.

The reparations question was made even more complicated because no one was sure what Germany would pay to the allies for losing the war, what it could pay, or what sanctions the allied powers would be willing to employ. The British originally demanded a much larger reparations bill than the French or the Italians. Since the allies could not agree, they postponed the question of the reparations that would be demanded to a subsequent conference, but required that Germany pay--as a first, down payment on the total bill--an amount equal to some fifty percent of a post-war year's national product.

The 1921 conference in London to settle on the magnitude of German reparations saw the French and the British switch positions, with France demanding higher figures. The French remembered the reparations burden imposed on the French by the Germans after the 1870-71 Franco-Prussian War, they saw that the United States was refusing to reschedule the war loans it had extended to the French government, they had taken stock of the war damage done to the ten province of northeastern France that had served as the war's principal battlefield, and the government was no longer the wartime coalition but instead the right-of-center National Bloc.

The final reparations bill presented was for 340 percent of Germany's 1921 national income, denominated in gold to make sure that inflation and exchange rate deprecation did not erode the value of the debt, with roughly sixty percent of the debt carried interest-free for some portion of time. The reparations schedule was tied to Germany's "ability to pay", heightening uncertainty about its true magnitude. One proposed schedule for repayment had Germany paying an average of 7.5 percent of its national product over forty years in reparations--and still, in 1962, owing a debt to the allies equal to Germany's entire 1921 national income.

Supporter of the conference said that the bill was well within Germany's capacity to pay: Great Britain had, routinely, transferred some five to ten percent of GDP abroad in overseas lending before World War I. Opponents like John Maynard Keynes pointed out that loans from London had financed purchases of British goods--and that it was extremely unlikely, in a climate of high unemployment, that reparations payments would be spent on boosting German exports to France and Britain. Barry Eichengreen points out that such a transfer would have required that Germany create a surplus of exports relative to imports equal to eighty percent of the value of its trade, and that:

Even had Germany somehow been able to provide this astonishing increase in exports, the allies would have been unwilling to accept it.... German exports would have been heavily concentrated in the products of industries already characterized by intense international competition, like iron, steel, textiles, and coal.... Even while complaining the Germany's effort to meet its reparations obligation was inadequate, the allies raised their import barriers....

The fear of how large the reparations bill would be coupled with the balance of trade deficit led the foreign exchange value of the mark to fall. And rising import prices fed back to rising domestic product prices and wages, and further accelerated inflation.

For a while the government welcomed the inflation: easier to finance spending by printing money than by actually trying to collect taxes. Industrial and mercantile interests also benefitted from inflation: they borrowed from banks, and repayed them in badly depreciated marks. For a while labor benefitted too: unemployment almost vanished, and in the early stages of the inflation at least real wages and thus workers' purchasing power did not fall. By the end of 1922 the German price level was 1,475 times what it had been at the start of World War I.

In January 1923 the French government, faced with the German government's failure to meet the reparations payments schedule that had been imposed on it as part of the post-World War I settlement, sent troops to occupy the Ruhr, the principal industrial region of western Germany. The German government responded with passive resistance: the inhabitants of the Ruhr struck to prevent the French government from extracting reparations deliveries from the occupied area. And the German government printed money to try to maintain the incomes of the passive resisters.

By the end of 1923 the German price level was 1,260,000,000,000 times what it had been at the start of World War I.

The mark was stabilized by a currency reform, that struck twelve zeroes off of the currency, so that one new mark was equal to one trillion old marks. An international loan was made so that Germany could make some reparations payments and build up its hard currency reserves. The new mark was strictly limited in supply-no more printing of bank notes at the request of the Treasury. And once the expectation of future money-printing was gone, the inflation was over.

Upper middle class savings in Germany were wiped out during the hyperinflation. Such savings had usually been invested in bonds and bank accounts, not in equity stocks. So the collapse of the real value of the mark carried with it the collapse of the value of the bonds. Debtors benefitted substantially, for their debts were effectively wiped out. Equity investors benefitted, because the hyperinflation effectively expropriated bondholders' shares of the capital contributed to the enterprise. But the relatively small, financially unsophisticated savers who made up Germany's upper middle class had nothing left.

This may have been the most important aspect of Germany's early-1920s hyperinflation. People who are not rich but are well-off-pillars of their community, in middle-age, who have done well in economic life and saved enough to feel comfortable-are usually the strongest supporters of relatively democratic, relatively liberal governments. They have done well enough that they see no great need to move to the right, and they have no particular interest in redistributing income away from the working to the employing class. The fear the redistributional plans of the left. And they value individual freedoms and social peace. The professional and mercantile upper middle classes of Germany should have been the principal support of the post-World War I democracy-the "Weimar Republic"-that had emerged from the collapse of the monarchical, militaristic, semi-democratic German Empire at the end of World War I.

The British economist John Maynard Keynes had seen the political danger from government resort to inflation in 1919, well before Germany embarked on the road that carried the value of the mark from $0.25 to $0.00000000000025. He--falsely, I believe--attributed to Lenin the claim that "the best way to destroy the Capitalist System was to debauch its currency" through hyperinflation; and he wrote of how inflation not only "confiscate[s wealth], but... confiscate[s] arbitrarily.... The sight of this arbitrary rearrangement of riches strikes not only at security, but at confidence in the equity of the existing distribution of wealth.... [It] engages all the hidden forces of economic law on the side of destruction, and does so in a manner which not one man in a million is able to diagnose." Keynes concluded that the European governments which had resorted and were resorting to inflation were "fast rendering impossible a continuation of the social and economic order of the nineteenth century. But they have no plan for replacing it."
Adolf Hitler, however, did have a plan for replacing the social and economic order of the nineteenth century. Through the inflation of the early 1920s, the democratic government of this Weimar Republic did its natural supporters, the prosperous relatively small-scale savers of Germany in the professional and mercantile classes, a most grevious economic injury by confiscating most of their savings. This German class of savers that had lost so much in the inflation of the 1920s--the so-called mittelstand, or "middle estate"--would be correspondingly lukewarm in its support of the Weimar constitution and democracy at the end of the 1920s and into the 1930s, when the Nazi Party became a political force in Germany.
 
 

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The Economic Consequences of Mr. Churchill

Perhaps the best way to stabilize the post-World War I economy would have been to recognize that World War I had completely disrupted the old system, and that it was time to construct a new system with new parities. But general international cooperation was lacking. And so, once they had dealt with their internal problems of debt management, countries took one of three roads to stabilization:

Countries that had experienced hyperinflation simply pegged their currencies to the dollar and to gold at whatever the free-market value was at the end of the hyperinflation. (For example, Austria, Germany, and Hungary.)
Countries that had seen their value against the dollar drop by more than half (but that had not experienced hyperinflation) gave a small sop to creditor interests by recovering a part, but only a small part, of their currencies' values against the dollar before stabilization. (For example, Czechoslovakia, France, and Italy.)
Countries where freely-floating currencies were only a few tens of percent below their pre-World War I dollar values dealt with the problem of stabilization by returning to par: deflating their economies and incurring domestic unemployment in order to restore the pre-World War I peg against gold and the dollar, in the hope that by so demonstrating their "credible commitment" to the gold standard they would reap increased stability, greater confidence, and lower interest rates. (For example, Britain, the Netherlands, and Scandinavia.)
In Britain, politicians and bankers blamed exchange rate instability for depressing international trade and investment. They saw a stable exchange rate as a necessary prerequisite for the restoration of domestic prosperity.

It is less clear why the stable exchange rate had to be the pre-World War I rate of $4.86 to the pound. To obtain $4.86 to the pound and maintain it over the long run would, in post-World War I Britain, require a substantial internal deflation: a reduction in the level of nominal wages and prices of between ten and thirty percent--no one was sure by how much. Such internal deflation would carry with it unemployment, bankruptcy, and labor unrest. It might well destroy whatever government undertook it, for the short-term costs to the electorate were immense--whether to workers rendered unemployed by the depression accompanying deflation, or to manufacturers rendered bankrupt by competition from abroad at an unrealistic exchange rate.

Why was the government ruling Britain in 1925 willing to run such risks? P.J. Grigg was private secretary to the Chancellor of the Exchequer at the time. He reports a dinner at which supporters and opponents of return argued in front of the Chancellor. Reginald McKenna (a former wartime Chancellor of the Exchequer himself) and John Maynard Keynes argued that overvaluation would discourage exports, create unemployment, put downward pressure on wages, and trigger waves of strikes. P.J. Grigg thought that Keynes did not argue his case very well--but given that the introduction to Grigg's memoirs denounces economists (like Keynes) who tried to teach Britain to "live beyond its means on its wits," it is doubtful that Grigg would have found Keynes and McKenna convincing no matter how well they argued their case.

In the last analysis the political risks of postponing the return to the gold standard seemed large and immediate; the economic risks of return seemed vague, distant, and uncertain. Thus the decision was made to return to the gold standard after World War I. Moreover, the decision was to return at largely the pre-World War I currency parities, and to restore the prewar system of exchange rates. They were thought to be more "credible," that is, it was thought that investors would have more confidence that they would be maintained than that newly chosen parities (corresponding to real exchange rates in "fundamental equilibrium") would be chosen. It was thought that the additional benefits in terms of credibility would more than offset the adjustment costs necessary to bring the world economy back into balance on the gold standard.

Benjamin Strong, leader of the U.S. central bank, analyzed Bank of England head Montagu Norman's decision:

Mr. Norman's feelings, shared by me, indicated that the alternative--failure of a resumption of gold payments--being a confession by the British government that it was impossible to resume, would be followed by a long period of unsettled conditions too serious really to contemplate--violent fluctuations in the exchanges, progressive deterioration of foreign currencies vis-a-vis the dollar; it would provide an incentive to all advancing novel ideas other than the gold standard, and incentive to governments to undertake inflation; it might, indeed, result in some kind of monetary crisis which would finally result in ultimate restoration of gold but only after a period of hardship and suffering, and possibly some social and political disorder.
 

For the commitment to gold convertibility to be credible, the argument ran, it had to be immutable: fixed forever. Once you abandon $4.86 for--say--$4.16, you raise the possibility that the commitment to $4.16 might be abandoned as well. There were other reasons for return as well: the belief that return to the pre-World War I parity was necessary to demonstrate that Britain was still the preeminent superpower, the special role played by the City of London's financiers in Britain, the fear that devaluing the pound against the dollar would raise the real cost of Britain's war debts to the U.S.

This analysis was wrong. Instead, it was the resumption of the gold standard that was followed by hardship and suffering, and by social and political disorder. In late 1924 sterling speculators bid up the price of the pound almost to its pre-World War I parity, realizing that the act of Parliament suspending Britain's adherence to the gold standard expired in 1925, and that the ruling--Conservative--government would be extremely unlikely to ask for an extension. Britain's finance minister--the Chancellor of the Exchequer--Winston Churchill announced that Britain would return to the gold standard on April 25, 1925.

The appreciation of the pound from its early-1920s average value of approximately $3.80 to its par value of $4.86 had taken place without any shift in the relative level of British prices. Thus British industries from coal mining to textile to chemical and steel manufacturers found themselves facing severe competitive difficulties. Britain's return to gold in 1925 resulted in unemployment in export industries, and a push for wage reductions to make industry more competitive.

Britain's problems were accentuated because sterling speculators could see what the Bank of England could not: that returning to the gold standard at an overvalued parity signalled the likely vulnerability and not the strength of the pound sterling. In order to balance its payments, the Bank of England had to keep British interest rates above American interest rates. Higher interest rates depressed investment, further increasing unemployment. The slow growth and double-digit unemployment that plagued the British economy in the late 1920s were the result of the decision to return at the pre-World War I parity.
 
 

Social conflict--at its strongest in the General Strike of 1926--broke out over the distribution of the adjustment burden. The British economy had to be depressed in order to avoid losing gold. British unemployment remained high relative to the pre-World War I standard throughout the 1920's.

Perhaps the policy of restoration would ultimately have worked. Near double-digit unemployment and slack export demand did reduce British costs and wages. British unions lost forty percent of their members in the decade after the end of World War I.

But before Britain's adjustment to its return to gold at an overvalued parity was complete, the Great Depression of the 1930s arrived.
 
 

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The Restored Gold Standard

Great Britain returned to the gold standard in 1925. The French franc was stabilized in mid-1926. The Italian lira was stabilized by the end of 1927. To all intents and purposes, the restoration of the gold standard was then complete.

"Peripheral" countries in Latin America and elsewhere whose adherence to the gold standard had been tenuous or wanting before World War I joined the interwar gold standard and established independent central banks, in the hope of reaping the benefits that they had seen accruing to those who adhered to the pre-World War I gold standard.
 
 

While Britain had an overvalued currency, France and the United States had undervalued currencies. They exported more than they imported, loaned some of the surplus abroad, and used the rest to acquire more gold. These two countries held more than 60 percent of the world's monetary gold by 1929; their share of world trade was less than one-third that proportion. But neither the U.S. nor France was willing to tolerate the domestic inflation that would have restored balance, and removed the tendency for their two countries to continue to accumulate gold.

Most countries tried to stretch the gold reserves of the system to cover a larger nominal volume of international trade transactions than before the war by concentrating gold inside of central banks. Many countries reacted to the shortage of gold by deciding that they would hold the reserves of their central banks--the funds to be spent in order to preserve liquidity and restore confidence in a financial crisis--in foreign exchange: holding either dollars or pounds. Thus they transformed the gold standard into a gold exchange standard. This created an additional point of vulnerability in the system, for what if the currencies held as exchange reserves themselves came under specualtive attack? Reserves are valuable because their worth and stability are unquestioned.

This imbalance in the distribution of gold produced a built-in deflationary bias in the monetary policies of all countries outside of France and the United States throughout the late 1920's and early 1930's. Unless they kept interest rates high and domestic investment and consumption low, countries with low gold reserves were in danger of losing their small remaining gold reserves and of being forced off the newly restored gold standard unless they took care to keep their economies on a deflationary path.

All central banks agreed that it was worthwhile to maintain the newly-restored gold standard. Thus the industrial economies had in committing themselves to the gold standard implicitly adopted a policy of slow deflationary pressure, always on the edge of being forced off the gold standard or into severe domestic recession by the next adverse economic shock. British central banker Montagu Norman was later to describe the late 1920s as years that he, the Bank of England, and the country had spent "under the harrow."
 
 

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Labor Parties, Welfare States, and the Interwar Gold Standard

Before the interwar period the idea that the aggregate health of the economy was the government's business, and that the government was responsible for in some way maintaining a stable price level and a high level of production, was a fringe idea. It might have been part of socialist, but not of mainstream politics. There were panics, depressions, and deflations, but they were regarded more as acts of nature than as acts to be prevented by government. Public works in time of depression were beneficial in the same sense that flood relief was beneficial. But the idea that a government could and should manage the economy as a whole was as foreign as the idea that a government could and should manage the weather.

World War I and the decades following changed this. Wartime inflation everywhere and postwar inflation in countries like France and Germany made it very obvious that the government could, and on occasion would, allow a massive shift in the level of prices and thus upset the distribution of wealth. The high unemployment period of the 1920s (and even more so the 1930s) made it obvious that the market system did not consistently produce full employment. Macroeconomic events--unemployment and inflation-had as large an effect on individuals' total lifetime incomes as the independent success or failure of their businesses or the expansion or contraction of their crafts. Governments' pursuit of policies of inflation and failure to control unemployment were seen to have as much of an impact on people's lives as any element of personal skill or luck.

Thus macroeconomics emerged: individual prosperity depended on inflation and the business cycle. Hence booms and busts, panics and recessions became of interest not only to Wall Street and to large manufacturers, but to everyone. The delivery of a healthy macroeconomy became a touchstone by which politicians were judged. And politicians responded, eagerly consulting economists to learn how to deliver certain prosperity.

The birth of macroeconomics created grave problems for the restored gold standard. Part of the functioning of the gold standard is that countries running balance of payments deficits experience deflation, and high unemployment. A balance of payments deficit sees reserves leave the country, the money stock shrink, and aggregate demand decline. But no modern democracy interested in macroeconomic management can afford to ignore such a recession--it must take steps to counteract the recession and to boost demand or risk losing office. Attempts to head off the gold standard adjustment process will generate capital flight, a drain on reserves, and eventual collapse of the currency.

This danger is summarized in the Eichengreen doctrine. A country can have two of (i) a fixed exchange rate system, (ii) free capital mobility, and (iii) modern democratic politics oriented toward preserving full employment. But it cannot have all three. Fixed exchange rates and modern democratic politics can coexist as long as capital mobility is restricted so that large-scale speculative attacks on the currency cannot develop. Fixed exchange rates and free capital mobility can coexist as long as democratic politics are absent--so that a government does not feel the need to intervene to stimulate aggregate demand during a gold standard-generated deflation. Free capital mobility and modern democratic politics can coexist as long as exchange rates are floating.

The Eichengreen doctrine suggests that there was no way in which the sacrifices made to restore pre-World War I gold-standard parities in Europe could ever have borne fruit. The government could point to its restoration of the pre-World War I parity, and say that it showed that the government's commitment to the gold standard was immutable. International speculators would watch the polls, and conclude that the first time that commitment to the gold standard clashed with the maintenance of high employment and thus of political popularity, the gold standard would go over the side: there is nothing worse than attemtpting to establish the credibility of an incredible commitment.

And indeed in 1931 the British government was to cast the gold standard over the side, well before the nadir of the Great Depression.

XII. Alternatives to Capitalism and Democracy-
 
J. Bradford DeLong

University of California at Berkeley and NBER

February 1997

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Marxism
Communism
Nazism
Fascism
Two Radical Political Movements or One?
 

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Marxism

Karl Marx, one of the few in the nineteenth century to see the explosion of wealth the twentieth century would bring, mocked the sober, dark-suited businessmen of his time. They claimed to want only stability. Their claimed to view revolution with horror. Yet they were themselves, in a sense, the most ruthless revolutionaries the world had ever seen. Businessmen--members of what standard translations of Marx call the bourgeoisie-- were indeed a most revolutionary and progressive class. In a real sense, the prehistory during which scarcity, want, and oppression had been human destiny was about to end. It was the business class of entrepreneurs and investors, together with the market economy that pitted individual businessmen against each other through competition, that was responsible for this greatest of all revolutions in the potential human condition.

But Marx also saw an overpowering danger: the economic system that the bourgeoisie had created would soon become the main obstacle to happiness. It could, Marx thought, create wealth, but it could not distribute wealth evenly. Alongside prosperity would come increasing polarization of wealth. The rich would become richer. The poor poorer, kept in a poverty made all the more hateful because needless.

Marx tried to make his argument as simple and convincing as one, two, three. He chose to analyze the economy using "labor value" units: define the production of the average worker to have a "labor value" of one. As time passes and productivity grows, the quantity of commodities that make up this one unit of value will increase. As long as this is remembered, the use of "labor values" is innocuous: production can be measured in any units as long as they are used consistently.

At any given time, the economy as a whole has a fixed, set stock of capital. Call the amount of capital that the average firm has for each of its workers "Capital". The economy also has a set total flow of annual profits. Call the profits that the average firm earns divided by its total capital stock the "Profit_Rate". Call the annual wages of the average worker "Wages". Then it must be--arithmetically--that the Profit_Rate times Capital per worker plus Wages must add up to one, where everything is measured in terms of its "labor value".

(1) Profit_Rate x Capital + Wages = 1

As time passes and economic development progresses, production becomes more and more capital intensive. More machines are used by each worker. New methods are more productive, and new methods are more capital intensive. Businesses that do not adopt the newest technology will lose first market share and then money as other, more efficient, more modern firms undersell them. So over time the variable "Capital"--the number of machines per worker--grows.

But the economic system requires profits to function. If the rate of profit drops too low, then investors will stop investing. A falloff in investment causes a depression and unemployment. During the depression wages will drop, and the depression will not lift until the rate of profit is once again up above some minimum acceptable rate necessary to induce the business class to invest again.

Call this long-run floor that bounds the sustainable Profit_Rate "Profit_Floor". Because the rate of profit cannot stay lower than the Profit_Floor for long, we know that:

(2) Wages < 1 - Profit_Floor x Capital

Over time, Marx argued, "Capital"--capital per worker--grows, and "Profit_Floor" stays the same. So Wages--the real annual wage of the average worker, defined in "labor value" terms--must fall. Profits per unit of capital must be at least as large as Profit_Floor. The number of units of capital per worker--Capital--grows. So either economic development comes to a halt, or workers' wages will keep falling.

This was Marx's argument that capitalism can deliver rapid economic growth, but it cannot deliver permanently rising living standards for the working class--the proletariat.

There are holes in this argument.

When a normal reader hears "declining wages" he or she hears not that workers' share of total production falls, but that workers' material standard of living--their ability to buy goods and services on the market--falls. Yet workers' material standard of living is not "Wages" but is instead equal to the labor value of wages times the average productivity of labor. There is no reason in Marx's system for this--the labor value of wages times average labor productivity--to fall.

One interpretation is that Marx never meant to imply that the absolute standard of living of workers falls, but only that relative standards of living fall--that workers would be paid a smaller share of total production, and would feel realtively deprived as they gazed on the palaces of the rich. But those who hold to such an interpretation have a very hard time facing passages in Marx's writings like:

In proportion as capital accumulates, the lot of the laborer, be his payment high or low, must grow worse. The law that always equilibrates the relative surplus [unemployed] population to the extent and energy of accumulation, this law rivets the laborer to capital more firmly than the wedges of Vulcan did Prometheus to the rock. It establishes an accumulation of misery, corresponding with accumulation of capital. Accumulation of wealth at one pole is, therefore, at the same time accumulation of misery, agony of toil, slavery, ignorance, brutality, mental degradation, at the opposite pole, i.e., on the side of the [working] class...

Or:

The more productive capital grows, the more the division of labor and the application of machinery expands. The more the division of labor and the application of machinery expands, the more competition among the workers expands and the more their wages contract. [T]he forest of uplifted arms demanding work becomes thicker and thicker, while the arms themselves become thinner and thinner.

Leon Trotsky, a good authority on Marx, thought that the doctrine was one of "relative immiserization" --increasing income inequality going along with rising working class material standards of living--in good times, absolute immiserization in bad times, all adding up to absolute immiserization over the long run.

But the logic slips for "relative immiserization" as well. "Capital" is the value of the machines used by the average worker measured in labor value units. Yet the argument that "Capital" will increase is an argument that the machine-to-worker ratio will rise--not that the labor value of the machines used by each worker will rise. If the price of machines falls relative to the price of labor as economic development continues, the capital intensity of production can rise while the variable "Capital" measured in labor units stays constant. In fact, this is economic development: machines become cheap relative to labor as technology advances. Relative wages-of skilled and of unskilled workers-in rich industrial nations have by and large kept pace with the growth of productivity over the past two centuries. There has been no consistent pattern of "relative immiserization."

The holes in Marx's logic would be unimportant had the substance of Marx's predictions been correct. If decade after decade had seen falling wages, growing productivity, and polarization of the income distribution, we would not care whether Marx's logic was airtight or not. We would say that while he got details wrong he got the big picture right.

The holes would also be unimportant if we were judging Marx as a critic of his time. For in the mid-nineteenth century his fears were not unreasonable. The early stages of industrialization in Great Britain saw total production and national wealth rise, and saw wages fail to keep pace. It is possible to argue--it is not crazy to think--that from a material welfare standpoint the average unskilled laboring Englishman was worse off in 1840 than his predecessor had been in 1790.

But Britain's "first industrial revolution" is the only national case of industrialization in which there is a "standard of living debate." In all subsequent national industrial revolutions, whether in Europe, in Asia on the Pacific rim, or in Europe's settler colonies, even early industrialization has enriched the poor.

Marx, however, did not have this multiplicity of examples before him in the 1840's when his views crystallized. He had only one example of industrialization to draw on: Britain. In Britain large and visible sections of the working class were worse off in 1840 than in 1790. Spinning and weaving textiles had been a part-time occupation for many and a full-time occupation for some of Britain's rural poor. The "putting out" system by which merchants would hire rural "handloom weavers" to turn yarn into cloth had provided much employment in Britain's countryside in the early nineteenth century. But with the coming of the power loom first the wages of the handloom weavers collapsed, and then the jobs themselves disappeared. Dark satanic mills in Lancashire left rural weaving skills useless, and populations impoverished. Andrew Carnegie's father was an impoverished handloom weaver in rural Scotland. Deprived of his livelihood, the family emigrated to America.

Some of the economists of the day said that the plight of the weavers was awful, but that nothing could be done. Attempts to ease their lot would only decrease the speed with which they abandoned the industry for other employments. This decreased speed of exit would lengthen and increase the total mass of misery generated by technological change. Hence the merciful thing was to let them starve as fast as possible.

The fact that nineteenth-century economists preached such doctrines led Thomas Carlyle to call economics by a nickname that has stuck: "The Dismal Science."

Such was the situation that confronted Friedrich Engels in the early 1840s when he went to work in his family firm in the British textile industry, and that he then taught to his friend Karl Marx. Is it any wonder that Marx turned his mind to trying to discover why it was that the tremendous advances in productivity of the industrial revolution did not raise the standard of living of the poor?

But Marx mistook the birth pangs of industrial market capitalism for its death throes. In 1848 the belief that market capitalism inevitably produced a distribution of income that was unbearable and doomed to get worse was reasonable. By 1867, when Marx published the first volume of Capital, such a belief was eccentric. And by 1883, when Marx died, such a belief was indefensible. By 1914 or 1933 it was a doctrine not of reason, but of pure faith alone.

Why, then, spill so much ink on Marx? Because Marx became the prophet and his writings became the sacred texts of what can only be described as a Major World Religion: Communism. As interpreted by Lenin and others, Communism has been one of the major political forces of the twentieth century. Without Marx, the history of the twentieth century would have been unimaginably different: probably much better, possibly much worse, but very much other than it actually was. The dogmas of Communism as derived from the writings of Marx dictated insane and destructive policies to governments that ruled over billions, and left pronounced scars on the history of the twentieth century.
 
 

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Communism

As Europe industrialized in the second half of the nineteenth century and the first quarter of the twentieth, its politics became dominated by Marxian socialism. This is not to say that political parties pledging allegiance to Marxian versions of socialism won and held power: by and large they did not. But political debate revolved around the question of what should be done to deal with, ameliorate, or accept the forces pushing for socialism: socialism became the axis around which politics revolved.

Communism as we have known it was born when Vladimir Lenin's fraction of the Russian left seized power in a late-1917 coup from the post-Czarist Social Democratic government led by Kerensky. A brutal Civil War followed, as "White" supporters of the Czar, local autocrats seeking effective independence, Lenin's "Red" followers, stray other forces--including a Czech army that found itself effective ruler of Siberia for a while, and Japanese regiments fought back and forth over much of Russia for three years. The United States sent both troops to secure base areas for anti-Communist forces, and food to feed Russians (and Red Army soldiers) in Communist-controlled areas.

When the Civil War ended, Lenin's regime was in control. The Czarist generals were dead or in exile in Paris. Any liberal democratic or social democratic center had been purged by the Whites or the Reds in the course of the Civil War. And the relatively small group of socialist agitators that had gathered under Lenin's banner before the revolution found itself with the problem of running a country and building a utopia, with the assistance of all those who had declared for the Reds and against the Whites and joined Lenin's banner during the Civil War.

Almost all observers had long seen Czarist Russia as heading for a revolution-including the Czar's government. Indeed, Russia had blundered into the 1905 Russo-Japanese War that it lost decisively in large part because the Czar's officials hoped that a "short victorious war" would distract popular attention and dampen the smoldering fires of revolution. The Czarist regime barely survived the uprising of 1905. It did not survive the First World War: military defeat left the Czar without supporters; Nicholas II fell in February 1917; and for the rest of the year various political groups tried to fill the power vacuum. Lenin won the struggle in the capital of St. Petersburg, and then was faced with the challenge of governing a country.

The first imperative facing Lenin's regime was the necessity of eliminating capitalism. According to the Marxist theory that Lenin deeply believed, capitalism--private ownership of businesses and land, and private receipt of profits--was the source of inequality or exploitation.

But how do you run industry and economic life in the absence of business owners--of people whose incomes and social standing depend directly on the prosperity of individual enterprises, and who thus have the incentives and the power to try to make and keep individual pieces of the economy productive and functioning? Lenin's answer was that you organize the economy like an army: top down, planned, hierarchical, with under-managers promoted, fired, or shot depending on how well they attained the missions that the high economic command had assigned them. Lenin had been impressed by what he saw of the German centrally-directed war economy of World War I:

The war has reaffirmed... that modern capitalist society... has fully matured for the transition to socialism. If... Germany can direct the economic life of 66 million people from a single, central institution... then the same can be done... by the non-propertied masses if their struggle is directed by the class-conscious workers.... Expropriate the banks and... carry out in [the masses'] interests the same thing the [wartime] Weapons and Ammunition Supply Department is carrying out in Germany.

The second imperative facing Lenin's regime was to industrialize Russia. Frightened that the powers of the industrial core might decide to overthrow their regime, and desperately aware of their economic weakness, it seemed to Lenin and his followers that military discipline in the service of industrialization was essential. For someday the Communist regime might have to fight a war to survive. And Lenin was not wrong: on June 22, 1941 Nazi Germany attacked the Soviet Union with all its strength, its wars aims (i) to exterminate Jewish Bolshevism, and (ii) to enslave or exterminate the inhabitants of the Soviet Union, in order to acquire more land for German farmers and more "living space"--Lebensraum--for the German nation.

How do you industrialize rapidly? Lenin's answer was that you take a leaf from Marx's interpretation of how Britain industrialized. Marx interpreted the economic history of Britain as one of "primitive accumulation" in which landlords used the political system to steal land from the peasantry, squeeze down their standard of living, force them to migrate to the cities to become a penniless urban working class, and use the resources from squeezing the peasant standard of living to build factories. Thus Lenin and his successors believed that industrialization was possible only if the ruling Communists first waged economic war against Russia's peasants. Squeeze their standard of living a far as you can in order to extract as much as possible to feed the growing industrial cities. Keep urban wages high enough to provide a steady stream of migrants to city jobs, but no higher. Every kopek that can be kept from being spent on consumption goods is a kopek that can go to a new dam, a new railroad, a new steel mill.

Communist ideologues justified this depression of the living standards of the current population for the benefit of a nebulous future by saying first that Russia had no choice, and second that the sacrifice was worth it for the sake of the future. Communism could never survive unless Russia were powerful enough to fight off military enemies. And the more the sacrifices of this generation the quicker would utopia be attained.

In fact, there is a very wide range of experience showing that industrialization does not have to take place through blood and fire. Countries as diverse as France, the U.S., Korea, and Italy have seen industrialization take hold as better opportunities in the cities pull workers in from the countryside; there is no necessity for the peasantry to be starved, beaten, and pushed into the cities by making conditions in the countryside more miserable.

The third imperative was to survive. As the British historian Eric Hobsbawm has written of Lenin's regime, "as Lenin recognized... all it had going for it was the fact that it was... the established government of the country. It had nothing else. Even so, what actually governed the country was an undergrowth of smaller and larger bureaucrats..." And for a government to survive when there are no powerful social classes or interest groups that have ideological allegiances or substantive reasons to back it requires great ruthlessness.

The first severe test was the counterrevolution: the White armies bent on restoring the Czar. It soon became clear that volunteer cadres with their own elected officers were not very effective: the Communist government needed to draw on the skills of the old Czarist army officers. But could they be trusted?

Leon Trotsky, Commissar for War, came up with the answer: draft the officers, and shadow each one with an ideologically-pure political commissar who needed to sign each order, and who would indoctrinate the soldiers in socialism. This system of "dual administration" could be--and was--applied to everything. It was the origin of the pattern of administration that was to be common throughout Soviet society: the party watches over the technocrats to ensure their obedience at least to the formulas of Communist rule. And if the technocrats do not behave, the Gulag is waiting for them.

Lenin and the Communists won the Civil War, in part because of Feliks Dzerzhinsky's skill at organizing the secret police and Trotsky's skill at organizing the Red Army, in large part because although the peasants hated the Reds (who confiscated their grain), they hated the Whites even more: the Whites brought back the landlords whom the peasants had expelled in 1917-1918. The peasants saw the Reds as their only hope to stay free and keep their porperty (a vain hope, as it turned out in the end).

However, during the Civil War the Communist Party acquired the habit of great ruthlessness that was in the end exercised not only against society outside the Communist Party but against the activists of the Communist Party itself. A "command economy" turned out to require a "command polity" as well. The Communist Party won the Russian Civil War as a one-party dictatorship with a powerful and aggressive secret police, committed to using mass terror to suppress counter-revolutionaries, and banning even internal democracy and discussion of policies and politics.

We can gain at least some insight into Lenin's character from a short monolog that the writer Maxim Gorky reported, of Lenin as a classical music critic:

I know nothing that is greater than the Appassionata [by Beethoven]; I'd like to listen to it every day [Lenin said]. It is marvelous superhuman music. I always think with pride--perhaps it is naive of me--what marvelous things human beings can do!

But I can't listen to music too often. It affects your nerves, makes you want to say stupid nice things, and stroke the heads of people who could create such beauty while living in this vile hell. And now you must not stroke anyone's head: you might get your hand bitten off. You have to hit them on the head, without any mercy, although our ideal is not to use force against anyone.

Hm, hm, our duty is infernally hard.

As the German Marxist Rosa Luxemburg had warned, the process begins by ruling in the name of the people, then by substituting the judgment of the Party for the wishes of the people, then by substituting the decisions of the Central Committee for the judgment of the Party, and then by substituting the whim of the Dictator for the decisions of the Central Committee.

Nevertheless complete disaster and terror could probably have been avoided had the dictator who won the struggle for power after Lenin's death--Josef Stalin--not been a paranoid psychopath. Peasants were shot, died of famine, and were exiled to Siberian prison labor camps in the millions during the 1930s. Factory workers were shot or exiled to Siberian labor camps for failing to meet production targets assigned from above. Intellectuals were shot or exiled to Siberian labor camps for being insufficiently pro-Stalin, or for being in favor of the policies that Stalin had advocated last year and being too slow to switch.

Communist activists, bureaucrats, and secret policemen fared no better. Communists in other countries seeking to cooperate with their Russian comrades found themselves subject to dizzying changes in political tactics and strategy that had much more to do with inner party court politics in the Kremlin than with making the world a better place. Following Moscow's instructions, the Communist Party of Germany--largest and strongest in western Europe--spent its energies on trying to disrupt the Social Democrats rather than on trying to resist the Nazi takeover, and was destroyed by Hitler in 1933. Following Moscow's instructions, the largely urban Chinese Communist Party cooperated with Chiang Kai-Shek's Kuomintang until the day in 1927 that he purged them. More than five million Soviet Union government officials and party members were killed or exiled in the Great Purge of the 1930s as well. All of Stalin's one-time peers as Lenin's lieutenants were gone by the late 1930s--save for Leon Trotsky, in exile in Mexico, who survived until one of Stalin's agents put an icepick through his head in 1940.

We really do not know how many people died at the hands of the Communist regime in Russia. As Basil Kerblay write in his Modern Soviet Society, we know more about how many cows and sheep died in the 1930s than about how many of Stalin's opponents, imagined enemies, and bystanders were killed. Eric Hobsbawm writes "eight, rather than seven digits" of victims. R.J. Rummel estimates 62 million dead.
 
 

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Nazism

Adolf Hitler took the turn of the nineteenth century economist Thomas Robert Malthus very seriously.

We today know Malthus as the pessimist who gloomily predicted that human populations would outrun their food supply. That either nature would bring human populations back into balance with the food supply via war, famine, disease, and death; or (a better alternative) that "moral restraint"--late marriages and infrequent sex supported by strong religious faith--could allow a small gap between the edge of starvation and average living standards. We know Malthus as somone whose doctrines provided a good description of life before he wrote, but were a bad guide (so far) to subsequent history.

Hitler drew different lessons from Malthus. He began thinking about foreign policy from the premise that;

Germany has an annual increase in population of nearly nine hundred thousand souls. The difficulty of feeding this army of new citizens must grow greater from year to year and ultimately end in catastrophe.... There were four ways of avoiding so terrible a development:

One way was birth control to reduce population growth, but Hitler saw population restriction as a violation of the principles of social Darwinism and a way to weaken the German race. A second way was to increase agricultural productivity and farm more land, but Hitler saw this as doomed for the same reason as Malthus did: diminishing returns. The third way was to purchase food from abroad by "produc[ing] for foreign needs through industry and commerce"; Hitler calls this way relatively "unhealthy" and unrealistic, for Britain would never allow Germany to become the dominant industrial and mercantile power without a fight, and without using all its political resources to discourage German competition with British industries.

What is left? The fourth way is to acquire "new soil": a policy of territorial expansion. And Hitler goes on to say:

We must... coolly and objectively adopt the standpoint that it can certainly not be the intention of Heaven to give one people fifty times as much land and soil in this world as another.... [W]e must not let political boundaries obscure for us the boundaries of internal justice....[T]he law of self-preservation goes into effect; and what is refused to amicable methods it is up to the fist to take...

If land was desired in Europe, it could be obtained by and large only at the expense of Russia, and this meant that the new Reich must again set itself on the march along the road of the Teutonic knights of old, to obtain by the German sword sod for the German plow and daily bread for the nation. (pp. 138-41.)

Pre-World War I German foreign policy went wrong because it tried to make Germany an industrial and a commercial rather than a terriorial power--and thus involved itself in a war with Britain. Hitler wanted to take a different road, and:

...consciously draw a line beneath the foreign policy tendency of our pre-War period. We take up where we broke off six hundred years ago. We stop the endless German movement to the south and west, and turn our gaze toward the land in the east. At long last we break off the colonial and commercial policy of the pre-War period and shift to the soil policy of the future.

If we speak of soil in Europe today, we can primarily have in mind only Russia and her vassal border states.

Here fate seems desirous of giving us a sign. By handing Russia to Bolshevism, it robbed the Russian nation of that intelligentsia which... guaranteed its existence.... For centuries Russia drew nourishment from this Germanic nucleus of its upper leading strata. Today... it has been replaced by the Jew.... [I]t is... impossible for the Jew to maintain the mighty empire forever.... The giant empire in the east is ripe for collapse...

Here we have the core of Nazism: (i) a very strong dose of German anti-semitism (with a paranoid belief in a conspiracy between Jewish financiers who control the capitalist economy and steal from the Germans, Jewish liberal intellectuals who preach humanism and enfeeble the Germans, and Jewish communists who seek to enslave the Germans; (ii) a belief in the German nation and the "aryan" German race as an entity with a special, heroic destiny; (iii) war as the ultimate test of national strength and worth; and (iv) conquest--with extermination or removal of the resident population--to create more "living space" or the German people and larger fields for the German farmers. Add to this (a) the "leadership principle"--a hatred of parliamentary institutions, and a belief that a good political order sees an inspired leader giving people vision and commands (rather than see parliamentarians haggle and compromise on behalf of interest groups)--(b) the use of terror to obtain obedience, and (c) the desire to make sure that all of society's organizations serve the national cause, and you have Nazism.

Hitler took his Malthusian economics-based Aryan-racial-domination ideology in dead earnest. He took it in earnest on March 15, 1939, when German tanks rolled (unopposed) into Prague and Germany annexed Czechoslovakia. He took it in earnest on September 1, 1939, when German tanks rolled (opposed) across the Polish border, crushed the Polish army in less than three weeks, and began the European phase of World War II. He took it in the most earnest of all on June 22, 1941, when German tanks rolled (opposed) across the Soviet border and Germany--still engaged in a brutal war with Britain--took on the Soviet Union as an enemy as well because the entire point of Hitler's foreign policy was the drive to the east: to win bread for the German nation and sod for the German plow by the sword, and to exterminate, expel, or enslave the slavic peoples who lived to Germany's east and stood in the way.

And he took it in dead earnest in the Final Solution to the "Jewish Problem".
 
 

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Fascism

Fascists were tamer versions of Nazis. Most fascists' economic doctrine was largely negative: they were not socialists, and they did not believe that the Marxist platform of the nationalization of industry and the expropriation of the capitalist class was the right way to run an economy. But they did not buy into the "national living space", "lebensraum" doctrines of Hitler. They were less anti-semitic. They tended to do their killing on a retail rather than a wholesale scale.

But fascists were identifiably of the same ideological genus as Nazis. They recognized each other. It is no accident that Hitler writes of his "profoundist admiration for the great man south of the Alps," Benito Mussolini, the founder of fascism. It is no accident that Mussolini allied with Hitler during World War II, and no accident that both Hitler and Mussolini sent aid to Francisco Franco's rebels in the Spanish Civil War of the late 1930s. It is no accident that Nazis fleeing Europe after the collapse of Hitler's "Third Reich" found a welcome in Juan Peron's Argentina.

The fasces were a symbol of order and strength in the more than 2,000 years-dead Roman Republic. They became a standard symbol of republican strength in the iconography of the post-1500 revival of republican doctrines and ideals. Go into the mid-nineteenth century U.S. Treasury building, and look at the ironwork of the railings in the southern staircases. And there you will find the fasces. The fasces were bundles of sticks, tied together. They were carried by the bodyguards and attendants of Roman politicians. The message was that one stick could be easily broken, but that a bundle of sticks tied together was very strong. Hence the strength and power of the Roman Republic depended on its unity, and its respect for each of its citizens.

Fascism as a twentieth-century doctrine was the invention of Benito Mussolini, who had been a rising if erratic star in Italy's socialist party before World War I. Mussolini, however, became convinced during World War I of the inadequacy of socialism: it had no place for the enormous outpouring of nationalist enthusiasm that he saw during the war, no place for the struggle between nations, and no recognition of the fact that solidarity was associated with the national community--not with one's international class or with humanity in general.Moreover, socialism had no plan for how a post-capitalist economy would operate. Mussolini soon became an ex-socialist, intent on integrating the lessons and appeal of nationalism with the appeal of socialism. The movement he produced he called "fascism."

Mussolini's new movement first supported Italian nationalism, expressed in the occupation of regions on the Italian-Yugoslav border. It second opposed socialism, recruiting groups of young thugs and sending them out into the streets to beat up socialists, disrupt working-class orgnizations, and their supporters among elected officials. Italy's elected politicians alternately tried to suppress and to ally with fascism. In 1922, after winning some electoral successes, Mussolini threatened to make Italy ungovernable through large-scale political violence unless named prime minister. The king named him prime minister. And from there he became dictator of Italy: Duce, or "leader".

There are some who deny the existence of "fascism," save as a confidence trick performed by Mussolini to seize power and give some cloak of ideology to his personal despotism. It is certainly true that fascism was disorganized, self-contradictory, confused, and vague. But most political movements are disorganized, self-contradictory, confused, and vague. In forming a coalition or a party the goal is to maintain friendships and alliances by the blurring of differences and the vagueification of concepts inside the group, and not to obtain conceptual clarity, or logical, or correct thought.

But fascism in the twentieth century had too many adherents to be a non-existent ideology, even if most fascists most of the time were clearer on what they were against than what they were for. I count six elements usually found--in Italy and elsewhere--in regimes that called themselves "fascist":

A belief in leaders: good politics sees not representatives expressing the desires of those below but leaders who command; the goals of a country are imposed by leaders of vision from above.
A belief in the value of a strong and unified nation: the willing and eager sacrifice of individual goals and lives to strengthen the national purpose, with war and expansion as tests of strength and arenas for heroic sacrifice.
Coordination and propaganda: advertising, ceremonies, the ruling party as an enforer of social discipline and respect for the leader.
A belief in at least some traditional hierarchies: the army, the family, sometimes the church.
A hatred of socialists and liberals: socialists as opponents of national self-assertion (and as potential betrayers of the people to slavery under a foreign Russian elite); liberals as unwilling to take the steps necessary to fight socialists, as self-absorbed individualists who weakened the nation, and as parliamentarians who did not recognize that the nation, not the individual, held rights.
A hatred of Jews: rootless cosmopolitans uninterested in the national destiny; theieves and deceivers to boot; people who made their money through financial manipulation rather than heroic feats of engineering and construction.
Perhaps the dominant theme of fascism as an ideology was that liberal capitalism had had its chance and had failed along several dimensions, which were seen as--somehow--linked together. The first was economic failure: it had not guaranteed high employment and rapid economic growth. A second was distributional failure: either the rich got richer and everyone else stayed poor, or liberal capitalism failed to preserve an adequate income differential between the more-educated, more-respectable lower middle class and the unskilled industrial proletariat; depending on which aspect of income distribution was highlighted, industrial capitalism produced an income distribution that was either too unequal or not unequal enough.

The third dimension was moral failure: the market economy reduced all human relationships--or at any event many human relationships--to arms-length market transactions: you do this for me, and I will pay you. But people are not entirely comfortable dealing with each other as nothing but black boxes: machines for transforming your money into useful commodities, or your labor time into your money. Contests and gift-exchanges have more psychological resonance. And by ignoring and trying to suppress as much as possible of the contest and gift-exchange dimensions of economic relationships, the market society dehumanized much of life.

Moreover, fascists said, the liberal capitalist order ignored the fact that we are all in this together: that inhabitants of a nation have common interests that are much more powerful than any one individual's interest. Thus economic policy needs to be made in a "syndicalist" or "corporatist" mode: the state needed to mediate between employers and unions, and the state needed to crack heads when necessary to make sure that employers and unions did the right thing. Not market forces but government regulation would set the price of labor and the quantity of employment.

Not only the liberal economy but also the liberal government was flawed: parliaments were incompetent. Composed either (a) of time-servers with no initiative, (b) corrupt distributors of favors to special interests, or (c) ideological champions who focused not on the public interest but what made their own narrow slice of supporters feel good. Parliamentary regimes were simply incompetent to handle the problems of modern life, and needed to be replaced by leaders who would not "represent" but would lead the people.

In many ways, fascism was the only game in town if you were a non-socialist who did not approve of liberal democracy--or who feared that liberal democracy led to Communism once the working class realized its voting strength. Traditional hierarchies--kings, nobles, and priests--no longer had force or legitimacy. So the only alternative was arbitrary despotic leadership in the service of fighting socialism.

If you took a look at European and Latin American governments between the World Wars, you could easily convince yourself that fascism was the wave of the future. Nearly everwhere democracy was in retreat, unable to provide answers to the economic problems of the Great Depression or to resolve social conflicts. On the eve of World War II democracies in the world were few and far between: Great Britain and its Dominions (Australia, New Zealand, Canada, and perhaps South Africa), the United States (if you were white), Ireland, France, Belgium, Holland, and Scandinavia (Sweden, Norway, and Denmark). That was it. Everywhere else you had authoritarian, non or anti-democratic governments of the left or the right.

Your choice appeared to be between Stalin--or Hitler.
 
 

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Two Radical Political Movements or One?

Yet was there much difference between the two?

The historian Felipe Fernandez-Armesto sees the struggles between radical fascists and radical socialists as in some way registering their closeness. He ponders George Orwell's "naive" question "aren't we all socialists?", asked in Barcelona in 1937 during the Spanish Civil War as the Stalinist Communist Party exterminated the anarchist POUM (while Franco's fascists waited outside); and compares it to asking "aren't we all Christians?" at the sixteenth-century massacre of Protestants in Paris on St. Bartholemew's Day.

Fernandez-Armesto concludes that:

from the perspective of the future, the differences among all forms of violent political extremism will blur. The politics of twentieth-century Europe were horseshoe-shaped, and the extremists at both ends seemed close enough to touch.... Individuals moved between fascism and militant socialism as if by connecting channels. Mussolini was a socialist youth leader before he became a fascist duce.... [M]any Nazis tried to make the party conform to its name: the National Socialist German Workers' Party. Britain's [fascist leader], Oswald Mosley, was a socialist cabinet minister before he took to the streets.... [M]y father... carried a communist card and wore a [fascist] Falangist uniform [in Spain] at different moments in the 1930s.

The British socialist historian Eric Hobsbawm--a card-carrying communist from before World War II until 1956--has a couple of asides in his histories that strike me as (perhaps unconsciously) revealing of the closeness between fascism and communism. The first comes in his history of the twentieth century, the Age of Extremes:

In short, to be a social revolutionary increasingly meant to be a follower of Lenin and the October Revolution [in Russia], and increasingly a member of supporter of some Moscow-aligned Communist party.... Nobody else within sight offered both to interpret the world and to change it, or looked better able to do so.... So long as the communist movement retained its unity, cohesion, and its striking immunity to fission, it was, for most of the world's believers in the need for global revolution, the only game in town. Moreover, who could possibly deny that the countries which broke with capitalism in the second great wave of world social revolution, 1944 to 1949, did so under the auspices of the orthodox, Soviet-oriented communist parties?... The force of the movement for world revolution lay in... Lenin's "party of a new type," a formidable innovation of twentieth-century social engineering.... It gave even small organizations disproportionate effectiveness, because the party could command extraordinary devotion and self-sacrifice from its members, more than military discipline and cohesiveness, and a total concentration on carrying out part decisions at all costs. This impressed even hostile observers profoundly...

The assumption that unthinking obedience to the current dictator in Moscow was appropriate because it was the way to change the world begs the question of what kind of change, and what kind of world, was to be made. It seems only a hair's breadth away from a fascist worship of force and the leader. For did party discipline "impress" or "horrify" observers?

The impression that for Hobsbawm (and for manyothers) a principal attraction of communism was in its fascist-like glorification of force and effectiveness comes in a discussion of the British and French Communist parties' role as a pro-Nazi "fifth column" in the early stages of World War II. When World War II broke out, Stalin and Hitler were allied--and world communist doctrine was that the British and French were the bad guys in trying to stop Hitler's expansion. Hobsbawm comments that:

There is something heroic about the British and French Communist Parties in September, 1939. Nationalism, political calculation, even common sense, pulled one way, yet they unhesitatingly chose to put the interests of the international [Communist] movement first [and side with Hitler]. As it happens, they were tragically and absurdly wrong. But their error, or rather the error of the Soviet line of the moment... should not lead us to ridicule the spirit of their action. This is how the socialists of Europe should have acted... carrying out the decisions of the [Communist] International.... It was not their fault that the [Communist] International should have told them to do something else.

That right action could ever be unthinking, automatic, complete, and voluntary obedience to a superior human authority--no matter which--is a strange doctrine. That right action would have been unthinking, automatic, complete, and voluntary obedience to an "International" that was the psychopathic Soviet dictator Josef Stalin is simply insane.

The answer to Hobsbawm was given best more than fifty years ago by the American literary critic Edmund Wilson, who writes of the:

...remarkable scene at the first congress of the Soviet dictatorship after the success of the October insurrection of 1917, when [Leon] Trotsky, with the contempt and indignation of a prophet, read [the socialist] Martov and his followers out of the meeting. "You are pitiful isolated individuals," he cried at this height of the Bolshevik triumph. "You are bankrupt; your role is played out. Go where you belong from now on--in the garbage-pile of history!"

These words are worth pondering for the light they throw on the course of Marxist policy and thought. Observe that the merging of yourself with the onrush of the current of history is to save you from the ignoble fate of being a "pitiful isolated individual"; and that the failure to so merge yourself will relegate you to the garbage-pile of history, where you can presumably be of no more use.

Today [in the late 1930s], though we may agree with the Bolsheviks that Martov was no man of action, his croakings over the course that they had adopted seem to us full of far-sighted intelligence. He pointed out that proclaiming a socialist regime in conditions different from those [of advanced industrialization, high technology, and material abundance] contemplated by Marx would not realize the results that Marx expected; that Marx and Engels had usually described the "dictatorship of the proletariat" as having the form, for the new dominant class, of a democratic republic, with universal suffrage [for the working class] and the popular recall of officials; that the [Bolshevik] slogan "All power to the Soviets [workers' councils]" had never really meant what it said and that it had soon been exchanged by Lenin for "All power to the Bolshevik Party."

There sometimes turn out to be valuable objects cast away in the garbage-pile of history--things that have to be retrieved later on. From the point of view of the Stalinist Soviet Union, that is where [Leon] Trotsky himself is today [in the late 1930s]. He might well discard his earlier assumption that an isolated individual must needs be "pitiful" for the conviction of Dr. Stockman in Ibsen's [play] An Enemy of the People that "the strongest man is he who stands most alone."

XIII. The Roaring Twenties-
 
J. Bradford DeLong

University of California at Berkeley and NBER

February 1997

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Mass Production
Mass Consumption
Income Polarization
 

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The end of World War I saw the United States retreat into isolation. The Senate refused to ratify the Versailles Peace Treaty that ended World War I. The U.S. failed to join the League of Nations--the international organization that was the less-successful interwar predecessor of the United Nations. The U.S. raised tariffs early in the 1920s (although not to levels that appreciably discouraged imports). Most important, perhaps, the 1920s saw he end of free immigration into the United States. Migration from Asia had been restricted for several generations. Migration from Africa had never been an issue. But up until the mid-1920s migration from Europe had been unrestricted.

More than 1.2 million immigrants had come to the U.S. in 1914. But once the immigration restrictions of the 1920s took effect, the overall total was fixed at only 160,000 or so immigrants a year. Moreover, different nations had different quotas. The quotas for immigrants from northern and western Europe were more than ample for the demand. The quotas for immigrants from southern and eastern Europe were very small.

The United States tried to pretend that the rest of the world did not really exist. Its people turned inward, and they found that they had plenty to do. For in the 1920s the United States became a modern middle-class economy of radios, consumer appliances, automobiles and suburbs. Nearly thirty million motor vehicles were on the road in 1929, one for every five residents of the country. Mass production had made the post-World War I United States the richest society the world had ever seen.
 
 

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Mass Production

Begin with the "American system of manufactures." In the middle of the nineteenth century English engineers viewing production on the Western side of the Atlantic Ocean noticed some regularities in the way Americans seemed to do things. Their manufacturing industries made simpler and rougher goods, used much less skilled labor, and seemed to incorporate much more of the knowledge needed to run the process of production into machines and organizations--leaving much less in skilled workers' brains and hands.

Some of this was simply economizing on the relevant margin. In America skilled workers were exceedingly scarce, and it seemed worthwhile to follow production strategies that used skilled workers as little as possible. Some of this was finding new and more productive ways of doing things: ways that would have been profitable for British, or other manufacturers, even facing lower costs for skilled labor, to adopt.

Mass production, as it was developed in the United States in the early years of the twentieth century, was the carrying of the American system on to its logical extreme. Henry Ford planned large scale production of his Model N in 1905 to reduce expensive skilled work to as small a part of production as possible.

Ford minimized his costs by building a capital intensive plant that was very good at building automobiles, and not for building anything else. The increase in capital intensity increased the potential risk. The productivity and profitability of the Ford plant depended on a high rate of production. Anything that threatened the pace of production--union strike or anarchist sabotage--threatened to be very expensive. Ford could employ unskilled workers in jobs that had previously required highly skilled craftsmen, but only if he kept his workforce happy.

Moreover, in "moving the work to the men" by means of the assembly line, a second fundamental tent of mass production, the Ford engineers found a method to speed up the slow men and slow down the fast men.

This was, originally, an unintended benefit of mass production: the factory considered as a machine would monitor the progress of its human elements, and immediately signal where a unit was not accomplishing its job satisfactorily by the buildup of work by that station--a process undergone by Charlie Chaplin in Modern Times. The pace of work could be increased. Unskilled workers could be substituted for skilled labor. The task of management was made much simpler: the assembly line forced the pace of the slower workers and made it obvious where bottleneks were occurring. Fixed overhead costs were spread out over larger and larger volumes of production, thus lower and lower prices became possible.

The same set of forces can be seen at work in other industries as well. For example, Theodore N. Vail, President of American Telephone and Telegraph, argued in the 1908 AT&T Annual Report that the telephone business exhibited enormous economies of scale: "The particular circuit connecting any subscriber with the exchange is what might be termed a convenience to that particular subscriber, but a necessity to all other subscribers. It is the ability to communicate with others that makes the exchange valuable." The realization of these economies of scale required the highest output, and the lowest practicible prices to make sure that the output could be sold.

Vail distinguished two different competitive strategies: "Net revenue can be produced in two ways: by a large percentage of profit on a small business, or a small percentage of profit on a large business." And in America the second was best:

...with a large population with large potentialities, the experience of all industrial and utility enterprises has been that it adds to the permanency and undisturbed enjoyment of a business, as well as to the profits, if the prices are put at such a point as will create a maximum consumption at a small percentage of profits."

This strategy--invest heavily in fixed capital, try to produce the maximum output at low prices, and use the productive expertise gained to forge technological leadership and lowest cost positions--was to become characteristic of American industry throughout the twentieth century. It was made possible because half of North America was the single economic unit of the United States. With no obstacles to shipping commodities off of state lines, the possibilities of benefitting from a low price-high volume strategy were much greater than in Europe, especially in the interwar years of active trade restrictions.

In the labor history literature, the adoption of the American system is often called deskilling. Knowledge of how to run the factory and the production process is taken out of the hands of skilled craftsmen and put into the hands of the managers and the machine makers. Jobs become more boring and more alienating. And wages fall. Historians' accounts of American industrialization often see the coming of mass production as a fight between the process of deskilling, tending to lower wages and make the distribution of income more unequal, and the process of unionization and collective solidarity, which is seen as powerful enough in the end to keep wages from falling.

But high wages for skilled craftworkers who have relatively low productivity implies high prices--and relatively low standards of living--for everyone else. By contrast, "deskilling" opens jobs that are relatively high-paid (albeit not as high-paid as the original craftwork jobs) to people who were outside the magic circle beforehand: unskilled farm laborers, immigrants, minorities, and women now have more options on the production side. Most important, higher productivity leads to lower product prices--massively expanding options on the consumption side as well.

And the deskilled, repetitive, assembly-line jobs were not low-paying jobs.

Henry Ford would have been happy if he could have found qualified workers for his assembly lines at low rates of pay. But he could not. Work on Ford's emerging assembly line was brutal. Workers paid the standard wages for unskilled labor at Ford's Detroit factory--a little less than $2.00 a day--quit at astonishing rates. In one year, 1913, Ford had an average annual labor force of 13,600 and yet 50,400 people quit or were fired.

Ford's workers-sped--up, automated, short-term, alienated, and about to quit--seemed obvious fodder for recruitment into the International Workers of the World, and Ford's profits were very vulnerable to IWW-style wildcat action.

Ford's solution was a massive increase in wages: to $5.00 a day for unskilled workers whose family circumstances and deportment satisfied Ford. By 1915 annual turnover was down to 16%, from 370% before the raise. Many to whom Ford jobs had not been worth keeping at $1.75 a day found the assembly line more-than-bearable for $5.00 a day. Many more linedup outside the Ford factory for chances to work at what appeared to them to be (and, for those who did not mind the pace of the assembly line much, was) an incredible boondoggle of a job.

Ford became a celebrity, and a symbol. This man was using the extraordinary productivity of modern manufacturing not (or not just) to make a fortune for himself, but to instantly raise his unskilled employees into the comfort of the middle class. Mass production, as some nameless publicist began to call it, offered the prospect of a ride to utopia via technology alone.

Was the five dollar day good business practice for Ford? Or was his company so profitable that he could afford a few highly unprofitable business practices and still flourish. There are two reasons why Henry Ford might have gotten more than his money's worth out of the $5.00 day--gotten more than an extra $3.25 a day of valuable work out of his employees in exchange for their massive raises.

The first is that an inattentive or sullen worker could disrupt a mass production assembly line and lose large amounts in profits. Workers paid $5.00 a day when the prevailing wage at the next job they would get was less than half that would be eager not to get fired. Higher-than-market wages induce high effort, because the job becomes a valuable asset for the worker. By tripling his workers' wages, the company could ask its workers to become for eight hours a day a part of the production machine that the Ford engineers had designed and refined. The five dollar day assured the company that the essential human appendages to this machine would always be present.

The second is that an assembly line is very vulnerable to "direct action." It is easy to sabotage--a word derived from the sabot, the wooden shoes of northern France and Belgium, that could be thrown into the works and jam the textile machinery. Ford feared the American Federation of Labor's more radical union competitor: the Industrial Workers of the World. By raising the stakes that workers had at risk in any shut down of Ford's operations, he made it less likely that strikes and sabotage would hit his company.

The automobile and other products of mass production quickly diffused throughout America. Manufacturers then faced a problem: once the market had been saturated, replacement demand was lower than demand during the rapid expansion of the market. Producers faced the problem of figuring out how to add value to the product, so that consumers would not simply "replace" but would "upgrade." Since you can't sell them the good a second time, you have to to figure out some way to sell customers an improved good.

This was a big problem for Ford.

If the Model T was supposed to be changeless, how can the company use "improvement" as a selling point? "New and improved" was perhaps the one advertising slogan that Ford could not use-especially because Henry Ford adhered to changelessness for ideological as well as production-based reasons. This became an especially knotty problem because consumers did, it turned out, want novelty. They were willing to pay a premium to have a car, not of their own, but a car not identical to every other car on the street.

As the twentieth century passed, U.S. manufacturing turned its skill to making differentiated products-not all the same-using mass production. The first to do this was the management team, headed by Alfred P. Sloan, at General Motors. Make the guts of the cars the same--that is, sell to everyone as many Chevrolet parts, made in extraordinarily long production runs to take full advantage of economies of scale. Put the guts in differently colored boxes, and change the boxes--so that someone who wants to stay up to date has to buy a new car relatively rapidly. Rely on advertising to create different images and different auras surrounding the different lines of cars.

Now it is natural to be of two minds about this surge of product differentiation. It seems wasteful--sacrificing potential economies of scale for diversity--and deceptive: Coca-Cola doesn't "really" "add life," does it? Wearing celebrity-brand sneakers while listening to one's walkman does not "really" bring one closer to the lifestyles of rich and famous celebrities than does listening barefoot, does it? This echoes George Orwell's complaint: that the cheap luxuries of the modern world create the illusion that you have gotten something valuable and worthwhile for your money. But in reality, as opposed to in front of the veil of illusion, it just is not true.

The only real benefit to buying expensive brand-name sneakers is that they give you explicit permission to dream certain dreams and have certain fantasies. Yet dreams are, or should be, free: for the mind is its own place, and can make a heaven of hell, or a hell of heaven.

On the other hand, product differentiation is popular: consumers are happy to be able to order a blue car with a sunroof. Given the immense wealth of the industrial economies, why not use some of it to create more color and variety? The anti-utopias of the twentieth century, from Modern Times to We, Brave New the World, and Nineteen Eighty Four, terrify readers by picturing society as a colorless grey inhumanity in which even the smallest of individual differences is removed, and everything the same: mass-produced. To be able to achieve almost all of the gains of mass production without imposing the cost of endless uniformity may truly be a major achievement.

The diffusion of high-productivity "mass production" industries from the rich industrial core to the poor periphery took place surprisingly slowly. One would have thought that mass production industries should have been 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?

Yett mass production diffused slowly even within the developed world only. Ford's plants in Britain had difficulty obtaining even half the labor productivity of Ford plants in the United States. There were even difficulties in the diffusion of mass production throughout the United States. Only one firm--General Motors--could even come close to matching Ford's productivity levels in the 1920s and the 1930s. 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 Ford's Highland Park plant as its individual members, one after the other, fell out of favor with Henry Ford.
 
 

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Mass Consumption

The flip side of mass production was mass consumption: the creation of America as a middle-class society, made up increasingly of people living in suburban houses, and commuting and shopping using automobiles.

The speed with which the products of mass production diffused through America was astonishing: not just automobiles but also washing machines, refrigerators, electric irons, electric and gas stoves--a whole host of inventions and technologies that greatly transformed that part of economic life that takes place within the household. For one of the major consequences of mass production was the building-up of the stock of capital goods for within-the-home production.

As the historian Ruth Schwartz Cowan has written:

...kitchens are as much a locus for industrialized work as factories and coal mines are, and washing machines and microwave ovens are as much a product of industrialization as are automobiles and pocket calculators. A woman who is placing a frozen prepared dinner into a microwave oven is involved in a work process that is as different from her grandmother's methods of cooking as building a carriage from scratch difers from turning bolts on an automobile assembly line; an electric range is as different from a hearth as a pneumatic drill is from a pick and shovel...

The incandescent light bulb was invented by Thomas Edison in 1879. By 1882 New York city had its first central generating station. By 1910 the alternating-current electric motor had become a low-cost provider of mechanical power that could be made small enough to run a fan (or large enough to power a locomotive). Eight percent of American households were wired for electricity in 1907; 35 percent were wired by 1920; 80 percent were wired by the beginning of World War II.

Thus the 1920s were the decade of consumer appliances: electric sewing machines, electric washing machines, electic vacuum cleaners, electric dishwashers, electric mixers, electric stoves, electric toasters, electric irons, electric hot-water heaters, electric space heaters, and electric refrigerators. By the start of World War II 79 percent of households had electric irons; half had washing machines, half had refrigerators, and half had vacuum cleaners.

An important novelty lay in the rapid spread of a new form of purchase: installment credit. The major consumer appliances had long lifetimes, and relatively high prices. Businesses found that their potential markets were much larger if they were willing to loan a large portion of the purchase price to the consumer, for one or five years.

United States: Approximate Hours of Housework per Week, 1900-1975
 
Year Meals and Dishwashing Laundry General Cleaning
1900 44 7 7
1925 30 5 9
1975 15 1 7
 

One consequence of the consumer durables revolution was to turn doing laundry from a task that took up nearly one full day a week to a task that took up a considerably smaller share of time. But the biggest changes in within-household production appear to have been the result of the dishwasher and the modern stove, on the one hand, and the growth of the food processing industry, on the other. They have cut the amount of time spent on food preparation and cleanup by roughly two-thirds over the past century.

Put the consumer durables revolution together with the reduction in family size caused by the demographic transition, and modern feminism becomes possible: keeping the household running is no longer a more-than-fulltime task for an adult. However, the modern industrial world could have further economized on "housework," but did not. Turn-of-the-century feminists and utopians had anticipated communal kitchens; communal laundries; cleaning done in an organized way by collective teams. Over the course of the twentieth century a few steps were to be taken in that direction: restaurants flourished, as did services that offered one or two days a week of cleaning. But laundromats were reserved for those living in small apartments. And restaurant meals remained a small part of meals eaten at home.

More and more over the twentieth century, people in rich industrial societies chose--or others in their households chose for them--private life. What relative opulence bought was not further economizing on housework, but rather more separation of the private from the social: houses with lawns so that one did not have to hear the neighbors through the walls, with their own washing machines, and with refrigerators and stoves capable of storing and cooking an enormous variety of foods. No utilitarian social planner would have allowed such a diversion of resources into infrequently-used stoves, washing machines, and dining rooms. Indeed, in "institutions"--whether army barracks, residential schools, prisons, or hospitals--utilitarian social planners did not. Yet where they had the choice, the middle classes in industrial economies cherished their suburban privacy, guarded it closely, and sunk increasingly large sums into embellishing it.
 
 

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Polarization

From the 1890s a substantial minority of Americans believed that the country had somehow taken a wrong turn. There was little socialism in the United States. Farmers feared the language of nationalization; immigrants were too busy taking advantage of living standards twice or more those of their relatives left behind in Europe; there was no entrenched landed aristocracy to rebel against; the principal political demand of the socialists--a free and equal vote--had been granted (for white males) since Andrew Jackson's day in the 1830s.

Yet the feeling grew that Ameria was no longer an open, equal society of potential mobility but a place where they were in control.

"They control the people with the people's own money." So Louis Brandeis, strong Democratic political activist, wrote of the turn of the century financiers. He saw J.P. Morgan and company as controlling the American economy, deciding which companies would flourish and which companies would shut down, through their domination of the commanding heights of finance.

There was reason for the progressives to worry. The rapid growth of managerial enterprises, the rapid increase in the "optimal scale" of continuous process manufacturing plants, and the realization of economies of distribution together transformed many American industries into oligopolies. When only a few firms dominated an industry, firms could protect themselves against "cut-throat" or "ruinous" competition either through collusion, or through mergers that would end in monopolization. Naomi Lamoreaux has analyzed 93 turn-of-the-century mergers of the American economy: 46% resulted in firms that controlled at least 70 percent of their product's market.

In 1890 the American Congress passed the Sherman Antitrust Act. But the Sherman Act did little to affect industial structure. In response to antitrust judgments, a few companies--the Northern Securities Company, and the Standard Oil Company of New Jersey, and a few others--were divided into their subsidiaries. But industrial consolidation, oligopoly, and big business run by managers became the rule in the manufacturing sectors not just of American but of the British, the German, and other industrialized economies as well..

Brandeis had relatively simple answers to the problems of industrializing America. Regulation of hours and working conditions to prevent bosses from exploiting workers' hunger for a job. Strong anticorruption drives to clean up municipal governments. The separation of banking from finance so that the bankers who collected the savings of the people through the acceptance of deposits would be unable to use those savings to increase their bargaining power vis-a-vis the managers of American enterprise.

It is doubtful that Louis Brandeis's proposed solution was any solution at all. Large-scale businesses borrow from banks, true. But remove some power to control and infiuence the managers of large-scale enterprises that borrow from the bankers, and where does it go? It fiows to the managers of the oligopolies and the monopolies that no longer have to look over their shoulders to make sure that Wall Street is satisfied; it does not fiow to the "people." Even before Brandeis's program was put into effect in the 1930s, Adolf Berle and Gardiner Means were warning of the unchecked and unaccountable power of the self-appointing managers of large corporations.

But Brandeis's cure was a response to a real disease. For the United States as of the turn of the twentieth century was a much more economically and socially unequal place than it had been even thirty years before.

On the eve of the American Revolution, the United States-to-be had been a relatively egalitarian society. The richest one percent of households owned perhaps fifteen percent of the total wealth in the economy-a very low value for such an inequality statistic. Even by the immediae aftermath of the Civil War wealth was still not that concentrated: the top one percent of households appear to have had a little more than a quarter of the wealth of the country.
 
 

By 1900, however, the U.S. had become the Gilded Age country of industrial princes and immigrants living in tenements of our political memory. On the one hand, Andrew Carnegie building the largest mansion in Newport, Rhode Island with gold water faucets. On the other hand, 146 largely-immigrant workers dying in the 1911 Triangle Shirtwaist Factory fire in Manhattan because the exits had been locked to keep workers from taking fabric out of the building for their own clothes.

Surveys suggest that in 1929 the richest one percent of U.S. households held something like 45 percent of national wealth, and that the concentration of wealth had been sharply rising in the 1920s. We strongly suspect that World War I had seen substantial deconcentration, as infiation eroded the value of bondholders' wealth and as high demand for labor boosted workers' earnings. It is my guess that the second was stronger than the first; that the concentration of wealth was eroded more during World War I than it was boosted in the 1920s, and that the concentration of wealth in the United States peaked sometime in the twenty years before World War I, with the richest one percent of households owning some 50% or so of total national wealth.

Attempts to count the wealth of the merchant princes themselves reinforce the suspicion that the pre-World War I U.S. was more unequal than at any time before or since. John D. Rockefeller was some eight times richer relative to the wages of the average American of his day than William H. Gates is today. (And Rockefeller was some twenty times richer relative to the total size of the U.S. economy

A country of immigrants and plutocrats is very different from the country of yeoman farmers that the United States had been in its Founding Fathers' imagination, and in large part in reality, in the late eighteenth century. Alexis de Tocqueville, a keen-eyed commentator on American society in the first half of the nineteenth century, had feared the growth of such a class of plutocrats, such an "aristocracy of manufacturers":

The territorial aristocracy of past ages was obliged by law, or thought itself obliged by cutom, to come to the help of its servants and relieve their distress. But the industrial aristocracy of our day, when it has impoverished and brutalized the men it uses, abandons them in time of crisis to public charity to feed them.... Between workman and master there are frequent relations but no true association.

I think that, generally speaking, the manufacturing aristocracy which we see rising before our eyes is one of the hardest that have appeared on the earth....

In the United States the rising concentration of wealth provoked a widespread feeling that something had gone wrong with the country's development. The rich (and many of the native-born not-so-rich) blamed foreigners: aliens born in China, Japan, Italy, Spain, Poland, and Russia who were incapable of speaking English, or understanding American values, or contributing to American society. Many of the middle class, especially the farmers, blamed the rich, the easterners, and the bankers. The Populists of the 1890s blamed the eastern bankers and the gold standard. The Progressives sought reforms to try to diminish the power of what they saw as a wealthy-would be aristocracy.

But the Populists and the Progressives remained minority political currents in America until the coming of the Great Depression. In the meantime, the voters continued to elect Republican presidents who were more-or-less satisfied with American economic and social developments, and who believed that "the business of America is business." The United States did very well at business in the 1920s. Industrial production in 1929 was nearly twice what it had been in 1913.

The managers who ran Americas firms and the politicians who got elected were not oblivious to the Progressive challenge. Scared of what unionization or a shift to left-wing politics might bring, and concerned about the welfare of their workers, American business in the 1920s developed "welfare capitalism." Social-work professionals employed by the firm provided counseling and visited the homes of workers. Businesses offered stock-purchase plans to help workers save for retirement, and insurance: sickness, accident, and life insurance.

Welfare capitalism appears to have worked as long as relative prosperity continued: the welfare of workers covered rose. Welfare capitalism appears to have worked for the bosses as well: the 1920s saw rapid erosion of union membership in the United States. But when the Great Depression came, the availability of the Populist and Progressive agendas made the shift in American politics in response to the depression rapid and substantial.

XIV. The Great Crash and the Great Slump-

J. Bradford DeLong
University of California at Berkeley and NBER

February 1997
 
 
 

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The Great Depression in Outline
The Great Crash
Even a Panic Is Not All Together a Bad Thing
Debt-Deflation
Golden Fetters
The Persistence of the Great Depression
 

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The Great Depression in Outline

It is straightforward to narrate the slide of the world into the Great Depression. The 1920's saw a stock market boom in the U.S. as the result of general optimism: businessmen and economists believed that the newly-born Federal Reserve would stabilize the economy, and that the pace of technological progress guaranteed rapidly rising living standards and expanding markets. The U.S. Federal Reserve's attempts in 1928 and 1929 to raise interest rates to discourage stock speculation brought on an initial recession.
 
 

Caught by surprise, firms cut back their own plans for further purchase of producer durable goods; firms making producer durables cut back production; out-of-work consumers and those who feared they might soon be out of work cut back purchases of consumer durables, and firms making consumer durables faced falling demand as well.

Falls in prices--deflation--during the Depression set in motion contractions in production which riggered additional falls in prices. With prices falling at ten percent per year, investors could calculate that they would earn less profit investing now than delaying investment until next year when their dollars would stretch ten percent further. Banking panics and the collapse of the world monetary system cast doubt on everyone's credit, and reinforced the belief that now was a time to watch and wait. The slide into the Depression, with increasing unemployment, falling production, and falling prices, continued throughout Herbert Hoover's Presidential term.

There is no fully satisfactory explanation of why the Depression happened when it did. If such depressions were always a possibility in an unregulated capitalist economy, why weren't there two, three, many Great Depressions in the years before World War II? Milton Friedman and Anna Schwartz argued that the Depression was the consequence of an incredible sequence of blunders in monetary policy. But those controlling policy during the early 1930s thought they were following the same gold-standard rules of conduct as their predecessors. Were they wrong? If they were wrong, why did they think they were following in the footsteps of their predecessors? If they were not wrong, why was the Great Depression the only Great Depression?

At its nadir, the Depression was collective insanity. Workers were idle because firms would not hire them to work their machines; firms would not hire workers to work machines because they saw no market for goods; and there was no market for goods because workers had no incomes to spend. Orwell's account of the Depression in Britain, The Road to Wigan Pier, speaks of "...several hundred men risk[ing] their lives and several hundred women scrabbl[ing] in the mud for hours... searching eagerly for tiny chips of coal" in slagheaps so they could heat their homes. For them, this arduously-gained "free" coal was "more important almost than food." All around them the machinery they had previously used to mine in five minutes more than they could gather in a day stood idle.
 
 

The United States Business Cycle, 1890-1940
 
 

The Great Depression has central place in twentieth century economic history. In its shadow, all other depressions are insignificant. Whether assessed by the relative shortfall of production from trend, by the duration of slack production, or by the product-depth times duration-of these two measures, the Great Depression is an order of magnitude larger than other depressions: it is off the scale. All other depressions and recessions are from an aggregate perspective (although not from the perspective of those left unemployed or bankrupt) little more than ripples on the tide of ongoing economic growth. The Great Depression cast the survival of the economic system, and the political order, into serious doubt.
 

The United States Business Cycle, 1950-1990
 
 
 
 
 

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The Great Crash

The U.S. stock market boomed in the 1920s. Prices reached levels, measured as a multiple of corporate dividends or corporate earnings, that made no sense in terms of traditional patterns and rules of thumb for valuation. A range of evidence suggests that at the market peak in September 1929 something like forty percent of stock market values were pure air: prices above fundamental values for no reason other than that a wide cross-section of investors thought that the stock market would go up because it had gone up.

By 1928 and 1929 the Federal Reserve was worried about the high level of the stock market. It feared that the "bubble" component of stock prices might burst suddenly. When it did burst, pieces of the financial system might be suddenly revealed to be insolvent, the network of financial intermediation might well be damaged, investment might fall, and recession might result. It seemed better to the Federal Reserve in 1928 and 1929 to try to "cool off" the market by making borrowing money for stock speculation difficult and costly by raising interest rates. They accepted the risk that the increase in interest rates might bring on the recession that they hoped could be avoided if the market could be "cooled off": all policy options seemed to have possible unfavorable consequences.

In later years some, Friedrich Hayek for one, were to claim that the Federal Reserve had created the stock market boom, the subsequent crash, and the Great Depression through "easy money"policies.

pp. 161-2: "[U]p to 1927 I should have expected that the subsequent depression would be very mild. But in that year an entirely unprecedented action was taken by the American monetary authorities [who] succeeded, by means of an easy-money policy, inaugurated as soon as the symptoms of an impending reaction were noticed, in prolonging the boom for two years beyond what would otherwise have been its natural end. And when the crisis finally occurred, deliberate attempts were made to prevent, by all conceivable means, the normal process of liquidation."

Those making such claims for over-easy policy appear to have spent no time looking at the evidence. Weight of opinion and evidence on the other side: the Federal Reserve's fear of excessive speculation led it into a far too deflationary policy in the late 1920s: "destroying the village in order to save it."

The U.S. economy was already past the peak of the business cycle when the stock market crashed in October of 1929. So it looks as though the Federal Reserve did "overdo it"--did raise interest rates too much, and bring on the recession that they had hoped to avoid.

The stock market did crash in October of 1929; "Black Tuesday", October 29, 1929, saw American common stocks lose something like a tenth of their value. That it was ripe for a bursting of the bubble is well known; the exact reasons why the bubble burst then are unknowable; more important are the consequences of the bursting of the bubble.

The stock market crash of 1929 greatly added to economic uncertainty: no one at the time knew what its consequences were going to be. The natural thing to do when something that you do not understand has happened is to pause and wait until the situation becomes clearer. Thus firms cut back their own plans for further purchase of producer durable goods. Consumers cut back purchases of consumer durables. The increase in uncertainty caused by the stock market crash amplified the magnitude of the initial recession.
 
 

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Even a Panic Is Not Altogether a Bad Thing:

The first instinct of governments and central banks faced with this gathering Depression began was to do nothing. Businessmen, economists, and politicians (memorably Secretary of the Treasury Mellon) expected the recession of 1929-1930 to be self-limiting. Earlier recessions had come to an end when the gap between actual and trend production was as large as in 1930. They expected workers with idle hands and capitalists with idle machines to try to undersell their still at-work peers. Prices would fall. When prices fell enough, entrepreneurs would gamble that even with slack demand production would be profitable at the new, lower wages. Production would then resume.

Throughout the decline--which carried production per worker down to a level 40 percent below that which it had attained in 1929, and which saw the unemployment rise to take in more than a quarter of the labor force--the government did not try to prop up aggregate demand. The Federal Reserve did not use open market operations to keep the money supply from falling. Instead the only significant systematic use of open market operations was in the other direction: to raise interest rates and discourage gold outflows after the United Kingdom abandoned the gold standard in the fall of 1931. The Federal Reserve thought it knew what it was doing: it was letting the private sector handle the Depression in its own fashion. It saw the private sector's task as the "liquidation" of the American economy. And it feared that expansionary monetary policy would impede the necessary private-sector process of readjustment.
 
 

Contemplating the wreck of his country's economy and his own political career, Herbert Hoover wrote bitterly in retrospect about those in his administration who had advised inaction during the downslide:

The 'leave-it-alone liquidationists' headed by Secretary of the Treasury Mellonfelt that government must keep its hands off and let the slump liquidate itself. Mr. Mellon had only one formula: 'Liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate'.He held that even panic was not altogether a bad thing. He said: 'It will purge the rottenness out of the system. High costs of living and high living will come down. People will work harder, live a more moral life. Values will be adjusted, and enterprising people will pick up the wrecks from less competent people'

But Hoover had been one of the most enthusiastic proponents of "liquidationism" during the Great Depression. And the unwillingness to use policy to prop up the economy during the slide into the Depression was backed by a large chorus, and approved by the most eminent economists.

For example, from Harvard Joseph Schumpeter argued that there was a "presumption against remedial measures which work through money and credit. Policies of this class are particularly apt to produce additional trouble for the future." From Schumpeter's perspective, "depressions are not simply evils, which we might attempt to suppress, butforms of something which has to be done, namely, adjustment to change." This socially productive function of depressions creates "the chief difficulty" faced by economic policy makers. For "most of what would be effective in remedying a depression would be equally effective in preventing this adjustment."

From London, Friedrich Hayek found it:

...still more difficult to see what lasting good effects can come from credit expansion. The thing which is most needed to secure healthy conditions is the most speedy and complete adaptation possible of the structure of production.If the proportion as determined by the voluntary decisions of individuals is distorted by the creation of artificial demand resources [are] again led into a wrong direction and a definite and lasting adjustment is again postponed.The only way permanently to 'mobilise' all available resources is, thereforeto leave it to time to effect a permanent cure by the slow process of adapting the structure of production...

Hayek and company believed that enterprises are gambles which sometimes fail: a future comes to pass in which certain investments should not have been made. The best that can be done in such circumstances is to shut down those production processes that turned out to have been based on assumptions about future demands that did not come to pass. The liquidation of such investments and businesses releases factors of production from unprofitable uses; they can then be redeployed in other sectors of the technologically dynamic economy. Without the initial liquidation the redeployment cannot take place. And, said Hayek, depressions are this process of liquidation and preparation for the redeployment of resources.

As Schumpeter put it, policy does not allow a choice between depression and no depression, but between depression now and a worse depression later: "inflation pushed far enough [would] undoubtedly turn depression into the sham prosperity so familiar from European postwar experience, [and]... would, in the end, lead to a collapse worse than the one it was called in to remedy." For "recovery is sound only if it does come of itself. For any revival which is merely due to artificial stimulus leaves part of the work of depressions undone and adds, to an undigested remnant of maladjustment, new maladjustment of its own which has to be liquidated in turn, thus threatening business with another [worse] crisis ahead"

This doctrine--that in the long run the Great Depression would turn out to have been "good medicine" for the economy, and that proponents of stimulative policies were shortsighted enemies of the public welfare--drew anguished cries of dissent from those less hindered by their theoretical blinders. British economist Ralph Hawtrey scorned those who, like Robbins and Hayek, wrote at the nadir of the Great Depression that the greatest danger the economy faced was inflation. It was, Hawtrey said, the equivalent of "Crying, 'Fire! Fire!' in Noah's flood."

John Maynard Keynes also tried to bury the liquidationists in ridicule. Later on Milton Friedman would recall that at the Chicago where he went to graduate school such dangerous nonsense was not taught--but that he understood why at Harvard-where such nonsense was taught-bright young economists might rebel, reject their teachers' macroeconomics, and become followers of Keynes. Friedman thought that Keynesianism was wrong--but not crazy.

However, the "liquidationist" view carried the day. Even governments that had unrestricted international freedom of action--like France and the United States with their massive gold reserves--tended not to pursue expansionary monetary and fiscal policies on the grounds that such would reduce investor "confidence" and hinder the process of liquidation, reallocation, and the resumption of private investment.
 
 

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Debt-Deflation

Thus governments strained their muscles to balance their budgets--thus further depressing demand--and to reduce wages and prices--in order to restore "competitiveness" and balance to their economies. In Germany the Chancellor--the Prime Minister--Heinrich Bruening decreed a ten percent cut in prices, and a ten to fifteen percent cut in wages. But every step taken in pursuit of financial orthodoxy made matters worse.

For once the declines in wages and prices in the Great Depression had passed some critical value, they knocked the economy out of its normal business-cycle pattern. Severe deflation had consequences that were much me than an amplification of the modest five to ten percent falls in prices that had been seen in past depressions.

When banks make loans, they allow beforehand for some measure of fluctuation in the value of the assets pledged as security for their loans: even some diminuation of the value of their collateral will not cause banks to panic, because if the borrower defaults they will still be able to recover their loan principal as long as the decline in the value of the collateral is not too high.

But what happens when deflation reaches the previously never seen amount of thirty, forty, or fifty percent--as it did in the Great Depression? Banks become keenly aware that their loan principal is no longer safe: that if the borrower defaults, they no longer have recourse to sufficient collateral to recover their loan principal. if the borrower defaults, and if bank depositors take the default as a signal that it is time for them to withdraw their deposits, the bank collapses.

As Keynes, wrote, once banks realize that deflation has significantly impaired the value of their collateral:

...they become particularly anxious that the remainder of their assets should be as liquid and as free from risk as it is possible to make them. This reacts in all sorts of silent and unobserved ways on new enterprise. for it means that banks are less willing than they would normally be to finance any project...

In looking at the tracks of interest rates in the Great Depression, you can see a steady widening of the gap between safe interest rates on government securities and the interest rates that borrowing companies had to pay. Even though credit was ample--in the sense that borrowers with perfect and unimpaired collateral could obtain loans at extremely low interest rates--the businesses in the economy (few of which had perfect and unimpaired collateral) found it next to impossible to obtain capital to finance investment.

Thus the banking system freezes up. It no longer performs its social function of channeling purchasing power from savers to investors. As a result private investment collapses; falling investment produces more unemployment, excess capacity, futher falls in prices, and more deflation; and further deflation renders the banking system even more insolvent.

Morever, not only past deflation but also expected future deflation depresses investment. Why invest now if you expect deflation, so that everything you would buy this year will be ten percent cheaper next year?

In the end the spiral of deflation will continue to depress the economy until something is done to restore solvency to the banking system, and break the anticipations of further falls in prices. A few economists understood this process at work during the Great Depression--Irving Fisher, John Maynard Keynes, R.G. Hawtrey--but they did not walk the corridors of power at the nadir of the Great Depression.
 
 

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Golden Fetters

Countries without massive gold reserves did not have the luxury of even attempting to expand their economies, at least not until they abandoned the gold standard, let their exchange rates float freely, and so cast off their "golden fetters." A government that wished to stimulate demand in the Great Depression would seek to inject credit and bring down interest rates to encourage investment. But additional credit would mean higher imports, and lower interest rates would encourage domestic nvestors to invest abroad. The result would be a balance-of-payments gap: economic expansion at home was inconsistent with gold convertibility. And few countries wished to abandon the gold standard at the start of the Great Depression.

There were exceptions that proved the rule. Scandinavian countries cast off their "golden fetters" at the start of the Great Depression, pursued policies of stabilizing nominal demand under the intellectual influence of the Stockholm School of economists, and did relatively well. In Japan fiscal orthodoxy and budget balance were abandoned in 1931, when Korekiyo Takahashi became Minister of Finance. Industrial production in Japan in 1936 was half again as much as it had been in 1928; in Japan the Great Depression was over by 1932.

But these were unusual exceptions.

Before World War I the major industrial economies might have had some freedom of action. Before the war major industrial countries' commitment to the gold standard was unquestioned. Whenever an exchange rate fell to the lowest "gold point", the bottom of the band and the point at which it was profitable to begin shipping gold out of the country, capital would flow in betting on the future recovery of the exchange rate to the mid-point of its band, making the central bank's task of maintaining convertibility easy.

But in the 1920s, with governments under greater pressure from newly expande electorates to generate prosperity, it was not clear that the country was committed to the gold standard. Speculators, instead, began to pull their capital out of a country facing a balance-of-payments deficit, on the principal that the loss they would suffer should the currency recovery would be dwarfed by their profits if they could take advantage of a full-fledged devaluation.

With the growth of concern about currencies, central bankers wondered if the gold-exchange standard--by which they kept their reserves in sterling or in dollars--was wise. What if the pound or the dollar devalued? As the Great Depression gathered force, central banks fell back on gold as their principal reserve, increasing strains on the system.

One might have thought that those countries that had restored their pre-World War I parities would be immune from destabilizing speculation. Had not Britain returned to the gold standard at the pre-World War I parity precisely to give investors confidence that its commitment to the gold standard was absolute? But governments like Britain and the United States that had maintained pre-World War I parities found themselves lacking credibility. Because they had not experienced the 1920s as a decade of inflation, they lacked the tacit political consensus that inflation was to be avoided at all costs. By contrast countries that had undergone inflation in the 1970s found for the most part that they had high credibility, and that their exchange rates came under little speculative attack.

Austria's major bank, the Credit Anstalt, was revealed to be bankrupt in May 1931. Its deposits were so large that freezing them while bankruptcy was carried through would have destroyed the Austrian economy, hence the governmetn stepped in to guarantee deposits. The resulting expansion of the currency was inconsistent with gold-standard discipline. Savers liquidated their deposits and began to transfer funds out of the country in order to avoid the capital losses that would have been associated with a devaluation.

In order to keep its banking system from collapsing and in order to defend the gold standard, the Austrian central bank needed more gold to serve as an internal reserve to keep payments flowing and an external reserve to meet the demand triggered by incipient capital flight. The Bank for International Settlements began to host negotiations to coordinate international financial cooperation.

It is possible that rapid and successful conclusion of these negotiations might have stopped the spread of the Great Depression in mid-1931. Austria was a small country with a population well under ten million. There was not that much capital to flee. A sizable international loan to Austria's central bank would have allowed it to prop up its internal banking system and maintain convertibility. A month later those whose capital had fled would realize that the crisis was over, and that they had lost a percent of two of their wealth in fees and exchange costs in the capital flight. Other speculators would observe that the world's governments were serious in their commitment to the gold standard, that the potential foreign exchange reserves of any one country were the world's, and thus that the likelihood of a speculative attack succeeding in inducing a devaluation was small.

Perhaps investors would then have begun returning gold to central banks in exchange for interest-bearing assets, would have begun to shrink down their demand for liquidity, and would have begun to boost worldwide investment. The Economist's Berlin correspondent thought that it might well have done the job:

It was clear from the beginning... that such an institution [as the Credit-Anstalt] could not collapse without the most serious consequences, but the fire might have been localized if the fire brigade had arrived quickly enough on the scene. It was hte delay of several weeks in rendering effective international assistance to the Credit Anstalt which allowed the fire to spread so widely.

We don't know because it was not tried. The substantial loan to Austria was not made. Speculators continued to bet on devaluation, investors continued to hoard gold, the preference for liqidity continued to rise, and investment continued to fall.

The substantial loan to Austria was not made because French internal politics entered the picture. At the beginning of his political carreer French Premier Pierre Laval had styled himself a politician of the left: the Clarence Darrow of France. But by the early 1930s he was shifting to the position of a strong nationalist. He blocked the proposed international support package for Austria, insisting that if France was to contribute France had to get something out of it. The price that Laval demanded was made up of a series of diplomatic concessions, most important of which was the renunciation of a prospective customs union with Germany. To Laval, playing the nationalist card in French politics, nothing that benefited Germany could be allowed by France.

The Austrian government refused to make the required political concessions fast enough for negotiations to be completed in time to be of use. Austria lost: the support package collapsed, and the Austrian economy abandoned the gold standard and went into recession. In the long run France lost too: what might have been a chance to moderate the Great Depression was lost. The ultimate consequences for France were dire. The rise of Adolf Hitler in Germany is inconceivable in the absence of the Great Depression. Nine years after the Credit-Anstalt crisis the French governmentsurrendered to the Nazis.

Pierre Laval was not greatly inconvenienced at first by the Nazi conquest of Europe. He discovered that he was not a leftist at all but a Fascist. He became the second most powerful figure, and the true focus of decision making, in France's wartime collaborationist Vichy government. He was executed for treason after the end of World War II.

Back in 1931, speculators observed that the international financial community did not support currencies that came under pressure. They wondered which country would be next to devalue--and thus which country to pull their money out of fast if they did not want to lose the thirty percent or so of gold value that would be lost in a devaluation. The wave of bear speculation moved on to Hungary, Germany, and Britain. By the fall of 1931 Britain had abandoned the gold standard.

Thus international capital flows--in this case driven by fear of being caught in a devaluation--triggered devaluations and brought down the interwar gold standard. In a well-functioning gold standard, such impulses would have been damped by the credibility of the commitment to gold and by international cooperation. But in the early 1930s the commitment to gold had no credibility. And there was no international cooperation.

In the absence of international cooperation, the legacy of the gold standard was to make it impossible for any country to fight the Depression within its borders. Stimulative monetary and fiscal policies were inconsistent with the gold standard. And efforts to contain domestic banking crises were thwarted and rendered counterproductive because of the fear that rescuing the banking system or lowering interest rates was the prelude to devaluation.
 
 

As Eichengreen has pointed out, once countries had cast off the golden fetters of the interwar gold standard, the crisis was transformed into an opportunity. Policies to expand demand and production no longer required international cooperation once the gold standard framework had been abandoned. But as he has also pointed out, "liquidationism"--and fears of financial and political chaos--kept governments from beginning to fight the Depression in a serious manner for much of the 1930s.

The Great Depression is the greatest case of self-inflicted economic catastrophe in the twentieth century. As Keynes wrote at its very start, in 1930, the world was "... as capable as before of affording for every one a high standard of life.... But today we have involved ourselves in a colossal muddle, having blundered in the control of a delicate machine, the working of which we do not understand." Keynes feared that "the slump" that he saw in 1930 "may pass over into a depression, accompanied by a sagging price level, which might last for years with untold damage to the material wealth and to the social stability of every country alike." He called for resolute, coordinated monetary expansion by the major industrial economies to "restore confidence in the international long-term bond market... restore [raise] prices and profits, so that in due course the wheels of the world's commerce would go round again."

Charles Kindleberger has pointed out that such action never emerges from committees, or from international meetings. Before World War I the international gold standard was kept on track because there was a single, obvious, dominant power in the world economy: Britain. Everybody knew that Britain was the "hegemon", and so everyone adjusted their behavior to conform with the rules of the game and the expectations of behavior laid down in London. Similarly, after World War II the "hegemon" for more than a full generation was the United States. And once again, the existence of a dominant power in international finance--a power that had the capability to take effective action to shape the pattern of international finance all by itself if it wished--led to a relatively stable and well-functioning system.

But during the interwar period there was no hegemon: no power could shape the international economic environment through its own actions alone. Britain tried, attempting to restore confidence in the gold standard by the restoration of sterling, and failed. America might have succeeded had it tried--but successful policy requires that the hegemon recognize its leading position, which the interwar U.S. did not do. Thus "resolute, coordinated" action to expand demand and halt the depression did not emerge from the leading industrial power. And it was very unlikely to be generated by any committee operating via consensus.

So the action was not forthcoming. And Keynes's fears came to pass.
 
 

--------------------------------------------------------------------------------
 

The Persistence of the Great Depression

The "liquidationist" monetary-overninvestment view of business cycles collapsed in the Great Depression. It had provided a framework for economists to analyze the busts of the nineteenth and early twentieth century,but its interpretation of the Great Depression was absurd. Periods of high unemployment lasted not for months or years but for decades. They lasted too long to be dismissed as frictions that resulted as the market reallocated productive resources away from what were now seen as low value goods.

In response to the high persistence of unemployment in the interwar years, economists abandoned the idea that business cycles were the economy's best feasible response to inevitable shocks to present circumstances and expectations about the future, and that the Great Depression had been generated by the largest such shock ever seen. Instead, they turned to alternative--Keynesian--approaches to explain the persistence of high unemployment, even though these alternative approaches were not so much theories of business cycles as policy recommendations accompanied by promises that supporting theories would be constructed later.

Economists today have faith in market economies' abilities to eventually cure depressions even in the presence of unsound economic policies. Depressions and high unemployment arise when markets malfunction, or fail to find the correct equilibrium. But excess supply of labor and excess supply of goods should eventually register. Economists track channel after channel through which the market economic system can right itself from a depression and restoer full employment equilibrium. How well did these "natural" full employment equilibrium-restoring forces work in the Great Depression?

The answer is: not at all well.

Some nations--Scandinavian countries that abandoned the gold standard early--experienced the Great Depression as little more than an ordinary recession, albeit in some cases beginning from a position of relatively high unemployment in 1929. The collapse of international trade in the 1930s idled resources in specialized export industries, but for countries that had abandoned the gold standard early domestic manufacturing took up the slack and returned GNP and employment to relatively high levels by the middle of the decade. These fortunate nations experienced the Great Depression as more-or-less another episode of "normal" cyclical unemployment in response to a large shock, in this case the world market's signal that export sectors were too large.

Other countries--largely nations like the United States and France that remained on the gold standard beyond 1930-31--were not so fortunate. Their unemployment rose to and remained at levels that seemed too high to square with the normal mechanisms of standard business cycles. Their experiencewas a key factor leading economists away from "monetary overinvestment" theories and toward "underemployment semi-equilibrium" theories.

Even granted that policies to fight the Great Depression were not forthcoming, the persistence of the Depression still comes as a shock. In a normal pre-Great Depression business cycle, the economy the economy closes 97% of the gap back to usual employment in three years. But the Depression shows a different picture: the economy closed only half of the gap back to full employment in three years.

It is helpful to group the explanations for why Depression-era unemployment was so high and lasted so long along two axes: there are two candidates to take the blame for the persistence of unemployment during the Depression: the government, and the market.

Government-generated unemployment was widespread. In Britain some unemployment (although a small share during the peak unemployment years of the early 1930's) was surely generated by the government's unemployment insurance system. Thomas cites Eichengreen's earlier work, which presented a best estimate that some two or three percentage points of unemployment in 1929-32 could be attributed to the operation of the relief system. Thomas attributes some unemployment among secondary workers and unskilled young men with large families to the "OXO" system in which firms would systematically rotate two platoons of workers between time at work and time receiving unemployment benefit, thus turning unemployment insurance into a highly-subsidized work sharing scheme. Men receiving the standard unemployment benefit in February 1931 had on average experienced 8.6 different spells of employment during the past year, working an average of 151 days. Given such rapid turnover it is not at all implausible to argue that the availability of unemployment benefit, even with relatively low replacement rates, allowed workers to remain in labor market positions in which they were employed only half the time instead of migrating to some other industry. Thus it is possible that an underlying four or five percent of excess British unemployment may well have been maintained by the government's social policy.

In the United States even at the very end of the Depression unemployment was high. In the 1940 census some 11.1% of U.S. heads of household were counted as unemployed, of whom almost half-4.9% of all heads of household-held relief jobs. Michael Darby has argued that the government had managed to create a situation in which those on relief found themselves with little incentive to register their labor supply on the private-sector job market, and yet were doing little socially productive work. Relief jobs were attractive to many, in spite of their low levels of relief wages relative to average private sector wages. Relief jobs were secure and required little skill. The risk-averse or the lesser-skilled might well have found that their best option was to stay on relief jobs, and be counted as unemployed, rather than take even an immediately available private sector job.

In each of these cases there is no clear alternative way of organizing the unemployment insurance system that would have been a clearly better policy. A good society should offer support to those blocked from earning their wages in the market. And a well-functioning economy should create incentives for the unemployed to strongly register their excess supply of labor in the market. These two goals are inevitably in tension. The inescapable problem was that relief payments were too high for the short-term and too low for the long-term unemployed, and that there was no good way to structure relief programs to tell these two groups apart ex ante. William Beveridge was among the first to lay out the policy dilemma: the long-term unemployed "need... more money rather than less than those who have had short periods of unemployment. Yet they can hardly be given more money without... [creating an incentive] to settle down into permanent unemployment." Moreover, few of the long-term unemployed "escape physical and psychological deterioration through long idleness."

Nevertheless, a large part of the puzzle remains: roughly half of Depression unemployment was concentrated among long-term unemployed who could not take advantage of subsidized relief-work schemes.

This form of unemployment, principally long-term and somewhat of a residual category is, in the eyes of Eichengreen and Hatton and their contributors, the key to the persistence of the Depression. Long-term unemployment was strongly present in those countries that suffered worst from the Depression, including non-European nations like Australia, Canada, and the United States and European nations like Britain, Germany, Italy, and the gold block nations of France and Belgium. Of these only Germany achieved a strong recovery from the Depression in the 1930's.

Long-term unemployment means that the burden of economic dislocation is unequally borne. Since the prices workers must pay often fall faster than wages, the welfare of those who remain employed frequently rises in a depression. Those who become and stay unemployed bear far more than their share of the burden of a depression. Moreover the reintegration of the unemployed into even a smoothly-functioning market economy may prove difficult, for what employer would not prefer a fresh entrant into the labor force to someone out of work for years? The simple fact that an economy has recently undergone a period of mass unemployment may make it difficult to attain levels of employment and boom that a luckier economy attains as a matter of course.Once an economy had fallen deeply into the Great Depression, devalued exchange rates, prudent and moderate government budget deficits (as opposed to the deficits involved in fighting major wars), and the passage of time all appeared equally ineffective ways of dealing with long-term unemployment. Highly centralized and unionized labor markets like Australia's and decentralized and laissez-faire labor markets like that of the United States did equally poorly in dealing with long-term unemployment. Fascist "solutions" were equally unsuccessful, as the case of Italy shows, unless accompanied by rapid rearmament as in Germany.

Even today, economists have no clean answers to the question of why the private sector could not find ways to employ its long-term unemployed. The very extent of persistent unemployment in spite of different labor market structures and national institutions suggests that theories that find one key failure responsible should be taken with a grain of salt.

But should we be surprised that the long-term unemployed do not register their labor supply proportionately strongly? They might accurately suspect that they will be at the end of every selection queue. In the end it was the coming of World War II and its associated demand for military goods that made private sector employers wish to hire the long-term unemployed at wages they would accept.

At first the unemployed searched eagerly and diligently for alternative sources of work. But if four months or so passed without successful reemployment, the unemployed tended to become discouraged and distraught. After eight months of continuous unemployment, the typical unemployed worker still searches for a job, but in a desultory fashion and without much hope. And within a year of becoming unemployed the worker is out of the labor market for all practical purposes: a job must arrive at his or her door, grab him or her by the scruff of the neck, and through him or her back into the nine-to-five routine if he or she is to be employed again.

This is the pattern of the long-term unemployed in the Great Depression; this is the pattern of the long-term unemployed in western europe in the 1990s. It appears to take an extraordinarily high-pressure labor market, like that of World War II, to successfully reemploy the long-term unemployed.

XIV. The Great Slump-
 

J. Bradford DeLong

University of California at Berkeley and NBER
 
 

August 1996
 
 

In 1929 many economists saw business cycles as unfortunate but unavoidable elements of economic development. Cycles in GNP and employment were principally investment cycles. The value of investment today depends heavily on future interest rates and growth rates. With an uncertain future, there will inevitably be times when new information shows that future growth has been overestimated, and that too much capital-or the wrong kind of capital-has been put into place. The economy must then shift resources from investment for the future to present consumption. This shifting of resources out of the investment sector entails frictions that temporarily reduce production and employment.
 

In this monetary overinvestment view, demand stimulation is counterproductive. In a recession it keeps resources from shifting out of the investment sector where their marginal product is less than their resource cost, increases the overhang of excess capital, and thus deepens and prolongs the subsequent depression; in a boom it increases the chance that in the future new information will reveal that recent investment was unproductive and so trigger a recession. Proper policy is "neutral" so as not to disturb the market's balancing of savers' required real rate of return and investors' expectations of the value of new capital. Proper policy can moderate the business cycle, especially that part of the business cycle that arises because the money supply is too elastic in response to transitory demand shocks; but proper policy cannot be expected to come anywhere near to smoothing out the cycle.
 

The "liquidationist" monetary-overninvestment view of business cycles collapsed in the Great Depression. While the monetary overinvestment view provided a framework for economists to analyze the busts of the nineteenth and early twentieth century, its interpretation of the Great Depression was found unconvincing. Periods of high unemployment lasted not for months or years but for decades. They seemed too persistent to be attributed to the frictions that resulted as the market reallocated productive resources away from what were now seen as low value goods. Although workers seemed willing to labor hard for low implicit wages-George Orwell, for example, saw "...several hundred men risk their lives and several hundred women scrabble in the mud for hours... searching eagerly for tiny chips of coal... more important almost than food.," while "all around... are the slagheaps and hoisting gear of the [idle] collieries" at which they used to work.
 

In response to the high persistence of unemployment in the interwar years, economists abandoned the idea that business cycles were the economy's best feasible response to inevitable shocks to present circumstances and expectations about the future, and that the Great Depression had been generated by the largest such shock ever seen. Instead, they turned to alternative--Keynesian--approaches to explain the persistence of high unemployment, even though these alternative approaches were not so much theories of business cycles as policy recommendations accompanied by promises that supporting theories would be constructed later.
 

Some nations-Scandinavian countries that abandoned the gold standard early-among the European, North American, and Australasian set analyzed in Eichengreen and Hatton experienced the Great Depression as little more than an ordinary recession, albeit in some cases beginning from a position of relatively high unemployment in 1929. The collapse of international trade in the 1930's idled resources in specialized export industries, but for countries that had abandoned the gold standard early domestic manufacturing took up the slack and returned GNP and employment to relatively high levels by the middle of the decade. These fortunate nations experienced the Great Depression as more-or-less another episode of "normal" cyclical unemployment in response to a large shock, in this case the world market's signal that export sectors were too large.
 

Other countries-largely nations like the United States and France that remained on the gold standard beyond 1930-31-were not so fortunate. Their unemployment rose to and remained at levels that seemed too high to square with the normal mechanisms of standard business cycles. There experience seems to have been an important key factor leading economists away from "monetary overinvestment" theories and toward "underemployment semi-equilibrium" theories.
 

Were economists right to judge that unemployment was too high and too persistent to be interpreted as the best feasible redeployment of resources in response to a large shock? Aggregate data-fragile as they are-suggest that they were. Speeds of adjustment in the Great Depression do seem much slower than in other recessions. For example, consider the time-series properties of employment in the United States and the United Kingdom. An error-correction model of the gap between actual and usual United States manufacturing employment estimated over a pre-Great Depression 1900-1929 period finds an error correction coefficient of about 0.65 per year; the economy closes 97% of the gap back to usual employment in three years. But the same regression run over a 1924-1939 period that includes the Depression shows a different picture: the error-correction coefficient is about 0.20; the economy closes only half of the gap in three years. For the United Kingdom, the analogous error correction coefficients are about 0.55 and 0.20, respectively. These correspond to an economy that closes nine and fifty percent of the gap to usual employment in three years, respectively.
 

These regressions are useful as descriptions of the data only. But as descriptions they are powerful. The self-regulating mechanisms of the market appear to work less well in the Great Depression; speeds of adjustment seem to slow down. Alternative propagation mechanisms that give increased persistence to downturns appear to be at work. The search for explanations of the Depression outside the compass of pre-1929 business cycle theory thus appears well-motivated.

Each paper in Eichengreen and Hatton presents its own distinctive point of view on the question of why Depression unemployment in the country it studies was or was not extraordinarily high and persistent, and as a result the book is sprawling-as is inevitable in conference volumes. Authors stress that France appears very different from Britain. They stress that Australia's labor market adjustment process bears little resemblance to that of the United States. Readers must extract the common themes and contrasts of the interwar unemployment experience by themselves.
 

It is helpful to group the explanations for why Depression-era unemployment was so high and lasted so long along two axes: government-generated unemployment, and a shadowy and somewhat residual category of market failure-generated unemployment. There are two candidates to take the blame for the persistence of unemployment during the Depression: the government, and the market.
 

Government-generated unemployment was widespread. In Britain some unemployment (although a small share during the peak unemployment years of the early 1930's) was surely generated by the government's unemployment insurance system. Thomas cites Eichengreen's earlier work, which presented a best estimate that some two or three percentage points of unemployment in 1929-32 could be attributed to the operation of the relief system. Thomas attributes some unemployment among secondary workers and unskilled young men with large families to the "OXO" system in which firms would systematically rotate two platoons of workers between time at work and time receiving unemployment benefit, thus turning unemployment insurance into a highly-subsidized work sharing scheme. Men receiving the standard unemployment benefit in February 1931 had on average experienced 8.6 different spells of employment during the past year, working an average of 151 days.
 

Given such rapid turnover it is not at all implausible to argue that the availability of unemployment benefit, even with relatively low replacement rates, allowed workers to remain in labor market positions in which they were employed only half the time instead of migrating to some other industry. Thus Thomas' essay tends to strengthen belief in Benjamin and Kochin's (1978) argument that the underlying layer of excess British unemployment-not the unemployment that prevailed in the deep slumps of 1922 and 1932 but the unemployment that prevailed in the relative booms of 1928 and 1937-may well have been maintained by the government's social policy.
 

Robert Margo's essay on the United States looks at the situation as described in the 1940 census at the very end of the Depression. At that time some 11.1% of U.S. heads of household were counted as unemployed, of whom almost half-4.9% of all heads of household-held relief jobs. Darby (1974) was the first to argue that the government had managed to create a situation in which those on relief found themselves with little incentive to register their labor supply on the private-sector job market and yet were doing little socially productive work. Margo largely supports Darby, thinking that relief jobs were attractive to many in spite of their low levels of relief wages relative to average private sector wages. Relief jobs were secure and required little skill. The risk-averse or the lesser-skilled might well have found that their best option was to stay on relief jobs, and be counted as unemployed, rather than take even an immediately available private sector job.
 

Robert Salais' essay on France argues that the development of bureaucratic mechanisms of relief for dealing with unemployment in large part called forth the phenomena they were to address. The existence of programs that would not offer relief except to the wholly unemployed put pressure on the economy to shift its pattern of labor relations so that it would adjust to lessened demand and slack not by reducing hours or returning workers to agriculture but by creating the "unemployed."
 

In all of these cases there is no clear alternative way of organizing the unemployment insurance system that would have been a clearly better policy. A good society should offer support to those blocked from earning their wages in the market. And a well-functioning economy should create incentives for the unemployed to strongly register their excess supply of labor in the market. These two goals are inevitably in tension. The inescapable problem was that relief payments were too high for the short-term and too low for the long-term unemployed, and that there was no good way to structure relief programs to tell these two groups apart ex ante. William Beveridge was among the first to lay out the policy dilemma: the long-term unemployed "need... more money rather than less than those who have had short periods of unemployment. Yet they can hardly be given more money without... [creating an incentive] to settle down into permanent unemployment." Moreover, few of the long-term unemployed can "escape physical and psychological deterioration through long idleness."
 

In view of the general Keynesian orientation of the editors Eichengreen and Hatton, the fact that their contributors argue that government-generated unemployment played a significant role is interesting. My reading of Eichengreen and Hatton led me to place more weight on Benjamin and Kochin's and Darby's accounts of why unemployment was persistent in the interwar period. Nevertheless, a large part of the puzzle remains: Thomas, Margo, and the others note that slightly less than half of mid-1930's unemployment was concentrated among long-term unemployed who did not take advantage of subsidized relief-work schemes.
 

This form of unemployment, principally long-term and somewhat of a residual category is, in the eyes of Eichengreen and Hatton and their contributors, the key to the persistence of the Depression. Long-term unemployment was strongly present in those countries that suffered worst from the Depression, including non-European nations like Australia (compared to the U.S. by R.G. Gregory, V. Ho, L. McDermott, and J. Hagan), Canada (analyzed by Alan Green and Mary MacKinnon), and the United States and European nations like Britain, Germany (discussed by Dan Silverman), Italy (discussed by Gianni Toniolo and Francesco Piva), and the gold block nations of France and Belgium (analyzed by Martine Goosens, Stefaan Peeters, and Guido Pepermans). Of these only Germany achieved a strong recovery from the Depression in the 1930's.
 

Long-term unemployment means that the burden of economic dislocation is unequally borne. Since the prices workers must pay often fall faster than wages, the welfare of those who remain employed frequently rises in a depression. Those who become and stay unemployed bear far more than their share of the burden of a depression, as Bernard Harris' discussion of unemployment, insurance, and health in Britain shows. Moreover the reintegration of the unemployed into even a smoothly-functioning market economy may prove difficult, for what employer would not prefer a fresh entrant into the labor force to someone out of work for years? The simple fact that an economy has recently undergone a period of mass unemployment may make it difficult to attain levels of employment and boom that a luckier economy attains as a matter of course.
 

Indeed, long-term unemployment seemed stubbornly resistent to activist policies. Stimulative policies may well have helped cushion some countries' slide into the Great Depression, but once an economy had fallen deeply into the Great Depression, devalued exchange rates, prudent and moderate government budget deficits (as opposed to the deficits involved in fighting major wars), and the passage of time all appeared equally ineffective ways of dealing with long-term unemployment. Highly centralized and unionized labor markets like Australia's and decentralized and laissez-faire labor markets like that of the United States did equally poorly in dealing with long-term unemployment. Fascist "solutions" were equally unsuccessful, as the case of Italy shows, unless accompanied by rapid rearmament as in Germany.
 

Eichengreen and Hatton's contributors have no clean answers to the question of why the private sector could not find ways to employ its long-term unemployed. The very extent of persistent unemployment in spite of different labor market structures and national institutions suggests that theories that find one key market failure responsible should be taken with a grain of salt.
 

Perhaps the source of our puzzlement is our assumption that the economy's laws of motion are more or less linear-that twice as many excess unemployed should induce additional hiring and redeployment of labor so that the number of excess unemployed drops twice as fast. But should we be surprised that the long-term unemployed do not register their labor supply proportionately strongly? They might accurately suspect that they will be at the end of every selection queue. In the end it was the coming of World War II and its associated demand for military goods that made private sector employers wish to hire the long-term unemployed at wages they would accept.

XV. Nazis and Soviets-
J. Bradford DeLong
University of California at Berkeley and NBER

February 1997
 
 

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Germany: The Rise of Adolf Hitler
Germany: The Nazi Regime
The Soviet Union: The New Economic Policy
The Soviet Union: Stalin and "National Bolshevism"
 

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Germany: The Rise of Adolf Hitler

In 1928 the British publisher Methuen published a book entitled Republican Germany: An Economic and Political Survey (by H. Quigley and R.T. Clark). In the introduction the authors wrote that they were fortunate because they had a single, central, powerful theme: the coming-to-maturity of the post-World War I German republic:

The consolidation of the German [Weimar] Republic is in itself a theme of the most absorbing interest; it lends itself to dramatic presentation with the leading characters active at moments with a real dramatic force.... The fifth and probably last act is now being played, and promises something more heartening than a catastrophic ending. There may be scenes of conflict, world-shaking events, accompanied by the possibility and dangers of war, but the real consumation will probably be reached--namely, the recognition of the German Republic as a permanent feature in German history and its economic and political relations, and, with it, the opening of a new era of international prosperity.

Quigley and Clark's--long--book contains three mentions of Adolf Hitler: a passing reference to the "Hitler incident", a half-page narrative of Hitler's unsuccessful 1923 attempt to take over the Bavarian provincial government via a coup, and a classification of Hitler as one of the leaders of:

...secret societies in morality and mentality far more akin to the worst traditions of medievalism than to those of the twentieth century...

Writing in 1928, five years before Hitler was to take power and destroy the German Republic, and Adolf Hitler is simply not a big deal to two people writing a political and economic survey of Germany. Were Quigley and Clark obtuse? Not at all. Hitler was an unimportant part of the political fringe in Germany in 1928.

In May 1928 Germany held elections for its legislature, the Reichstag. The Nazis won 2.6% of the vote: they were part of a fringe of small parties with more-or-less impractical and nutty programs that together drew off some twelve percent of the vote from the established parties on the right-left spectrum.

1928 Reichstag Election: Distribution of Votes
Party May, 1928
Communists 11.7%
Social Democrats 33.0%
Democrats 5.4%
Center 13.4%
German People 5.2%
German National People 15.8%
Bavarian People 3.4%
 
Nazi 2.6%
Landbund 0.6%
Economics Party 5.0%
Landvolk 2.2%
Farmers' Party 1.7%
 

On the far left were the Communists--obedient to Moscow's every whim, dedicated to the overthrow of the democratic Weimar Republic and to the comng social revolution. They polled 11.7% of the vote in May 1928. But their 11.7% of the vote did not shift the center of gravity of German politics to the left, but to the right. The fact that the Communists attracted a sizeble share of the vote terrified the center and right wing parties. And the Communists devoted more of their attention to undermining the Social Democrats to their left--"social fascists," they called them--than to advancing Germany's welfare state or to opposing the right.

Why did the Communists hate the Social Democrats so? One reason was that the Social Democratic government had assassinated the Communists' two best-loved leaders--Karl Leibknecht and Rosa Luxemburg--when they were under arrest in 1919 after the unsuccessful Spartakist uprising. But a second reason was that Stalin and his henchmen in Moscow were more interested in making the Moscow-run Communist International the only political force on the European left than in pushing for liberal and leftist parliamentary victories. Since Communism was to be established by a revolution that would sweep away the old order, why bother to try to make the old order better? The only purpose of parliamentary struggles, to Lenin and Stalin, was to solidify the working clas and teach them that compromise with the capitalists was a mistake. A more brutal and right-wing government did more to advance the cause: "the worse, the better" in Lenin's formulation. So why help the Social Democrats make the Weimar Republic a success?

Moreover, Karl Marx's theory of history guaranteed the victory of socialism. It did not guarantee the victory of Lenin's Bolshevik brand of Marxist socialism rather than, say, German Social Democrat Friedrich Ebert's revisionist brand. So from Stalin's perspective to made sense to spend all your institutional resources trying to discredit the Social Democrats, and to leave the broader task of destroying capitalism and fascism to the Angel of History.

The belief was that if the Nazis should come to power they would not be able to maintain themselves for long. They would quickly alienate the people, radicalize the masses, and set the stage for a Communist revolution in Germany. Or so was the justification for making tactical alliances with the Nazis against the Social Democrats in the hope of bringing down the Weimar Republic. Not until the end of 1934 would Moscow and the Comintern give their blessing to the idea of the "Popular Front"--the general alliance of all forces in the center and on the left against fascism. And by the end of 1937 the Popular Front would be losing support in Moscow once again, although Stalin would not formally ally with Hitler until the middle of 1939.

On the near left were the Social Democrats, with 33% of the vote. The Weimar Republic had been their creation. The Social Democrats, as the major parliamentary opposition to the Imperial regime, had seized power with the fall of the German Imperial government in November 1918. They had quickly reached an agreement with the army: the army would support the Social Democratic provisional government if the Social Democrats would refrain from large-scale expropriations, confiscations, and executions and would set up a genuinely democratic, rather than a socialist, republic. To Friedrich Ebert and his colleagues, this had seemed like a good deal: universal suffrage would lead to large socialist majorities in the Reichstag as workers, peasants, and small shopkeepers realized their common interest in social democracy. Thus they would be the natural party of government.

They were wrong, in the 151 months between the first elections for the Reichstag and the fall of the Weimar Republic, a Social Democrat was Chancellor--Prime Minister--for only twenty-one of them. Three things kept the Social Democrats from being the natural center of the Weimar government. First, the Communists would not support them under any circumstances. Second, the farmers, paper-shufflers, and small shopkeepers of Germany were scared by the Marxist class-struggle-and-nationalization rhetoric of the Social Democrats. Third, the Social Democrats had signed the Treaty of Versailles and accepted the reparations burden imposed on Germany by the victorious Allies: they were thus seen as the servants of foreign domination, and were anathema to any interested in German national reassertion.

Further to the right were the Democratic Party, the Catholic Center Party, the German People's Party, the German National People's Party, and the Bavarian People's Party, all with varying degrees of fear of the Social Democrats and the Communists, nostalgia for the old order, desire to reverse the humiliation of the Treaty of Versailles, and--among the rightmost--contempt for a democracy that gave Social Democrats and Communists more than forty percent of the seats in the legislature. For most of the 1920s, these parties to the right of the Social Democrats made up a shifting coalition government, with Gustav Stresemann (of the German People's Party), Wilhelm Marx (of the Center Party), or Hans Luther (who claimed to have no party at all) as the dominant player in the government.

All this changed with the Great Depression. In the March 1930 election the Communists took 13.8% of the vote; the Nazis took 19.2% of the vote. Since neither Communist Ernest Thaelmann nor Nazi Adolf Hitler was interested in anything other than destroying the republic, a government could have the support of a parliamentary majority only with the active support and cooperation of the Social Democrats, the Center, and the "establishment" right wing parties.

And here the Great Depression made such a "grand coalition" impossible. The Social Democrats demanded an expansion of the welfare state: unemployment insurance, public works, and large budget deficits to reduce the impact of the Great Depression. The establishment parties demanded --wrongly--financial orthodoxy: balance the budget, cut spending, and restore confidence in non-socialist parties. Neither block thought that it could afford to compromise with the other and still survive as a political movement. So parliamentary government became impossible.

Subsequent elections in search of a viable parliamentary majority only made things worse. The Nazis took 38.4% of the vote in the elections of July 1932. The Communists and the Nazis together had a majority: no parliamentary majority was possible. The German constitution offered an out: if no parliamentary majority could be assembled, the Chancellor could ask the President--himself directly elected for a seven-year term--to rule by decree.

Heinrich Bruening, the leader of the Catholic Center party who became Chancellor when the Social Democrats and the establishment parties split in March 1930 under pressure from the Great Depression, was chosen Chancellor by the aging President of the Weimar Republic, the war hero Paul Hindenburg. Bruening sought to use this escape hatch to pass a policy of fiscal retrenchment and welfare state cutbacks. For as he promised Hindenburg, Bruening tried "at any price [to] make the government finances safe": balancing the budget--reassuring investors that Germany was committed to financial orthodoxy--was Bruening's first and nearly his only priority.
 
 

Thus Bruening spent the first months of his Chancellorship trying to balance the budget, only to find the economic situation outrunning him. The projected deficit tripled during his first three months as tax collections fell and social insurance spending rose.

On July 16, 1930 Bruening's budget-balancing program was defeated in the Reichstag by 256 to 193. Bruening immediately reissued the entire program as a presidential emergency decree. By a very close vote, the Reichstag demanded that the decree be rescinded. In response Bruening dissolved the Reichstag, hoping that new elections would give him a mandate to continue purusing policies of fiscal austerity. The dissolution of the legislature blew up in his face: the Nazis gained 107 seats. The conservative establishment parties from which Bruening drew his base collapsed.

But Bruening still believed in the necessity of a balanced budget and the maintenance of the gold standard. Government expenditures were cut by one-third from 1928 to 1932. But fiscal retrenchment and welfare state cutbacks did no good, and some harm. The German economy slid further into the Great Depression.

Bruening, desperate for some economic policy success, attempted to negotiate a customs union with Austria: the policy move that turned out in the end to block French assistance to Austria's central bank during the financial crises of 1931. The abandonment of the gold standard by Austria led speculation to pull money out of Germany. When the North German Wool Combing Company declared bankruptcy, and worry began to spread about the solvency of its creditor banks, Germany faced a full-fledged speculative attack on the currency. Bruening abandoned the gold standard, creating two different currencies, one for international and one for domestic use.

The speculative attack against the German mark, and Germany's abandonment of the gold standard, finally focused attention on the overhang of reparations obligations. U.S. president Herbert Hoover proposed a one-year suspension of all international debt payments, both war debts owed to the United Staets and reparations owed by Germany. But even if this moratorium had been a factor restoring confidence, it would have come too late to help Heinrich Bruening.

For Bruening did not use the freedom of action created to pursue loose monetary and expansionary fiscal policies, even though urged to do so by once and future central bank president Hjalmar Horace Greeley Schacht. Even after the financial crises of 1931 made expansion possible--because Germany was no longer on the gold standard--Bruening continued to hope that balancing the budget would restore investor confidence. In the end he enforced deflation on the economy: a December 8, 1931 decree ordering the reduction of all fixed prices by ten percent, and a ten to fifteen percent cut in wages.

From our perspective such a fall in prices would not be expected to help the economy. Debts would be a larger burden on the lower-price economy, uncertainty about the stability of the financial system would be greater, and so investment would fall. Bruening's deflationary and budget balancing measures did not help. British attempts to cancel the reparations burden came too late to restore confidence while Bruening was still in office. Unemployment rose.

And as unemployment rose, the Nazi Party vote rose as well.
 
 

Why did higher unemployment raise the Nazi Party share of the vote? As the Great Depression deepened, old party allegiances were shaken and the formerly apathetic began to go to the polls. Voters were unlikely to move to the establishment parties: they had ruled the country and thus presumably bore some responsibility for the Depression.

Voters outside the industrial working class were unlikely to move to the Social Democrats: the Social Democrats were an explicitly "class" based party, their rhetoric and their form of organization making belonging somewhat uncomfortable for the middle class; and the Social Democrats carried the twin burdens in a strongly nationalist country of being officially "internationalist" and of having been the collaborators of the allies who had imposed the Versailles peace settlement. Indeed, Social Democratic voters tended to move to the Communists.

Disaffected voters were interested in a party that promised to do something about the Depression: that had a theory of who was responsible, a program, and a bias toward action rather than parliamentary talk. the Nazis had a theory of who was responsible: the Jews, the financiers, foreign capitalists, and the "November criminals"--the Social Democrats who had signed the Treaty of Versailles. They had a bias toward action. And they had a program, confused as it was: the overthrow of the Treaty of Versailles, German rearmament and national reassertion, and the drafting of industry into the service of the nation to provide unemployment.

The "socialist" in National Socialism was taken very seriously: it was the opposite of liberalism and individualism, it was the submission of the individual to the collective interest, and it was a national--a German--socialism, as opposed to what they called the Marxist-Jewish-internationalist-unGerman socialism. As Hitler once said:

I had only to develop logically what social democracy failed.... National Socialism is what Marxism might have been if it could have broken its absurd ties with a democratic order.... Why need we trouble to socialize banks and factories? We socialize human beings....

The growth of such authoritarian-fascist movements in (or at other times) the Great Depression was not at all unusual. Think of Father Coughlin or Huey Long in the United States during the Great Depression; think of the French interwar right with its emphasis on national discipline; or think of Patrick Buchanan's calls for a culture war, and ascription of blame to immigrants and to foreign trade in the contemporary United States.

What was unusual was the virulence of the National Socialist strain of fascism: their love of war even at unfavorable odds, their murderous anti-semitism (and anti-gypsyism, anti-slavism, anti-disabledism), their eagerness to resort to not just retail but wholesale murder, and the speed with which they seized control of Germany.
 
 

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Germany: The Nazi Regime

On January 30, 1933, in accord with the German constitution, President Hindenburg named Adolf Hitler Chancellor of Germany. The Nazis held only three of eleven cabinet posts. Their government rested on a coalition with the Nationalists. On February 27, 1933, someone--probably the Nazis--burned down the Reichstag building. On February 28 President Hindenburg proclaimed martial law. On March 23 the Reichstag passed a "Law for Removing the Distress of the People and the Reich" which centralized all legislative powers in the cabinet for four years. By July 14 the Nazi Party was the only political party in Germany.

As a political venture, Nazism was a smashing success in its first few years. The political correspondent William Shirer was posted to Berlin in the late summer of 1934, a year and a half after Hitler took power. He found:

much that impressed, puzzled, and troubled a foreign observer about [Hitler's] Germany. The overwhelming majority of Germans did not seem to mind that their personal freedom had been taken away, that so much of their culture had been destroyed and replaced with a mindless barbarism, or that their life and work had become regimented....

In the background, to be sure, there lurked the terror of the Gestapo.... Yet the Nazi terror in the early years affected the lives of relatively few Germans, and a newly arrived observer was somewhat surprised to see that hte people... did not... feel that they were being cowed and held down by an unscrupulou and brutal dictatorship. On the contrary, they supported it with genuine enthusiasm....

Hitler was... confounding the victorious Allies and making Germany militarily strong again. This was what most Germans wanted.... By the autumn of 1936 the problem of unemployment had been largely licked, almost everyone had a job again, and one heard workers who had been deprived of their trade-union rights joking, over their full dinner pails, that at least under Hitler there was no more freedom to starve.... "The Common Interest before Self-Interest!" was a popular Nazi slogan in those days... the masses were taken in by the new "national socialism" which ostensibly put the welfare of the community above one's personal gain.

The racial laws which excluded the Jews... seemed... to be a shocking throwback...but since the Nazi racial theories exalted the Germans as the salt of the earth... they were far from being unpopular...

The image of Hitler's ideology can be seen in the Nazi program for the German agricultural sector. The Hereditary Farm Law of September 1933 transformed all farms of less than 300 acres into hereditary estates that must be passed down undivided to the next male heir. Only an Aryan German who could prove "purity" of blood back to 1800 could own such a farm. Such a farmer's estate could not be sold or seized for debt or bankruptcy. And farm prices were raised an average of twenty percent.

The industrial policies of the Third Reich were in the beginning the brainchildren of Hjalmar H.G. Schacht, who assumed office as president of the central bank under Hitler in 1933, and because finance minister in the following year. Schacht was one of the few finance ministers to take advantage of the freedom provided by the end of the gold standard to keep interest rates low and government budget deficits high: massive public works funded by large budget deficits. The consequence was an extremely rapid decline in unemployment--the most rapid decline in unemployment in any country during the Great Depression. Eventually this Keynes-like policy was to be supplemented by the boost to demand provided by rearmament and swelling military spending.

In the longer run the corruption and bureaucracy that the Nazi government imposed on the government would slow Germany's economic progress. Hjalmar H.G. Schacht was replaced in September 1936 by Hitler's lieutenant Hermann Goering, with a mandate to make Germany self-sufficient to fight a war within four years (and to acquire a vast industrial conglomerate from looted Jewish-owned properties for himself. Under Goering imports were slashed. Wages and prices were controlled--under penalty of being sent to the concentration camp. Dividends were restricted to six percent on book capital. And strategic goals to be reached at all costs (much like Soviet planning) were declared: the construction of synthetic rubber plants, more steel plants, automatic textile factories.

The replacement of Schacht by Goering was fortunate for the rest of the world: the German economy during World War II was not as strong, and hence could not give as much support to the military, as it might have.

Real wages in Germany dropped by roughly a quarter between 1933 and 1938. Trade unions were abolished, as was collective bargaining--which would have been of little use with wages frozen by government decree. The right to strike was, of course, abolished. And the right to quit disappeared as well: labor books were introduced in February 1935, and required the consent of the previous employer in order to be hired for another job.

In William Shirer's view, however, German workers were not actively discontented with Hitler's regime: it had, after all, brought the Great Depression to an end in Germany, and removed the fear of unemployment. Loss of the freedom to quit, the freedom to engage in politics, and the freedom to join a union was worth less than the loss of the freedom to starve.
 
 

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The Soviet Union: The New Economic Policy

It was not foreordained that the Soviet Union would turn into a terror-ridden prison camp. There were strong signs of impending disaster under Lenin: the promotion of the secret police-first called the Cheka, then the OGPU, then the NKVD, and at its end the KGB-to a prominent place. The use of unselective terror to dominate regions during the Russian Civil War. The suppression of discussion and debate within the Communist Party.

But Lenin--ever the pragmatist--had taken a number of steps backward from the central command-driven, terror-using, Communism-now-at-all-costs policies of the Civil War. "War Communism" had been replaced by a "New Economic Policy" placing less emphasis on the elimination of the business class and more emphasis on boosting production to make up for the losses of World War I and the Civil War.

"War Communism" was Lenin's attempt to achieve both the degree of military mobilization of the economy that he believed World War I-era Germany had obtained, and to accomplish the goals of nationalization and income equalization to which he and his Communists were strongly committed. It took place against the desperate background of the Russian Civil War. The first economic consequence was inflation, ending in a 1924 reform of the currency that exchanged fifty million "old" rubles for one "new" ruble. The second economic consequence of War Communism was complete nationalization: all factories were nationalized. All credit institutions were nationalized. International trade was nationalized. All wages were equalized. Instead of employers hiring workers, party functionaries conscripted them.

In agriculture War Communism was a disaster--the first of many agricultural disasters. The do-it-yourself redistribution of land that the peasants accomplished and the Bolshevik Party blessed was very popular. But the government needed food for the towns--and peasant farmers living in the countryside were much less interested in delivering grain in exchange for urban luxuries than had been noble landlords under the Czar.

The government tried to requisition the food it needed for the cities. The peasants hid the grain they had, and cut back on production because they thought that any excess above their own subsistence would be confiscated. Urban workers, short of food, returned to their relatives' family farms in the countryside, where they at least thought that they could get fed. Industrial output fell.

In 1920 agricultural output was perhaps half of what it had been in 1913. And industrial output was perhaps one fifth of what it had been in 1913.

Nikolai Bukharin--one of the big losers in the succession struggle following Lenin's death (he was in the end shot in the late 1930s) and the model for Arthur Koestler's protagonist, Rubashov, in the novel Darkness at Noon--saw the New Economic Policy [NEP] as desirable for perhaps generations: let the Soviet Union build up its productive power and improve its living standards; let progressive income taxes keep the successful entrepreneurs of the NEP--the so-called NEPmen--from getting too rich; slowly build up the backbone of the economy in the form of state-owned and -operated dams, railroads, utilities, and heavy industrial plants; and then at sometime in the relatively distant future attempt to move beyond a market economy in which goods were distributed "to each according to his work" to a Communist economy in which goods would be distributed "to each according to his need."

The New Economic Policy of Lenin restored private enterprise to the distribution sector. Heavy industrial production remained nationalized. Artisans, and small light industry factories, could work on their own account. But distribution was privatized: private traders bought output from state factories, transported it, and then delievered it to private stores that sold it to consumers. Peasants sold grain to private traders as well-and taxes in money replaced the previous requisitions of surplus.

By 1926 Russian industrial production was back to the level of 1913.
 
 

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The Soviet Union: Stalin and "National Bolshevism"

The dictator who won the struggle for power after Lenin's death--Josef Stalin, born Josef Vissarionovich Djugashvili--was a paranoid psychopath: the lead candidate for the greatest mass-murderer in human history. His bureaucratic triumph over first the left and then the right opposition within the Soviet Communist Party in the late 1920s left him as the unchallenged dictator of the Soviet Union, surrounded by supporters, clients, and yes-men.

Stalin had been born in what would become the Soviet Republic of Georgia, and ventured into revolutionary-politics-with-banditry after being expelled from an Orthodox seminary He was arrested and exiled to Siberia four times; he escaped four times, suspiciously quickly. Trotsky and others thought that Stalin had spent his time before World War I as an agent provocateur, a spy on the Communists for the Okhrana, the Czar's secret political police.

In 1912 Lenin needed somebody from one of the ethnic minorities of the Russian Empire to stir up agitation at the fringes of the Empire. He chose Stalin. In 1917 Stalin was the first major Bolshevik to return to the then-capital--St. Petersburg or Petrograd--after the fall of the Czar. Lenin gave Stalin the post of editor of the party newspaper, Pravda. During the Civil War he was Commissar for Nationalities--responsible for trying to cement the revolution among the ethnic minorities at the fringes of the Russian Empire. Lenin named him "General Secretary"--responsible for personnel and other bureaucratic matters--of the Communist Party after the Civil War. And Stalin used his post to promote his friends, scatter his opponents, and build up a large faction of clients in the party.

Trotsky thought that Stalin poisoned Lenin.

After Lenin's death, Stalin outmaneuvered his political rivals one by one, allying with one group to expel another from the party before turning on his former allies. Upon Lenin's death the rulers of the Communist Party--the Politburo--established an uneasy truce of "collective leadership." But Trotsky appeared first among equals: Lenin's right hand during the Bolshevik Revolution and the leader of the victorious Red Army. So the other party barons Zinoviev and Kmenev united with Stalin against Trotsky. At the Thirteenth Parthy Congress in 1924 Trotsky's advocacy of rapid industrialization at home and continuous attempts to spark more revolutions abroad was condemned as a "Left" deviation. Trotsky lost his share of power.

Within a year Zinoviev and Kamenev were scared of Stalin--and realized that on the substance of rapid industrialization they agreed with Trotsky. Their "Left Opposition" was condemned by the Party Congress at the end of 1925: Stalin's control of personnel was a more powerful weapon than they had realized. Before 1917 the party had been an underground conspiracy of hunted revolutionaires. In 1917 the hunted revolutionaries emerged above ground after the overthrow of the Czar, and the Communist Party became a more normal political party: a large number of voters and allies among the public following the lead of the party officials. During the Civil War the Communist Party beame a coalition to fight the war. And after the war it became a bureaucracy.

Recruitment drives brought the party membership up to one million in 1929, with the new members selected and screened by the party. The General Secretary--Stalin--was responsible for recruitment, promotion, and personnel, an onerous task that he had agreed to assume at Lenin's plea. The General Secretary appointed the secretaries of subordinate local committees. The local secretaries would appoint those who screened incoming members. And the local secretaries would choose the delegates to the Communist Party Congresses--who would then do as their patron's patron Stalin suggested.

By 1927 Zinoviev and Kamenev were expelled from the Communist Party.

Two years later Stalin turned on his allies--Bukharin, Rykov, and Tomskii--who had helped him expel Kamenev, Zinoviev, and Trotsky. Bukharin and company were a "Right Deviation" that wanted to restore captialism. Thus by the end of the 1920s all of the rest of Lenin's lieutenants--Kamenev, Zinoviev, Bukharin, and Trotsky--were powerless. They were dead by the end of the 1930s.

After the end of the Russian Civil War, Lenin had taken several steps back away from the planned, centralized, and militarized economy. His "New Economic Policy" allowed the return of entrepreneurs, merchants, and middlemen--the so called "NEPmen." It encouraged the growth of a class of relatively rich peasants--the "kulaks"--to produce the agricultural surplus needed to feed the cities. Forced confiscations of grain were replaced by a proportional tax, and peasants received the right to sell their surplus on the market. Lenin exhorted the Party to learn khozraschet--in Martin Malia's translation, "profit and loss business methods."

The Russian economy recovered relatively quickly under the New Economic Policy. Martin Malia believes that ordinary Russians had a higher standard of living in the mid-1920s than at any time since:

the superior living standard of the NEP is eminently plausible with respect to the obvious availability in the earlier years [of NEP] of food, of consumer goods that people actually wanted, and of personal freedom...

As far as material wealth is concerned, Malia is almost surely wrong. Soviet households of the 1980s had radios, and apartments with some consumer appliances rather than cottages with straw floors. But the gain in material living standards was not nearly as much as it should have been. Traditionally-measured real wages in 1952 appear no higher than in 1929, when they were about at the level of 1913; and Soviet urban consumers saw few of the new inventions that enriched consumer choice elsewhere. The grain harvest of 1952 was less than that of 1929, which was less than that of 1913.

And throw into the balance the chance of being arrested, shot, or exiled to Siberia after the end of NEP, and it does look like a golden age.

But NEP did little to equip the Soviet Union to defend itself against attack from abroad. And it did nothing to advance Communist ideals. It is possible to envision a different Soviet Union, in which other leaders had won the succession struggle after Lenin's death, which would have seen economic policy evolve very differently: an extension of the NEP coupled with an ever-postponed long-run plan to resume nationalization, arriving in the end at something like post-World War II Sweden as far as economic organization is concerned.

It is unlikely: practically all of the Bolsheviks who made the Russian Revolution would have been opposed to such an evolution, at least at first. And to all in the Communist Party, the increasing wealth of the NEPmen, the traders and distributors who had prospered under the New Economic Policy, was offensive: they toiled not, neither did they spin; all they did was carry things from place to place; and Communists saw no creation of economic value in distribution; so their profits were pure exploitation of the people, and the Party, by bloodsucking parasites. NEP could not last. To the Bolshevik cadre, NEP was a betrayal of the dream of socialism. When Stalin began his industrialization drive, all elements of the Party--in power or not, expelled or not, exiled or not--rallied to him in support of his policies (if not his rule).

Moreover, as Alec Nove has pointed out, national security considerations required an emphasis on building up those industries necessary to boost military might and maintain economic independence; steel, coal, and heavy machinery--not consumer goods. But how are you to persuade the peasants to boost agricultural production if you have no factory-made consumer goods to trade them for their grain?

So from the perspective of the Communist Party the problem of agricultural economics was how to extract as much as possible in the way of food from the countryside while giving up as little as possible, in the sense of the share of manufacturing production devoted to producing consumer goods for rural localities, as possible. In the latter stages of the NEP the government raised industrial prices and lowered farm prices--using "the scissors" to improve the government's terms-of-trade vis-a-vis the farmers. This had the expected result: the farmers did not want to sell grain to the cities at the prices the government was willing to pay.

The "goods famine" generated by the start of the first Five Year Plan and the shift of urban production from consumer goods to capital goods, and from light industry to heavy industry, called forth a "grain famine." Peasants shifted to growing industrial crops--cotton and flax--and to raising livestock rather than grain that the could not sell to the state at a reasonable price.

In 1929 urban rationing was reintroduced. The NEP had failed from the government's point of view: the peasants were not willing to deliver to the state the grain that the government wanted at the price that the government wanted to pay.

Thus the government decided that it would have to do something about the "kulak," the relatively rich peasant who was producing a surplus of agricultural products and yet unwilling to deliver it up to the party. Note that a "kulak" was not a landlord; a "kulak" was merely a peasant who had enough land and money to hire a farmhand. The poorest group of peasants were not sources but net purchasers of food, earning from handwork and handicrafts enough to bring their food consumption up from starvation levels. The so-called "middle" peasants were in rough balance, eating what they produced.

Only the "kulaks" produced a surplus.

Marx had claimed--wrongly--that the British industrial revolution had accumulated the capital to build the factories by expropriating the property of the peasants. The "enclosure" movement, Marx claimed, had deprived the peasants of their common property and their land, had turned them into a property-less industrial proletariat, and had concentrated the wealth that the rich then used to invest in factories.

Marx was wrong. The enclosure movement in Britain was not a win-win event: the politically powerful who could reach and influence Parliament did very well indeed. But the industrial working class of nineteenth century Britain was a consequence of population growth: there was no rural depopulation in Britain until the end of the nineteenth century, well after the industrial revolution took hold, when farm workers were pulled into the cities by higher urban wages. And factories were financed by merchants and entrepreneurs on shoestrings, not by landlords fattened by the profits of enclosure: landlords fattened by the profits of enclosure kept their wealth in land or loaned in to the governments that fought the wars that made the British Empire.

But by the end of the 1920s the Communists--not just Stalin, but Trotsky and such figures as Preobrazhensky too--had reached the conclusion that the Soviet Union needed to do what Marx told them the British business class had done two centuries before: "primitive accumulation." Confiscate the land and animals of the kulaks, the Party decided. Bring them into collective farms, along with the poor and middle peasants. Tighten down their standard of living to a little bit more than what the non-kulak average had been beforehand. The middle peasants and the poor peasants will be happy, the Party thought. Only the kulaks will be upset--and their resistance can be handled. Thereafter the entire agricultural surplus can be taken for the cities, with no need to supply the countryside with any consumer goods at all.

John Maynard Keynes wrote that:

The ideas of economists and political philosophers... are more powerful than is commonly understood... the world is ruled by little else. Practical men... believ[ing] themselves... exempt from any intellectual influences, are usually the slaves of some defunct economist. Madmen in authority, hearing voices in the air, are distilling their frenzy from some academic scribbler...

We have seen this in Hitler: driven to conquer Poland, Czechoslovakia, and Russia by his hearing the voices in the air of the economist Thomas Malthus (along with the racist philosopher Houston Stewart Chamberlain, and the social Darwinist sociologist Herbert Spencer). We have seen this in Lenin, driven to try to destroy the market as a social mechanism by the voices in the air of Marx and Engels. And now we see this in Stalin and his peers, driven to kill and exile fifteen million peasants because Marx had once written five chapters on the "so-called primitive accumulation" of capital in pre-industrial Britain.

Beginning in 1929, Stalin decreed the collectivization of agriculture. Some ninety-four percent of the Soviet Union's's twenty-five million peasant households were gathered into state- and collective farms, averaging some fifty peasants per farm. Peasants were shot, died of famine, and were exiled to Siberian prison labor camps in the millions during the 1930s. Perhaps fifteen million died. Agricultural production dropped by a third. The number of farm animals in the Soviet Union dropped by half.

Certainly the entire surplus was taken, with little or anything being traded back from the cities to the countryside. But resistance was not confined to the kulaks. Peasants everywhere slaughtered and ate their animals, rather than submit calmly to their collectivization.

It is not likely that there were any benefits to the collectivization of agriculture. Food for the cities could have been obtained--more food on better terms--by devoting a share of urban industrial production to consumer goods useful for farmers. The underlying idea of collectivization was the re-enserfment of the peasantry: reduce their standard of living to the bare minimum, take the surplus, and use the surplus to feed the urban workers. But serfdom is not a very efficient way of squeezing food out of the countryside. More efficient to have kept the farm animals and the fifteen million people alive and traded consumer goods for the food to feed the cities.

The other side of Stalin's economic policy was rapid industrialization. After having condemned his political opponents as unrealistic "super-industrializers," Stalin announced a Five-Year Plan that exceeded even their hopes. During the First and Second Five-Year Plans Soviet statisticians claimed that industrial production--which had stood 11% above its 1913 level in 1928--was some 181 percent higher by 1933, and some 558 percent higher than 1913 by 1938. Heavy industry had the highest priority: coal, steel, chemicals, and electricity. Consumer goods were to come later, if at all.

The "Plan" was not an overall, integrated, achievable strategy for industrial development--what we would call a plan. Instead, it rapidly became a series of selected objectives--finish this dam, build so many blast furnaces, open so many coal mines--to be achieved whatever the cost. When in the mid-1960s Fidel Castro decreed that Cuba was to make a ten-million ton sugar harvest, nearly twice its normal production, and that everything else was to be subordinated to that goal, he was acting in the spirit of Stalin's Five Year Plans.

The aim was to build up heavy metallurgy. The task was to acquire--buying from abroad or making at home--the technology that American heavy industry deployed. A "steel city" was to be built in the Urals, at Magnitogorsk, and supplied with coal from the Chinese border. (And without Magnitogorsk it is hard to see how Stalin could have won World War II, or the factories of western Russia were under German occupation from July 1941 until late in 1943). Dams, automobile factories, tractor (or tank) factories--all located not near the border or where the people were but far to the east of Moscow. General Motors, Ford, and Caterpillar were eager to contribute engineering expertise for a price.

How to get workers to man the new heavy industrial plants--especially since Stalin couldn't pay them much: consumer goods were impossible to find with the shift to heavy industry, and agricultural production was in shambles. The answer was by drafting the population: internal passports destroyed freedom of movement, housing and ration books depended on keeping your job (and thus satisfying your employer), and there was always the threat of Siberian exile in a concentration camp or a bullet in the neck for those whose bosses accused them of "sabotage." Nonfulfillment of quotas led to arrest and imprisonment or execution. In 1932 the government empowered local authorities to dismiss workers and deprive them of their food ration cards and housing for one day's absenteeism. Unemployment was eliminated: if you were unemployed, you might as well be sent to a labor camp.

At the start of the industrialization drive, there were show trials of engineers (accused of being "plan-wreckers"). Squeezing down the rural standard of living further produced a mass exodus: bad and low-paid as the cities were, for an adult male being a semi-serf on the collective farm was worse. More than twenty-five million people moved to the cities and the factories during the 1930s.

On the one hand, the Soviet Union did outproduce Germany and Britain in war weapons during World War II--and many of the weapons were of excellent quality. On the other hand, the claims of nearly sevenfold growth in industrial production from 1913 to 1940 were significantly exaggerated: cut reported industrial production in 1940 in half relative to 1913 to get a better indication of Soviet industrial production growth: perhaps industrial production in 1940 was (measured using standard techniques) 3.5 times industrial production in 1913 (although, once again, Russia was making new goods and new types of goods that it could not have made in 1913). But by the end of the Second Five Year Plan Russia had a strong industrial base, with a greatly increased capacity to produce coal, steel, iron, electricity, airplanes, tractors (and tanks), and locomotives. As best as Bergson could estimate, Soviet real national product grew at some 4.5 percent per year on average from 1928 to 1958.

Factory workers were shot or exiled to Siberian labor camps for failing to meet production targets assigned from above. Intellectuals were shot or exiled to Siberian labor camps for being insufficiently pro-Stalin, or for being in favor of the policies that Stalin had advocated last year and being too slow to switch. Communist activists, bureaucrats, and secret policemen fared no better. More than five million government officials and party members were killed or exiled in the Great Purge of the 1930s as well. All of Stalin's one-time peers as Lenin's lieutenants were gone by the late 1930s--save for Leon Trotsky, in exile in Mexico, who survived until one of Stalin's agents put an icepick through his head in 1940.

Curiously enough, the most dangerous place to be in Russia in the 1930s was among the high cadres of the Communist Party. Of the 1800 delegates to the Communist Party Congress of 1934, less than one in ten were delegates to the Party Congress of 1939. The rest were dead, in prison, or in Siberian exile. The most prominent generals of the Red Army were shot as well. The Communist Party at the start of World War II was more than half made up of those recruited in the late 1930s, and keenly aware that they owed their jobs and their status in Soviet society to Stalin, Stalin's protegees, and Stalin's protegees' protegees.

We really do not know how many people died at the hands of the Communist regime in Russia. We do know that the Siberian concentration camps were filled by the millions at least five times. The Gulag Archipelago grew to encompass millions with the deportation of the "kulaks" during the collectivization of agriculture. It was filled again by the purges of the late 1930s. It was filled yet again by Poles, Lithuanians, Estonians, Latvians, and Moldavians when the Soviet Union annexed those territories on the eve of World War II. Soldiers being disciplined, those critical of Stalin's wartime leadership, and ethnic groups thought to be pro-German were deported during World War II. After World War II perhaps four million Soviet soldiers who had been captured by the Germans and survived Hitler were sent to the Gulag until they rotted and died.

The entire system would not be shut down until the late 1950s, when Nikita Krushchev was General Secretary.

As Basil Kerblay write in his Modern Soviet Society, we know more about how many cows and sheep died in the 1930s than about how many of Stalin's opponents, imagined enemies, and bystanders were killed. R.J. Rummel estimates 62 million dead from the Soviet regime. Other estimates tend to be somewhat but not orders of magnitude lower.

The reality of the Soviet Union in the 1930s was in strong contrast to the image that many outside had of it. Outsiders focused on three things. First, the Soviet Union had eliminated unemployment--in a decade in which unemployment was bitter and pervasive outside of Russia. Second, Soviet production was expanding rapidly--in a decade in which production stagnated elsewhere in the world. Third, shortcomings in the Soviet Union could be blamed on the past: the country's backwardness, the heritage of the Czars, the necessity of doing everything as fast as possible to strengthen the country and catchup to the advanced industrial powers. "You can't make an omelette without breaking eggs."

Yet it exerted a definite attraction on leftists and non-leftists alike. An effete intellectual upper-class snob like John Maynard Keynes--at the heart of the High British Decadence of the Bloomsbury group--had many reasons to dislike Leninism and the Soviet Union. As he wrote:

For me, brought up in a free air... Red Russia holds too much which is detestable. Comfort and habits let us be ready to forgo, but I am not ready for a creed that does not care how much it destroys the liberty and security of everyday life, which uses deliberately the weapons of persecution, destruction, and intenational strife... spending millions to suborn spies in every group and family at home.... How can I acept a doctrine which sets up as its bible, above and beyond criticism, an obsolete econmic textbook [Marx's Capital] which I know to be not only scientifically erroneous but without interest or application for the modern world? How can I adopt a creed which, preferring the mud above the fish, exalts the boorish proletariat above the bourgeois and the intelligentsia who... are the quality of life and surely carry the seeds of all human advanement? Even if we need a [new] religion, how can we find it in the turbid rubbish of the Red bookshops?

Yet even he wrote:

Now that the [Bolshevik Revolution] is done and there is no chance of going back, I should like to give Russia her chance; to help and not to hinder. For how much rather... if I were a Russian, would I contribute my quota of activity to Soviet Russia than to Tsarist Russia!... I should detest the actions of the new tyrants....But I should feel that my eyes were turned towards, and no longer away from, the possibilities of things...

The writer Lincoln Steffens ruined his reputation with the bon mot, on his return from Stalin's Russia: "I have seen the future, and it works." Yet even John Maynard Keynes is prepared to say that Soviet Russia may have some germ of the future in it, and may work.

XVI. Climbing Out of the Great Depression-
J. Bradford DeLong
University of California at Berkeley and NBER

February 1997
 
 

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The New Deal
Roosevelt Tries Again
Winners and Losers from the Depression
Could "It" Have Happened Here?
The Social Welfare State and the Great Levelling
Left, Right, or Center?
 

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The New Deal

Before the 1930s it was unheard of for a presidential candidate to appear at the national political convention of an American party. Candidates were supposed to remain at their homes, tending to their private affairs, until informed (a week or so after the convention) by party officials that they had been chosen. They were supposed to emulate the Roman politician Cincinnatus, who mythically remained on his small farm ploughing his crops until told that he had been elected commander-in-chief of the Roman army and dictator of Rome.

When the Democratic Party convention in Chicago nominated Franklin Delano Roosevelt, then governor of New York, as its presidential candidate in July 1932, Roosevelt broke tradition. He flew to Chicago--in part, historian Frank Leuchtenburg says, to disprove whispers that a polio victim with paralyzed legs was too frail to undertake a full-scale American presidential campaign--and spoke to the convention, saying:

I have started out on the tasks that like ahead by breaking the absurd tradition that the candidate should remain in professed ignorance of what has happened.... You have nominated me... I know it... I am here to thank you for the honor.... [I]n so doing I broke traditions. Let it be from now on the task of our Party to break foolish traditions.... I pledge you, I pledge myself to a new deal for the American people...

What was Roosevelt's "New Deal"?

First, it was a unique moment in American political history. Usually American politics is the politics of gridlock. James Madison and company constructed the American political system so that it would be broken by design: maneuvering programs and policies through several layers of committees, two legislative houses, past the president, and into execution is very complex, and overwhelming procedural obstacles can be erected by determined opponents at almost every step along the path. Legislative majorities for one party or the other in either house of the legislature are almost always small. American is governed by increments, from the center. Between 1900 and 1950 there were times when one party had a solid majority in the House, but its majority in the Senate then was small.

The elections of the 1930s were different. Roosevelt won 59 percent of the vote in 1932--an eighteen percentage-point margin over Herbert Hoover. Congress swung heavily Democratic in both houses. The 1930s would see Democratic political dominance in the congress to an extent never before seen since the Civil War. For the first and only time, the president and his party had unshakable working majorities in both houses of the legislature.
 
 

The figure shows the majoriity or minority status--as a percentage of the total number of seats in the body--of the Democrats in all the congressional elections from 1900 to 1950

But the new majority in congress had no idea what it was to do. It was looking for direction from the newly-elected president: whatever Roosevelt sent down, the congress would probably pass.

Roosevelt had no idea what he was to do, either. But he did have a conviction that he could do something important. So was born the strategy of the New Deal: try everything you can think of to cure the depression; drop and abandon the things that do not seem to be working; push the things that do seem to be working. And the important thing was action to change how America worked for two reasons. First because action would raise hopes, and as Roosevelt said in his inaugural address:

Let me assert my firm belief that the only thing we have to fear is fear itself--nameless, unreasoning, unjustified terror.

Second because the old way of doing things was clearly broken:

We are stricken by no plague of locusts. Plenty is at our doorstep, but a generous use of it languishes in the very sight of the supply. Primarily this is because rulers of the exchange of mankind's goods have failed through their own stubbornness and their own incompetence, have admitted their failure, and have abdicated.... The money changers have fled from their high seats in the temple of our civilization. We may now restore that temple to the ancient truths.

There was even a hint in Roosevelt's inaugural address that he would have limited patience with a congress that failed to follow his not-yet-constructed program for fighting the Great Depression. If so:

I shall not evade the clear course of duty that will then confront me. I shall ask the Congress for the one remaining instrument to meet the crisis--broad Executive power to wage a war against the emergency, as great as the power that would be given to me if we were in fact invaded by a foreign foe.

The day after his inauguration President Roosevelt exceeded his statutory powers by forbidding the export of gold and declared a bank holiday--a nationwide banking shutdown to freeze the then-ongoing banking crisis. Within four days the House and Senate had convened and--the House unanimously--passed Roosevelt's banking reform bill, arranging for the reopening of solvent banks, the reorganization of other banks, and giving Roosevelt complete control over gold movements.

The second bill Roosevelt submitted to congress--also passed immediately--was an "economy" bill, cutting federal spending and bringing the budget closer to balance. The third submission was a request for an end to Prohibition--for the repeal of the consitutional amendment banning alcohol. On March 29 Roosevelt called on congress to regulate financial markets to prevent fraud and overspeculation like that the U.S. had seen in the stock market crash.

On March 30 congress established Roosevelt's civilian conservation corps. On April 19 Roosevelt took the United States off of the gold standard. On May 12 congress passed Roosevelt's Agricultural Adjustment Act, promising federal aid to farmers nationwide and low-interest federal credit so farmers could refinance their mortgages. (In June congress was to extend low-interest federal credit to distressed homeowners as well.) On May 18 Roosevelt signed the bill creating the Tennessee Valley Authority, the first large government-owned utility corporation in the United States.

Also on May 18, President Roosevelt submitted to congress the center-piece of his first hundred days: the National Industrial Recovery Act, or NIRA.

Businesses won the ability to collude--to draft "codes of conduct" that would make it easy to maintain relatively high prices, and to "plan" to match captacity to demand.
Socialist-leaning planners won the requirement that the government--the National Recovery Administration, or NRA--approve the industry-drafted plans.
Labor won the right to collective bargaining, and the right to have minimum wages and maximum hours incorporated into the industry-level plans.
Spenders won some $3.3 billion in public works.
Congress adjourned on June 16, 1933, one hundred days after Roosevelt had called it into special sesson. Congress had committed the country to a strong "corporatist" program of joint government-industry planning, collusive regulation, and cooperation; put the entire farm sector on the federal dole indefinitely; promised to build and operate utilities; undertaken huge amounts of public works spending; established meaningful federal regulation over the financial markets; and provided insurance for small depositors' bank deposits. Congress had passed all fifteen bills submitted by Roosevelt.

 The Legislation of Roosevelt's First Hundred Days
(from Atack and Pasell)
 
 Date  Legislation  Acronym  Effect
March 9 Emergency Banking Relief Act   Authorized the "bank holiday"; gave the Reconstruction Finance Corporation authority to invest in banks, and gave the Federal Reserve authority to lend to non-member banks and to businesses; gave the executive broad powers over transactions in gold, silver, or foreign exchange.
March 31 Civilian Conservations Corps Reforestation Relief Act  CCC Authorized the employment of 250,000 males for reforestaton, road construction, national parks, flood control, and soil erosion control.
May 12 Federal Emergency Relief Act  FER A  Appropriated $500 million for relief; half given directly to the states, the rest on a $1 federal for each $3 given in state relief.
May 12 Agricultural Adjustment Act  AA A  Established "parity prices"--returning
 
 
 
 
 
 
 
 
 

But what did it all add up to? The NIRA broke the back of expectations of future deflation. The creation of deposit insurance and the reform of the banking system made savers willing to trust their money to the banks again, and began the reexpansion of the money supply. Corporatism and farm subsidies spread the pain of the Great Depression to some extent. These three policy moves kept things from getting worse, and probably made things somewhat better.

But the rest of Roosevelt's "hundred days"? It is not clear whether the balance sheet of the rest of the hundred days is positive or negative. The "economy" bill that cut spending and relief did harm. Much of financial market regulation (save deposit insurance) was simply irrelevant to the Great Depression. Farm subsidies set the American government on a path that would prove expensive and counterproductive for the next sixty years.

More important, perhaps, people relatively soon decided that they did not like the combination of "corporatist" government-business cooperation and business collusion embodied in the NRA. Consumers complained that the NRA raised prices. Workers complained that it gave them insufficient voice. Businessmen complained that the government was telling them what to do. Progressives complained that the NRA created monopoly. Spenders worried that collusion among businesses raised prices, reduced production, and increased unemployment. A committee to study the NRA headed by progressive lawyer Clarence Darrow denounced the NRA for promoting monopoly, urged a return to free competition, and then for good measure denounced competition as "savage and wolfish" and called for socialism: government nationalization of industry.

In May 1935 the Supreme Court unanimously declared the NIRA and its implementing agency, the NRA, unconstitutional. Roosevelt's experiment with "corporatism"--which crusty Democrats like Senator Carter Glass denounced as "the utterly dangerous effort of the federal government at Washington to transplant Hitlerism to every corner of this nation" was over. It was not success.

By the end of 1933 Roosevelt had shifted his attention to monetary matters: recovery was to be promoted by raising the prices of commodities in dollars, and the prices of commodities in dollars were to be raised by devaluing the dollar in terms of gold. By the end of January 1934 Roosevelt fixed the value of the dollar at 1/35 of a (troy) ounce of gold, fifty-nine percent of its pre-1933 gold-standard parity. But the full-fledged policy of monetary inflation and mammoth fiscal deficits that might have pulled the country out of the Great Depression quickly--that did pull Germany under Hitler out of the Great Depression quickly--was not tried. 1934 was a better economic year than 1933, 1935 was better than 1934, and 1936 was better than 1935, but not by much.

The slide in which each year was worse than the one before had been ended by the Depression. Some ground had been regained. But happy days were not here again.
 
 

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Roosevelt Tries Again

Therefore Roosevelt kept trying different things. If business-labor-government "corporatism" did not work, perhaps a safety net would. The most enduring and powerful accomplishment of the New Deal was to be the Social Security Act, which provided federal cash assistance for widows, orphans, children without fathers in the home, and the disabled; and which also set up a near-universal system of federally-funded old-age pensions. If pushing up the price of gold did not work, perhaps strengthening the union movement would: another enduring accomplishment of the New Deal was the Wagner Act, that set down a new set of rules for labor-management conflict, strengthened the union movement, and meant that the wave of unionization in the United States in the 1930s survived for half a century (rather than being rolled back within half a generation, as had happened to previous expansions of the union movement in the United States. Massive public works an dpublic employment programs restored some self-esteem and transferred some money to households without private-sector jobs--but at the probable price of some delay in recovery, as firms and workers saw higher taxes.

Antitrust policy? The breaking-up of utility monopolies? A more progressive income tax? Finally, a hesitant embrace of deficit spending not just as an unavoidable temporary evil but as a positive good? All were tried. In the end they probably did little to cure the Great Depression in the United States. But they did turn the U.S. into a modest European-style social democracy.

And as the decade came to an end Roosevelt's concerns shifted to the forthcoming war in Europe and to the Japanese invasion of China. Dr. New Deal was replaced by Dr. Win the War.
 
 

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Winners and Losers from the Depression:

Workers who kept their jobs, even with reduced hours, and financiers whose money was invested in bonds prospered during the Depression. Their nominal incomes in dollars dropped, but prices dropped even more: the baskets of goods they could buy increased. Farmers, workers who lost their jobs, and entrepreneurs who had bet their money on continued prosperity were the big losers of the Depression. Production was a third less than normal and the distribution of income had shifted toward those who kept steady employment or who had invested their financial wealth conservatively. As a result, at the nadir the standard of living of losers taken all together was perhaps half of what it had been in 1929.

No large-scale social insurance programs compensated the losers from the Depression during Hoover's term. In contrast to Europe, the United States had no effective system of unemployment insurance to cushion job loss. The Federal government's only significant action before the New Deal was the Veterans' Bonus-granted over Hoover's objection. State governments, with limited abilities to tax, could not come close to finding the resources to significantly cushion the decline in living standards of the unemployed.

Recovery in the U.S. began with the inauguration of Roosevelt. The two initial planks of the New Deal were the abandonment of the gold standard with the concomitant attempt to force the dollar price of gold and other commodities up, and the National Industrial Recovery Act (later declared unconstitutional) with its explicit aim of keeping competition from pushing wages and prices down. These two broke the expectation of further deflation. The end of deflation caused a mini industrial boom. Thereafter output slowly increased and unemployment slowly decreased throughout the New Deal.

While the shift in expectations brought about by the announcement of the New Deal deserves credit for breaking the downward slide, it may be the case--such arguments are still controversial--that the New Deal hindered the recovery as well. New Deal spending was by and large not deficit spending: each dollar Harry Hopkins funneled into relief was matched by a dollar removed from private-sector pockets by taxation, causing little if any rise in aggregate demand. The alliance of the New Deal with organized labor may have led to policies biased toward maintaining the real incomes of those still employed, perhaps at the expense of the unemployed in the late 1930's.
 
 

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Could "It" Have Happened Here?

In June 1932 the "Bonus Expeditionary Force" converged on Washington. The American Expeditionary Force [A.E.F.] of 1917-1918 was made up those American soldiers who had been sent to France in the latter stage of World War I and who had made up the margin of victory for the allies. The B.E.F. of 1932 was a group of some 20,000 massed war veterans who traveled to and demonstrated in Washington to try to convince congress to pay them at once bonuses for World War I that congress had voted to pay in 1945. The B.E.F. marchers camped in "Hoovervilles" and shantytowns by the Anacostia River and in unused government buildings on Pennsylvania Avenue. The congress rejected the B.E.F. petition, but many of the marchers remained in Washington.

Hoover panicked. He ordered the chief of the District of Columbia police to clear the veterans out of the buildings along Pennsylvania Avenue. First the police and then the army--commanded by Douglas MacArthur, armed with tanks, cavalry sabers, tear gas, and bayonets--cleared Pennsylvania Avenue, crossed the Anacostia River, and burned the shantytowns.

As historian Frank Leuchtenburg puts it: "That night, Washington was lit by the burning camps of Anacostia Flats."

Hoover's view of the situation was that:

...the march was in considerable part organized and promoted by the Communists and included a large number of hoodlums and ex-convicts determined to raise a public disturbance. They were frequently addressed by Democratic Congressmen seeking to inflame them against me for my opposition to the bonus legislation. They were given financial support by some of the publishers of the sensationalist press....

When it was evident that no legislation... would be passed... [many] availed themselves of...aid [to return home], leaving behind about 5,000 mixed hoodlums, ex-convicts, Communists, and a minority of veterans in Washington... fewer than a third of them had ever served in the armies, and... [45 percent] were ex-convicts and Communists.

Translation: the remaining B.E.F. members were not "real veterans."

Some old buildings on Pennsylvania Avenue had been occupied by about 50 marchers. These buildings stood in the way of construction work going on as an aid to employment in Washington. On July 28th the Treasury... requested these marchers to move to other quarters.

Translation: Hoover is saying that he, Herbert Hoover, had nothing to do with the eviction--that it was the doing of Treasury Secretary Andrew Mellon.

Whereupon more than 1,000 of the disturbers marched from camps outside of the city armed with clubs and made an organized attack upon the police. In the melee Police Commissioner Glassford failed to organize his men. Several were surrounded... and beaten up; two policemen... fired to protect their lives and killed two marchers....

In the midst of this riot the District Commissioners... asked military assistance to restore order.... General Douglas MacArthur was directed to take charge. General Eisenhower (then Colonel) was second in command. Without firing a shot or injuring a single person, they cleaned up the situation.

Translation: Hoover is saying "if I'm going down for this, I'm going to do my best to take Eisenhower with me."

Certain of my directives to the Secretary of War, however, were not carried out. Those directions limited action to seeing to it that the disturbing factions returned to their camps outside the business district. I did not wish them driven from their camps, as I proposed that the next day we would surround the camps and determine more accurately the number of Communists and ex-convicts among the marchers. Our military officers, however, having them on the move, pushed them outside the District of Columbia....

Translation: Hoover is saying "MacArthur, not me, fired the camps and dispersed the B.E.F. with tear gas."

Hoover's version is frightening: if Hoover is correct, then commander of the army MacArthur disobeyed orders given by his civilian superiors and used military force against American citizens exercising their constitutional right to petition for the redress of grievances. Hoover and MacArthur both agreed that the B.E.F. was "a mob... animated by the essence of revolution," and MacArthur at least believed that if there had been any further delay in disbursing the marchers "the institutions of our government would have been very severely threatened."

A version that puts less trust in Hoover's views is even more frightening: Hoover thought that in the Great Depression a large class of American citizens--B.E.F. marchers, communists, ex-convicts, "inflammatory" Democratic congressmen, the "sensationalist" press--had become Enemies of the People in Hoover's mind.

Hoover's search for anti-American enemies conspiring against him was not limited to impoverished ex-veterans. It included the legislative barons of the Democratic Party (who ); the legislative barons of the Republican Party (who ); and the powers-that-be on Wall Street, who had, Hoover believed, turned into "bears" conducting "bear raids" on the market to push prices down, line their own pockets further, and deepen the Great Depression. Early in 1932 Hoover summoned Wall Street's powers-that-be to account: either they were to stop their "bear raids" on the market and restore stock prices, or he would encourage the Senate to go on an investigative witch-hunt.

We were still--even with the burning of the B.E.F. shantytowns--light-years away from Hitler's suppression of the German Social Democratic Party, or Pinochet's soccer-stadium massacres of Chilean leftists and supposed leftists after his coup. There were additional signs of proto-fascism in the Depression-era U.S.: Huey Long, the anti-semitic radio priest Charles Coughlin, Gerald L.K. Smith. But we were still far from Mussolini's murders of socialist legislators like Mateotti, or from French Premier Daladier's resignation from the Prime Ministership out of fear of the French fascist mobs in the Paris streets outside.

But would the United States have stayed as far from a breakdown of democracy in the absence of Roosevelt's New Deal? What would four years of continued deep depression with no visible signs of recovery have brought?
 
 

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The Social Welfare State and the Great Levelling:

The usefulness of market systems as social allocation and control mechanisms--as instruments to guide economic activity in ways that promote the general welfare--depends on the distribution of income. Markets carry out their implicitly assigned tasks with ruthless efficiency. The key to managing systems of markets is to determine what instructions the market is being implicitly given, and how to alter those instructions.

Systems of markets can indeed promote the general welfare under certain conditions. These required conditions are that property rights be well-defined, and that spillovers be small--thus market systems will be good at activities like allocating labor or finding and exploiting minerals (where property rights in land are set), and will be bad at activities like directing the proper amount of resources to research (for one firm can receive powerful benefits from another's research) and controlling pollution (for no one polluter benefits directly and immediately from his own pollution reduction).

There is another required condition: that the general welfare be defined in a way that weights the material well-being and utility of each individual in an appropriate manner that depends on his or her wealth. A clarifying assumption is that each doubling of material consumption adds an equal amount to individual utility. This captures the fact that the first dollar of income is more valuable than the second, the second more valuable than the third, and so on. Under this clarifying assumption theoretical economists' formulas and theorems take on a particularly simple form: the market maximizes the general welfare if one's definition of the general welfare weights the material well-being and utility of each individual by the market value of his or her wealth. If I am ten times as wealthy as you are, then the market arrives at the distribution of production and consumption by transfering resources from making goods that you desire and consume to making goods that I desire and consume as long as each transfer that increases my material well-being by one unit decreases yours by ten units or less.

With unequal distribution a market economy will generate extraordinarily cruel outcomes. If my wealth consists entirely of my ability to work with my hands in someone else's field, and if the rains do not come so that my ability to work with my hands has no productive market value, then the market will starve me to death. The market system produces and allocates goods to individuals in a way that maximizes its definition of general welfare, a definition that gives my material well-being, utility, and indeed my survival a weight of zero if that is the market's valuation of my initial wealth-my ability to work.

For this reason, it is key to look at the distribution of wealth to assess the performance of any economy as an engine for producing human material well being. A natural way to evaluate the social and political order--a way embraced by conservative economists like James Buchanan as well as by liberals like John Stuart Mill--is to use Bentham's criterion: each individual counts for one and only for one so that the material well being and utility of each weighs the same in the balance.

The market seeks to maximize utility weighting each individual by his or her initial wealth, and will do the best that it can to accomplish this task. If the initial distribution of wealth is relatively equal, then the market's equilibrium will be close to the best that could be attained from Bentham's perspective: the allocation will be such that no one's material well-being can be raised without lowering someone else's material well-being by a greater amount. If the initial distribution is grossly unequal, then there will be plenty of rearrangements of goods that would raise some people's utility by more than they would lower others'. But those whose utility would be raised are the poor who do not weigh as heavily in the market's calculation, and those whose utility would be lowered are the rich whose preferences and desires weigh heavily indeed. The more unequal is the wealth distribution, the further will the economy as a mechanism for generating material well-being fall short of what could be attained, at least according to Bentham's perspective.

Levelling has not been the rule since the founding of the United States. There was an increase in inequality before the Civil War that turned what foreign observers saw as the remarkably egalitarian economy of the colonial era into an economy that from 1850 to 1929 had steep gradations of wealth not too different from those experienced in nineteenth century Europe or seen in the third world today. The lack of an egalitarian distribution of wealth in the United States at the turn of the twentieth century is somewhat surprising. The United States possessed many advantages: "abundant land, alleged equality of opportunity, democratic institutions... a nineteenth-century reputation as an ideal 'poor man's country'." Yet these were not enough to keep the distribution of income in the nineteenth century as equal as it had been in the eighteenth.

Growing inequality--not absolute immiserization of the working class, but a growing (relative) gap between the income and wealth of rich and poor even as industrialization raised living standards of all classes--was a natural result of the form industrialization took in nineteenth century America. Rapid accumulation of capital did tend to crowd unskilled labor out of its place in the workforce, and did tend to force unskilled laborers to reduce their relative wages in order to maintain or win back their jobs. In the nineteenth century skilled and educated workers could not easily be replaced by machines; capital could more easily substitute for unskilled workers. In addition, the opportunities of industrialization increased the share of total product that was paid as rent and profits. As farm productivity increased, the agricultural sector shrank, releasing additional supplies of relatively unskilled workers to the urban and industrial job markets. And tthe waves of mid- and late-nineteenth century immigration included many non English speakers, who found it very difficult to acquire skills or to use the skills that they had.

The distribution of income and wealth in the slaveholding south had always been extraordinarily unequal: how could it be otherwise when one-third of the population are held as chattels? But the distribution of income and wealth in the south did not become much more equal after the Civil War. Blacks remained extraordinarily impoverished relative to whites. And even southern whites were poor relative to northern city dwellers or midwestern farmers. In a sense, the relative impoverishment of the south was to be expected given the economic and political choices southerners made. The pre Civil War south had seen its wealthy accumulate not physical capital but slaves. The acquisition of a machine raises society's total wealth and productive power available per worker. The acquisition of a slave does not: it does not raise productivity, but merely gives the slaveholder an all but unlimited right to exploit the labor of the slave. The Civil War did not impoverish the south: it merely transferred "ownership" of ex-slaves' capacities to labor from masters to the ex-slaves themselves. It did reveal how impoverished the slaveholding south had become.

Choices made after the Civil War did not help. Mechanization did not come rapidly to southern agriculture. Southern governments did not believe in a good system of public education-particularly not for black Americans. This lack of a skilled, literate, and educated workforce meant that for most of a century northern manufacturers would not risk moving their operations to the south. The south would not begin to close the relative income gap separating it from the rest of the United States until the period after the First World War

World War I saw a sharp but short-lived compression of the income distribution. Wages became much more equal in the space of a few short years. But this compression was quickly undone in the 1920's, which saw "...very unbalanced technological progress, with productivity advancing faster in automobiles...consumer appliances, petrochemicals, and electric utilities" then elsewhere in the economy. These sectors were skill-intensive sectors. Relative skilled workers, both white collar and blue collar, once again captured the lion's share of the increased incomes made possible by technological change. The property income share also rose somewhat in the 1920's. It is uncertain whether relatively poor and unskilled blue collar workers experienced any rise in their wages adjusted for in_ation between 1920 and 1929.

The Great Depression, World War II, and the immediate post-World War II period saw a substantial levelling of the income distribution. The figure below plots the wages of three groups--skilled urban workers, skilled manufacturing workers, and professors--relative to the wages of unskilled laborers from 1907 to the early 1970's. The figure shows a reduction of at least half in wage differentials. Skilled urban workers earned ninety percent more than unskilled workers before the Great Depression; they earned some sixty percent more after World War II. Skilled manufacturing workers earned close to double what unskilled workers earned before the Great Depression; they earned only forty percent more after World War II. And professors' incomes before the Great Depression were (aside from the years immediately after World War I) four times those of unskilled workers before the Great Depression; they were only twice those of unskilled workers in 1960. Similar patterns can be found in the share of income going to property rather than to labor: it, too, dropped by a third-from thirty percent to twenty percent of total national product-between the 1920's and the 1950's.

Williamson and Lindert guess that about half of the reduction in wage inequality was due to a shift in the character of technological progress after 1929. Before 1929, productivity growth had been concentrated in manufacturing industry and other sectors that required a relatively skilled workforce. As the economy's structure shifted toward these sectors where productivity was growing most rapidly, demand for and returns to skills and capital rose and demand for unskilled labor fell. After 1929, productivity growth was much more balanced: productivity in agriculture and in service sector jobs that relied on unskilled labor more than skilled labor also grew rapidly. The other half of the levelling comes from demographic factors: fewer children and more education per child both shifts the distribution of skills within the population-making more skilled and fewer unskilled workers-and diminishes the supply of unskilled workers.
 

The Twentieth Century Levelling of the Income Distribution: Wage Levels as a Multiple of Unskilled Worker Wages
 
 
 

The levelling of the wage distribution was also encouraged by the growth in the number of jobs that were relatively low-skilled yet also paid high wages. English engineers had always noticed that American manufacturing industries made simpler and rougher goods, used less skilled labor, and seemed to incorporate much more of the knowledge needed to run the process of production into machines and organizations, leaving much less in skilled workers' brains and hands. Some of this was simply economizing on the relevant margin-skilled workers were exceedingly scarce in America throughout the nineteenth century, and it seemed worthwhile to follow production strategies that used skilled workers as little as possible. Some of this was finding new and more productive ways of doing things.

Mass production carried this "American system" to its extreme. As Henry Ford's engineer Max Wollering said: "Mr. Ford...realized...that in order to create great quantities of production, your interchangeability must be fine and unique in order to accomplish the rapid assembly of units. There can't be much hand work or fitting if you are to accomplish great things." Every time a skilled worker is needed to file or adjust an already-made part before it is added to the car under construction, time is wasted. At Ford in 1913 at most 26 percent of workers were classified as "skilled or skilled operators"--a substantially lower proportion for a substantially wider job class when compared to the 70% that Daimler employed who were "skilled workers." And Ford could build Fords with a productivity more than ten times that with which Daimler could build Mercedes cars.

Pre-Depression unions are usually counted as failures. Yet the "union threat" appears to have played a major role in starting the $5 day at Ford, and in setting the pattern for a system of labor relations that would dominate blue-collar assembly lines in the United States for half a century: we will pay you very high wages for unskilled, if difficult and alienating, work, and in return you will not disrupt production or smash the machines: even the likes of Herbert Hoover would, after the $5 day, say that of course firms should share their profits from mass production with their workers. This system was worthwhile for employers because it economized on expensive skilled labor. This system was worthwhile for employees because it paid them high wages. And this system was a significant contributing factor to the mid-twentieth century levelling of the American income distribution.

The restriction of immigration after 1920 also diminished the supply of unskilled, newly-arrived workers competing for low-level urban jobs. This made the distribution of income and wealth within America more equal. Note, however, that many who would have been Americans had the open-door immigration policies of the nineteenth century continued were excluded from the country. For the most part such excluded potential immigrants were far poorer than they would have been had they been allowed to come to America.

In addition to the levelling created by the drawing together of wage levels and the reduction in the share of income going to property, the distribution of income was also made more equal by the actions of the government. The New Deal of President Franklin Roosevelt saw the beginnings of a transfer system-Social Security, Supplemental Security Income, and Aid to Families with Dependent Chidren-to provide income to those who could not, for reasons of age, health, disability, or within-household demands on their time-earn money in the labor market.

The American welfare state was never seen as an income levelling tool in its own right, but only as a "safety net" to provide security against potential disasters: impoverishment in old age, disability, desertion by a husband, and so forth. The New Deal established a "social insurance" rather than a "welfare" state in that the point of the programs was as much to let the employed and relatively well off sleep easier at night by "insuring" them against porential disasters as to help raise the standard of living of the poor. The social insurance state did contribute to the levelling of the income distribution, although this was never its primary purpose. In addition, taxation became progressive. Those in higher income brackets were expected to, and until the 1980's by and large did, contribute a larger proportion of their incomes to the government in taxes than those in lower income brackets.

But civil rights for Blacks had to wait until after World War II.
 
 

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Left, Right, or Center?

The failure of "orthodox" economics to have anything constructive to say about the Great Depression paved the way for the advance of socialism, and the emergence of social democracy, during and after the Great Depression. The habits of mind that had supported laissez-faire capitalism--social Darwinism, the benefits of free competition, and the rest-seemed much less reasonable, and must less worthwhile during the Great Depression. A work ethic-a feeling that one should be ashamed not to be doing one's best and working one's hardest--was an important foundation stone for the pre-Depression order, yet such a feeling--that lack of a job was a sign of one's own lack of worth--was insane in the depths of the Depression.

As George Orwell put it:

the thing that horrified and amazed me was to find that many of [the unemployed] were ashamed of being unemployed. I was very ignorant, but not so ignorant as to imagine that when the loss of foreign markets pushes two million men out of work, those two million are any more to blame than the people who draw blanks in the Calcutta Sweep. But at that time...the middle classes were still talking about 'lazy idle loafers on the dole' and saying that 'these men could all find work if they wanted to'...

This, to Orwell, was all the proof he needed that the existing system was illegitimate. It raised people up to believe that they were failures if they failed to find work, and yet also created:

streets where nobody has a job, where getting a job seems about as probable as owning an aeroplane and much less probable than winning fifty pounds in the Football Pool.,,

Orwell's touchstone for judging a social system was a combination of honesty, decency, prosperity, and liberty, but with the accent on decency. The social and economic system had a moral obligation to treat these men-its most productive resource-well. It was not decent that they should be without work. And since the system did not live up to the obligations it had undertaken, it did not deserve to survive.

These sentiments were reinforced by the "orthodox" failure to come up with any plans for the alleviation of the Depression. It should be put more strongly: the "orthodox" belief that any plans set up for the alleviation of the Depression were counterproductive and would lead to more harm than good. In the 1930s, intellectuals and politicians turned this syllogism set out by Schumpeter and by his fellow believers such as Hayek, Mellon, and Robbins upside down. They had said that only if you accepted the necessity of Great Depressions could you have the benefits of capitalist development. Orwell and everyone left of center believed this--and concluded, instead, that we cannot afford the costs of capitalist, and must seek for some other kind of economic organization.

The relative stagnation and decline of average living standards during the Depression also sharpened conflicts over distribution. As long as the pie is growing and expected to keep on growing, the inequality of the slices may not matter as much as the fact that everyone's slice is getting larger. But when the engine of capitalist development appears stalled, the inegalitarian face of capitalism imposes costs unacceptable to a benevolent and decent society. For example, says Orwell, think of how modern civilization is built on the labor of the coal miner:

Practically everything we do, from eating an ice to crossing the Atlantic, and from baking a loaf to writing a novel, involves the use of coal....Here am I, sitting writing in front of my comfortable coal fire....It is only very rarely... that I connect his coal with that far-off labour in the mines.... Yet their lamp-lit world down there is as necessary to the daylight world above as the root is to the flower.... [I]t is brought home to you, at least while you are watching, that it is only because miners sweat their guts out that superior persons can remain superior. You and I and the editor of the Times Lit. Supp., and the Nancy Poets and the Archbishop of Canterbury and Comrade X, author of Marxism for Infants--all of us really owe the comparative decency of our lives to poor drudges underground, blackened to the eyes, with their throats full of coal dust, driving their shovels forward with arms and belly muscles of steel...

Hard work and inequality might be tolerated if, as the masters of capital had always said, they were necessary for the successful operation of the engine of capitalist development and would make everyone better off in the long run. But the Great Depression revealed that the guardians of economic orthodoxy had no more insight into the way the modern economy really did work than the Wizard of Oz. The Depression suggested that the costs of capitalist development--in terms of starvation, privation, and inequality--were far greater than had previously been thought. And the Depression made plausible once again the argument that the promise that inequality would generate growth was just a confidence game.

What was the alternative? one alternative was to believe that the Soviet Union promised a way out. A positive example of another, presumed to be better system. For example, Orwell's publisher Victor Gollancz, in the introduction Gollancz wrote to The Road to Wigan Pier, held that the Soviet Union had been a great boon because it had demonstrated that socialism was possible: "[T]he most frequent argument which socialists have to face is precisely this: 'I agree with you that Socialism would be wholly admirable if it would work-but it wouldn't'.... [This] objection was more frequently heard in 1919 than in 1927, in 1927 than at the end of the first Five Year Plan, and at the end of the first Five Year Plan than to-day-the reason being precisely that... the achievements of the Soviet Union are there to see."

From today's standpoint, it is hard to imagine what the impressive achievements of the Soviet Union that Gollancz pointed to were. Industrial production under Stalin did not recover to its pre-World War I Czarist trend line (such statistical comparisons were, however, unavailable). Stalinist Russia after the collectivization of agriculture was not an exporter of food. Czarist Russia had been one of the major grain exporters of the world. There was the suppression of internal dissent, the secret police, the terror-famine of the collectivization of agriculture, and--starting in 1934--the purges on a scale that not even Ivan the Terrible could have imagined.

Arthur Koestler--still in the early 1940's a man of the left and not yet famous as the anti-Communist author of Darkness at Noon-was heartbroken at the influence over the left exercised by the Soviet Union. Its suppression of internal dissent, its execution of most of its own founders, and its repeated shifts in foreign policy had robbed it of moral authority. Who could believe a movement that thought that Nazism was to be encouraged (for the Nazis will not last long, and will be followed by socialists: in Lenin's phrase, "the worse, the better") up to 1934, supported "Popular Front" alliances of Communists with Social Democratic parties from 1935 to 1937, in 1938 began shooting non-Communist left-wing allies claiming that they were fascists, and switched back to openly pro-Nazi in 1939 with the Nazi-Soviet pact, and then switched again in mid-1941 with the German invasion of Russia?

Yet the myth of the Soviet Union retained an astonishing hold. To some degree, this was simply a projection onto the present of the belief that the French Revolution had been an exciting, levelling, and redeeming cataclysm, and so the same must be true of twentieth century revolutions. Consider through Orwell's eyes revolutionary Barcelona during the Spanish Civil War:

In outward appearance [Barcelona] was a town in which the wealthy classes had practically ceased to exist.... [E]veryone wore rough working class clothes.... All this was queer and moving. There was much in it that I did not understand, in some ways I did not even like it, but I recognized it immediately as a state of affairs worth fighting for.... There was no unemployment...you saw very few conspicuously destitute people, and no beggars.... Above all, there was a belief in the revolution and the future, a feeling of having suddenly emerged into an era of equality and freedom. Human beings were trying to behave as human beings and not as cogs in the capitalist machines. In the barbers' shops were anarchist notices...solemnly explaining that barbers were no longer slaves...

Leninist socialism rested on Marx's belief that a sustained and permanent increase (as opposed to a selective, partial, and temporary increase) in the average worker's standard of living was not possible under market capitalism, and required full-scale socialism: abolition of the market system, government seizure of the "commanding heights" of the economy, from each according to his ability, to each according to his means. Such a belief had looked plausible through the "hungry forties"--the 1840's--in England. It looked plausible once again in the 1930s. Trotsky, writing during the 1930's , believed that the Great Depression had finally demonstrated showed that Marx had been completely right, and the foundations of the market capitalist order were completely rotten:

[In the 1920s]... the bourgeoisie, frightened by its own crimes and by the October Revolution, took to the road of advertised social reforms.... [But] the economic contradiction between the proletariat and the bourgeoisie was aggravated... the rise in the standard of living of certain strata of toilers... hid the decrease of the proletariat's share in the national income....

In 1930 began an ominous growth of unemployment.... The illusion of the uninterupted 'progress' of all classes has vanished without a trace. The relative decline of the masses' standard of living has been superseded by an absolute decline.... The history of the capitalist world since the last war has irrefutably borne out the so-called "theory of increasing misery"...

With the coming of the Depression, it was not unreasonable to conclude that the old order was bankrupt. There appeared to be no serious possibilities for reorganizing the market economy. Democracy was also on the retreat: Britain and its dominions, Ireland, France, the United States, Switzerland, and Scandinavia were the only democracies on the eve of World War II.And so the choices seemed boiled down to Hitler or Stalin. In which case, how should we choose? Many--including thinkers and politicians who would play major roles in the 1940's in setting the foundations of the post-World War II liberal democratic industrial capitalist order, like George Orwell and Harry Dexter White (architect of Bretton Woods, and at the least an "agent of influence" for Whittaker Chambers' Soviet spy apparatus in the 1930s)--chose Stalin for at least a little while, doubting the survival (or the value) of the old order, and hating Hitler more.

It was only by luck that the end of laissez faire as a doctrine for guiding economic policy did not mean the complete end of the market economy. "Keynesianism" and the "mixed economy" that it supported emerged barely in the nick of time.

XVIII. Falling into World War II-
J. Bradford DeLong
University of California at Berkeley and NBER

February 1997
 
 
 
 

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From the Rhineland to Munich
The Nazi-Soviet Pact
The Greater East Asia Co-Prosperity Sphere
The War
What If?
 

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From the Rhineland to Munich

While other countries continued to stagnate in the Great Depression, the German economy recovered rapidly. But peaceful spending-fueled recovery was not what Hitler thought his regime was about. His regime was about German rearmament: the breaking of the shackles of the Treaty of Versailles that restricted the German military to a total strength of 100,000; and eventually aggressive war with the Soviet Union and the other powers to Germany's east with the aim of increasing the "living space" of the German people.

Hitler announced that Germany was rearming, and met with no complaints. Did Britain and France want to invade Germany, depose Hitler, and set up an unstable government bound to be viewed as their puppet in his place, further inflaming German nationalism? Well yes--they did, had they but known what was coming. But their political leaders did not. In the Great Depression French and British political leaders believed that they had bigger problems than enforcing every provision of the Treaty of Versailles, that they wished to see Germany rejoin the community of western European nations. And since armaments were one of the standards prerogatives of the nation-state, it would be silly in addition to pointless to complain about Germany building its armed forces above the Versailles limits.

Besides, with Germany effectively disarmed there was a power vacuum between the border of the Soviet Union and the Rhine River. Poland and the Soviet Union had fought one war in the early 1920s that had seen the Red Army approach Warsaw before being turned back. Did French and British geopoliticians want to see a possible future Soviet war with Poland end with Communist armies on the Rhine River? Probably not.

In 1936 Hitler broke yet another provision of the Treaty of Versailles: he moved token military forces into the Rhineland, the province of Germany west of the Rhine that had been demilitarized after 1918. Once again it seemed pointless to protest, or to take action. No other European country had demilitarized zones within its borders. To require that Germany maintain a demilitarized zone seemed likely to pointlessly inflame German nationalism. And to enforce the provision would presumably require an invasion of Germany, the deposition of Hitler, and the installation of a puppet government--for Hitler seemed genuinely popular: there was a substantial risk that new elections would simply return Hitler to power.

In the spring of 1938 Hitler annexed Austria. Austria was inhabited overwhelmingly by ethnic Germans. One principle of the 1919 peace settlement had been, as much as possible and with a few exceptions, to draw national borders along ethno-linguistic lines so that every language had a nation, and everyone speaking a given language lived in the same nation. In annexing Austria, Hitler declared, he was simply gathering the German people into their one nation: reversing a political error committed in the late nineteenth century when the Austrian Germans were excluded from the political boundaries of Germany, an error that would have been corrected in 1919 save for Allied unwillingness to apply the same national self-determination principles to the Germans that they had applied to themselves and to the rest of Europe.

After the annexation of Austria, Hitler turned his attention to a second of the anomalous boundaries of post-World War I Europe: the "Sudetenland." The northern and western boundaries of Czechoslovakia followed the boundaries of the medieval Kingdom of Bohemia, and included a mountainous region that was the location of all the Czech frontier defenses and was also heavily populated by German-speakers. It took little for Hitler to fund a movement in the Sudetenland that decried oppression and discrimination by Czechs, and that demanded the annexation of the Sudetenland by Germany: the return of German-speakers to the German nation, according to the national self-determination principles of the Treaty of Versailles.

The British government had commitments to defend France; the French governments had commitments to go to war to defend the territorial integrity of Czechoslovakia; Czechoslovakia had no desire to surrender its mountain territories--and its frontier defenses. The British and French governments had no desire to get into a war to prevent the people of the Sudetenland from becoming part of Germany. Moreover, they feared the costs of a war. In the worlds of the novelist Alan Furst, they thought that:

The German bomber force as constituted in a theoretical month--May 1939, for instance--would be able to fly 720 sorties in a single day... 50,000 casualties in a twenty-four hour period. A million casualties every three weeks. And the USSR, Britain, and France were in absolute harmony on one basic assumption: the bomber would always get through. Yes, anti-aircraft fire and fighter planes would take their toll, but simply could not cuse sufficient damage to bring the numbers down.

The western democracies' military advisors feared that World War II would bring the horrors of the World War I trench line to civilians located far from the front.

They were right.

In order to avoid war, on September 29 and 30, 1938, at Munich in Germany, British Prime Minister Neville Chamberlain and French Prime Minister Edouard Daladier reached an agreement with Hitler: Hitler would annex the Sudetenland, would pledge to respect the independence of the rest of Czechoslovakia, and Britain and France would guarantee the independence of Czechoslovakia.

The Czechoslovak representatives were not even allowed in the room where the negotiations took place.

Upon his return to Britain, after being applauded by a cheering crowd that saw that general war had been averted, Neville Chamberlain irretrievably blackened his reputation for all time by saying:

My good friends, this is the second time in our history [the first time was 1878] that there has come back from Germany to Downing Street [official residence of the British Prime Ministers] peace with honour. I believe it is peace in our time.

Winston Churchill--out of office, and shunned by the other conservative members of the British House of Commons--had a very different view: better to fight Hitler in 1938 before German rearmament was well advanced and with Czechoslovakia as an ally, than to fight him later when Germany was better-armed and Czechoslovakia was gone. In retrospect Churchill was almost certainly correct. Given what was known about the ruthlessness and violence of the Nazi regime in its own country, it is hard to credit Chamberlain's belief that Hitler could be "appeased" and pacified by the abandonment of the restrictive military clauses of the Treaty of Versailles and by being allowed to absorb all regions occupied by ethnic Germans into his state.

On March 15, 1939, Hitler annexed the remains of Czechoslovakia, after first having sponsored secessionist movement in the "Slovakia" part of the country. Britain and France took no action. Neville Chamberlain stated:

The effect of this declaration [of independence by the Hitler-sponsored secessionist movement] put an end by internal disruption to the state whose frontiers we had proposed to guarantee [at Munich]. His Majesty's government cannot accordingly hold themselves any longer bound by this obligation.

In the spring of 1939 Hitler turned his attention to Poland, where the German-Polish border after World War I had been drawn not with attention to the ethno-linguisti principle but to give the newly-created Polish Republic at least one port city, and an outlet to the Baltic Sea. Hitler once again demanded the redrawing of borders--the elimination of the "Polish corridor" between the rest of Germany and the province East Prussia.

Had the British and French diplomatic policy makers been flinty-eyed realists, they would have shrugged their shoulders: Hitler wants to go east? Let him go east. They would have concluded that a Hitler fighting a series of wars to his east was unlikely to cause them trouble for a while at least. And that if Hitler at some point turned west, then would be the time to deal with him. But they did not do this. Neville Chamberlain and company extended guarantees to Poland and Romania: German attacks on Poland or Romania would cause declarations of war against Germany by Britain and France. Chamberlain appeared to believe that this commitment would deter Hitler from further adventures. He and his Foreign Minister, Lord Halifax, appear to have given no thought to what would happen if deterrence failed.
 
 

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The Nazi-Soviet Pact

And it was at this point that Hitler became interested in a--temporary--alliance with Stalin and the Soviet Union.

Stalin throughout the years of the "Popular Front" and "collective security," put out feelers to Hitler. Hitler was not interested. Hitler became interested in a deal with Stalin only in 1939, when he recognized how useful Soviet neutrality would be for his conquest of Poland. He and Stalin agreed to split Poland down the middle at the Bug River, and to give the Soviet Union a green light to annex the three Baltic Republics of Lithuania, Latvia, and Estonia.

On Stalin's part, this was the mother of all miscalculations. It allowed Hitler to fight three one-front wars in succession--one against Poland, one against Britain and France, and then one against the Soviet Union. Only by the skin of its teeth did the Soviet Union survive until America entered the war and American armies and air forces made it possible for an Anglo-American force to reenter the main theaters of the war.

Much better for Stalin and Russia to have fought Germany in 1939 with powerful British and French allies with armies on the continent than to, as he had to, face Germany's undivided attention in 1941 when no other anti-fascist armies were on the continent of Europe, or would be for two more years. For when Hitler and Stalin together moved into and partitioned Poland in 1939, Britain and France did carry out their commitments, and did declare war on Germany. Hitler attacked the Poles at dawn on September 1. After some hesitation the British government demanded at 9 A.M. on September 3 that the German army withdraw from Poland. At 11 A.M. Britain declared war.

But their forces were unready and were far from Poland, which fell to Hitler and Stalin in a month. After eight months of quiet on the western front, France fell in six weeks in 1940. To everyone's surprise, Britain--by then led to Winston Churchill--did not then negotiate a peace but kept fighting, daring Hitler to try an invasion across the English Channel. And in 1941 Hitler turned on the Soviet Union.

If Stalin did not recognize the danger of even a temporary alliance with Hitler, it was because he was--wrongly--anticipating a replay of World War I: trench warfare that would lead to a prolonged stalemate on the Franco-German border, during which another generation of young men would be turned into hamburger, another set of bourgeois countries would exhaust themselves, and another group of countries would become ripe for a Moscow-led Communist revolution.

When war came to the Soviet Union, and Germany attacked on June 22, 1941, Stalin's first instinct was to tell his troops not to fire back for fear of "provoking" the Germans. As a result, his air force was destroyed on the ground in the first day of the war. And the Soviet armies on the border died (or were taken prisoner) where they stood. In 1941 nearly four million Soviet troops were captured.
 
 

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The Greater East Asia Co-Prosperity Sphere

Japan responded to the Great Depression by turning imperialist.

World War I was a powerfu stimulus to Japanese industrialization. Although the Japanese government honored its alliance with the British government and declared war on Germany, its military actions during the war were limited to the largely-peaceful takeover of Pacific islands that Germany had claimed as colonies. However, exports from Europe to Asia effectively ceased during World War I. Where were the countries of Asia to purchase the manufactures that they had purchased from Europe? The growing and industrializing Japanese empire was an obvious source.

Industrial production and manufactured exports from Japan nearly quadrupled during World War I. Srong demand for Japanese goods provoked inflation: prices more than doubled during the war.

After World War I the European economies once again began to export to Asia, and the newly-expanded Japanese industries faced heavy competition. The Japanese economy in the first half of the 1920s was also badly hit by the disaster of the 1923 Tokyo earthquake, in which between 50,000 and 100,000 people died. But industrialization continued. Manufacturing surpassed agriculture in terms of the share of national product produced in the 1920s.

Japanese manufacturing originally relied--as had manufacturing in other countries--on the unmarried young woman as its typical worker. From the employers' point of view, the main problem with this workforce was its relative lack of experience. So over the first half of the twentieth century, Japanese manufacturers worked to try to balance their shor-term labor pool of unmarried females with a longer-term cadre of experienced male workers.

What evolved in Japan's industries was what is now called the "permanent employment system." Male workers were recruited on leaving school, or as apprentices, and promised effective lifetime employment and regular increases in wages in return or loyal service to the company. The company promised wages, medical care, and pension benefits. It is possible that this "permanent employment system" flourished in Japan because the system fitted Japanese sociology. It is also possible that Japan avoided the deep recessions that would have given manufacturing firms the incentive to fire their "permanent" workers.

Cotton textiles, furniture manufacturing, apparel, and a relatively small heavy industrial sector were the heart of the Japanese economy by the 1930s, and this modern manufacturing sector was dominated by the zaibatsu: associations of businesses that exchanged executives, cooperated, owned each other's stock, and relied on the same banking and insurance companies for finance. Japan's form of "financial capitalism" seemed to mimic Germany's to a large degree.

The Great Depression came to Japan in an attenuated form in 1930. Its exports, especially of silk, fell dramatically. The gold standard applied pressure to deflate the economy. Japan responded by cutting loose from the gold standard, and by expanding government spending--especially military spending. The Great Depression touched but did not stun the Japanese economy. More important, perhaps, the Great Depression revealed that the European imperialist powers were in crisis.

So 1931 saw the Japanese government turn expansionist. The extension of Japanese influence into Manchuria was followed by a Manchurian declaration of "independence" as the Japanese client state of Manchukuo. Expansion was followed by rearmament. Rearmament was followed by a full-scale attack on China in 1937. Government orders for war material and for capital goods to construct infrastructure in Manchuria provided a strong boost to Japanese industrial production at home. From 1937 on Japan turned to a war economy: warships, airplances, engines, radios, tanks, and machine guns.

But in order to continue its war against China, Japan needed oil from either the United States, or from what was to become Indonesia--what was then the Dutch East Indies. Roosevelt was anxious to exert what pressure he could on Japan. And in early 1941 the U.S. embargoed exports of oil to Japan.

Faced with the choice of backing down and abandoning the conquest of China, or seizing the Dutch-held oil fields of the southwestern Pacific and probably becoming embroiled in a war with the United States, the Japanese miliary elected to strike first. On December 7, 1941 atacks began on British, Dutch, and American forces and possessions in the Pacific. Most famous was the Japanese attack on Pearl Harbor that sank the battleships of the U.S. Pacific fleet. Most damaging was probably the attack on the U.S. airbase of Clark Field in the Philippines, which destroyed the B-17 bomber force that might have blocked Japanese searborne invasions.
 
 

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The War

World War II in Europe began on September 1, 1939. World War II in Asia had already been ongoing for more than two years. The range of belligerents expanded and contracted. In Europe the war began as France, Britain, and Poland against Germany. Poland was conquered by Germany and Russia by the end of September, 1939. Russia attacked Finland, which fought it to a draw and a peace, in the winter and spring of 1940. The spring of 1940 also saw Germany attack and occupy Norway, Denmark, Belgium, the Netherlands, and Luxemburg; and conquer France, with Italy joining in on Germany's side.

By the summer of 1940 only Britain was fighting Germany.

In late 1940 and early 1941 Britain acquired Greece and Yugoslavia as allies. But they were conquered by Germany by the spring of 1941.

In the summer of 1941 Germany attacked Russia. And on December 7, 1941, the Japanese navy bombed Pearl Harbor in Hawaii and attacked a wide range of U.S., British, and Dutch territories in the Pacific. Germany declared war on the U.S. a day later. (But, curiously enough, Japan remained at peace with Russia.) And the war was truly global.

World War II was a "total" war. At its peak, some 40 percent of U.S. GDP was devoted to the war. Some 60 percent of British GDP was devoted to the war. Some 50 million--plus or minus 10 million--people died in, during, and as a result of war.

From 1942 on, once the war had become a truly global war, Hitler's defeat was nearly inevitable. Even Britain alone was matching Germany and Nazi-occupied Europe in war production. Throw in the United States and the Soviet Union, and Germany was outproduced more than eight to one; Germany and Japan together were outproduced more than six to one. U.S., British, and Russian armies met in the rubble that had been Germany in the spring of 1945; Adolf Hitler committed suicide as the Russian armies closed in on his Berlin command post. Japan, atom-bombed, firebombed, blockaded, and threatened with invasion, surrendered in the summer of 1945.

When World War II ended, perhaps 40 million in Europe (and perhaps 10 million in Asia) were dead by violence or starvation. More than half of the dead were inhabitants of the Soviet Union. But even west of the post-World War II Soviet border, perhaps one in twenty were killed--close to one in twelve in Central Europe. In World War I the overwhelming proportion of those killed had been soldiers. During World War II fewer than half of those killed were soldiers.

Material damage in World War II was spread over a wider area than in World War I. Destruction in the First World War was by and large confined to a narrow belt around a static trenchline. Although material destruction along the trenchline was overwhelming, it extended over only a small proportion of the European continent. World War II's battle sites were scattered more widely. Weapons were a generation more advanced and more destructive. World War II also saw the first large-scale strategic bombing campaigns. The aftermath of World War II saw many of Western Europe's people dead, its capital stock damaged, and the web of market relationships torn. Relief alone called for much more substantial government expenditures than reduced tax bases could finance. The post-World War I cycle of hyperinflation and depression seemed poised to repeat itself. Prices rose in Italy to 35 times their prewar level. France knocked four zeroes off the franc.
 
 

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What If?

Had World War II gone otherwise, we would live in a very different world.

Had Franklin D. Roosevelt decided in the spring of 1941 that with Europe ablaze it was unwise for the U.S. to try to use an economic embargo of militarily-necessary oil to pressure Japan to withdraw from China, 1945 would probably have seen the U.S. and Japan at peace, the coastal provinces of China Japanese-occupied colonies, the interior of China an anarchy, and the prestige of the Japanese military that had established this co-prosperity sphere greatly heightened.

Had the British and French governments been willing to use force to remove Hitler when he occupied the Rhineland in 1936, or threatened Czechoslovakia in 1938, there would have been no World War II in Europe.

Had Stalin allied with Britain and France and declared war on Germany when Hitler invaded Poland in 1939, in all probability Hitler would have been crushed and World War II in Europe ended by the end of 1941.

Had anyone other than Winston Churchill become British Prime Minister in 1940--had Nevile Chamberlain remained, or had Lord Halifax assumed the post--then the British government would almost surely have negotiated a separate peace with Germany in 1940. When Germany attacked Russia in 1941, it would have done so with its full strength. Stalin's regime would probably have collapsed, and European Russia up to the Urals (and perhaps beyond) have become German territories, colonies, or puppet states.

It is not likely that Hitler would have refrained from attacking Russia in any possible universe. The need to do so was buried too deeply in his world view to be denied.

Last, what if Hitler had not declared war on the United States in 1941? Would Roosevelt have been able to get congress to declare war on Germany on the grounds taht all the Axis powers were allied, or would congress have insisted on concentrating on fighting Japan first? If the second, then would Britain and Russia have been able to defeat Germany by themselves, or would 1945 have seen the United States dominant in the Pacific and Germany dominant in Europe?

We do not know. We do know that most of the alternative ways that World War II might have gone would trade a postwar period with a Communist evil empire centered in Moscow and dominant over eastern Europe for a postwar period with a Nazi evil empire centered in Berlin and dominant over all Europe, or perhaps Eurasia. Not an improvement.

We are very lucky that World War II was not even worse for humanity than it was.
 

XIX. Present at the Creation-
J. Bradford DeLong
University of California at Berkeley and NBER

February 1997
 
 
 
 

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Overview
The Post-WWII Settlement: The United States
U.S. Economic Leadership: The Marshall Plan
The Post-WWII Settlement in Western Europe: NATO, Cold War, and Prosperity
 

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Overview

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.
 
 

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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.
 
 

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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.
 
 

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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.
 
 

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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.

XX. The Great Keynesian Boom: "Thirty Glorious Years"-
J. Bradford DeLong
University of California at Berkeley and NBER

February 1997
 
 
 
 

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European Supergrowth
The Moderation of the Business Cycle
Labor Peace
Bretton Woods
Technological Diffusion
 

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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.
 
 

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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.
 
 
 

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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.
 
 

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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:

Exchange rates were fixed and pegged, but the pegs were adjustable in response to "fundamental disequilibrium." The idea was to avoid a situation like that of Britain in the late 1920s, when either devaluation or deflation is called for, and adherence to the rules of the game of the gold standard would force deflation and a prolonged depression.
Controls on international capital flows were explicitly allowed: Keynes and White had no desire to see international speculators move exchange rates and upset governments' policies.
The International Monetary Fund was established to be a referee. It would extend financial support to countries that needed more reserves to ride out a temporary balance-of-payments deficit. It would be the judge of whether "fundamental disequilibrium" existed and thus of whether exchange rate pegs should be changed.
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.
 
 
 

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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.
 

XXI. False--and True--Starts to Development in the Third World-
J. Bradford DeLong
University of California at Berkeley and NBER

February 1997
 
 
 
 

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Decolonization
Government by the Thieves
Juan Peron and Argentina
The Case of Iran
Patterns of Growth
The Key Role of Mechanization
The Left in the Third World
 

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Decolonization

When the European colonial powers Britain and France withdrew from their empires, the bureaucracies and structures of government left behind were that of the industrial west: representative parliamentary institutions, independent judiciaries, laws establishing freedom of speech and of assembly, and a strong civil service tradition among the bureaucracy. The hope was that, freed from the oppressive controlling hand of colonial rule, democracy in the newly-independent former colonies was thought likely to fiourish. And since their economies would no longer be controlled in the interests of the imperial power, economic prosperity should follow as well.

But it was not to be. In most countries the political aftermath of decolonization was a catastrophe. Westminster-style parliamentary politics and independent judiciaries soon became rare exceptions: found only in India (a very important exception indeed) and a few others.

Instead, régimes emerged that derived their authority not from electoral competition between different groups of possible representatives but from the army and the police suppressing dissent with a varying level of brutality, or--in the best case--from populist attachment to a charismatic nation-symbolizing reforming leader.

In many places the economic aftermath was also a near-catastrophe. Relatively less oppressive modern dictatorships produced rapid and impressive economic growth in the non-Communist fringe of Pacific Asia, and in Saharan Africa. India with great tenacity maintained its hold on parliamentary democracy (but its economic growth was unimpressive).

But long-independent Latin America by and large continued to fail to close the relative income gap vis-a-vis the industrial west (although it continued to increase GDP per capita in absolute terms). And in a large belt beginning in South America, taking up almost all of tropical Africa, and also including much of southern Asia, economic growth has been the exception and not the rule over the past generation.

In Africa south of the Sahara, only Botswana, Lesotho, the Cameroon, and perhaps one or two others have managed to reduce the relative income gap vis-a-vis the industrial west. Kenya, Mali, Malawi, Zimbabwe, Guinea, the Côte d'Ivoire, Nigeria, and South Africa among others in Africa have seen rising living standards, but a rising relative income gap vis-a-vis the industrial core. In these countries the glass is still half-full: increasing relative income gaps vis-a-vis the industrial core have been nevertheless accompanied by rising living standards and productivity levels.

But in another group of countries the average person is probably poorer in absolute terms than their counterparts back in 1965: Mozambique, Togo, Ethiopia, Tanzania, Senegal, Ghana, Madagascar, Chad, Zaire, Zambia, Niger, and Uganda, among others in Africa; Argentina, Boliva, Chile, El Salvador, Jamaica, Nicaragua, Peru, and Venezuela among others in Latin America.

Why has this happened? What has gone wrong? The storehouse of industrial technologies developed since the industrial revolution is open to all. The forms of knowledge and technologies that make the industrial west today so rich are public goods. The benefits from tapping this storehouse are enormous, and have the potential to multiply the wealth of all social groups and classes--property owners and non-property owners, politically powerful and politically powerless alike--manyfold. All developing economies ought to have experienced not just substantial growth in absolute living standards and productivity levels, but ought to have closed some of the relative gap vis-a-vis the world's industrial leaders since independence.

Yet a large proportion of the successor régimes to colonial domination have failed to do so.

Absolute poverty is not the reason. Even relatively poor parts of the third world today have levels of material wealth as high as those found in seventeenth century Scotland or Italy. Resource scarcity is not the reason: the world as a whole can far more than feed itself, and there is no shortage of mineral and energy resources to provide constructive and socially valuable work for even unskilled hands.
 
 

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Government by the Thieves:

One short answer is that the fault--where there is fault--lies in governments: kleptocracy--govenment by the thieves, as it has been named in analogy with aristocracy (goverment by the best), monarchy (goverment by the one), and democracy (government by the people)--has impoverished much of the third world over the past generation.

A longer answer would detail why bureaucrats, army officers, and politicians in the third world, as benevolent and as concerned with national wealth as bureaucrats, army officers, and politicans anywhere, have so often sacrificed economic development and the long-run interests of all to the short-run interests of a relative few.

Many modern dictatorships rule because the army tolerates the present rulers, either the politicians or the set of colonels who led the last coup. The first priority, therefore, is to keep the army happy: well-fed and supplied with expensive war toys imported from abroad. Modern dictatorships rule peacefully because they control the visible centers of sovereignty: the physical locations in the capital from which the bureaucracy expect to receive their orders, and the centrally-located radio and television broadcast sites through which the rulers speak to the nation. Modern dictatorships are thus very vulnerable to urban discontent. If an urban riot overruns the president's palace, the ministries, or the television stations, then the government's rule is in serious danger. The second priority, therefore, is to avoid urban riots. And the third priority is to keep the notables-the bureaucrats and the political operatives-content, and potential opposition quiet or disorganized.

The pursuit of these aims comes prior to the formation of policy in the minds of rulers. All rulers believe they are the best people for the job: alternative ruling groups are at best incompetent, most likely wrongheaded and corrupt, and at worst amoral and destructive tyrants. Unless the government can stay in power, nothing good will be achieved for the country or the people. And so the first and most benevolent deed they can dois to make sure they remain in power. Only after the government's seat is secure will debates about development policy take place. But the pursuit of a secure hold on power almost always takes up all the rulers' time, energy, and resources-and thus makes their development policies for them.

To achieve the primary aim of damping down potential threats to the government, money is necessary. And not just any kind of money. Urban workers can be appeased by cheap food and high wages, but the army and the bureaucracy require imported luxuries, which requires that the government gain control of exports. Therefore governments squeeze export agriculture most of all: the acquisition of large revenues from it is the most important means to the preservation of the government's authority. And governments squeeze the rest of agriculture next: cheap food helps to avoid urban riots. High urban wages also protect against urban discontent, and urban discontent is dangerous because it immediately threatens the symbols of authority and sovereignty.

An overvalued currency makes everyone willing to do the government favors so that they can have access to scarce currency import pemits; and it makes imported luxuries relatively cheap. This policy package thus meets with the approval of the military, of the bureaucrats, and of the urban masses. The only politically powerful groups that remain whose interests are harmed by these policies are the bourgeoisie, the business class, the entrepreneurs and industrialists that serve as the engine of economic development in market economies.

Why don't potential entrepreneurs--those who would benefit most from pro-development policies, and whose enterprises would in turn employ and sell to and thus benefit many others--work to overthrow this anti-development ruling régime? Political scientist Robert Bates asked this question of a cocoa farmer in Ghana, seeking to learn why successful cocoa farmers did not lobby and agitate for a reduction in the huge gap between the price the government paid them for cocoa and the price at which the government sold the cocoa on the world market. "He went to his strongbox," Bates reports:

and produced a packet of documents: licenses for his vehicles, import permits for spare parts, titles to his real property and improvements, and the articles of incorporation that exempted him from a major portion of his income taxes. "If I tried to organize resistance to the government's policies on farm prices," he said while exhibiting these documents, "I would be called an enemy of the state, and would lose all these."

Businessmen find themselves heavily taxed and restricted by the state. But they also know that they continue to operate at even this reduced level because of the permission of the state, and that the state has the power to shut them down. The most vulnerable spot is usually the requirement of businesses to import goods to maintain their equipment. Permits for such imports are easy to control or withhold, are relatively cheap to provide, and yet can serve as sources of very strong pressure: without small and inexpensive imported spare parts, large, expensive, and highly productive imported machines will not work.

Besides, the state can also protect key existing businessmen from potential competition: potential future entrants into industries produce the most social benefit from an economic development perspective, yet have no resources with which to lobby because they have no existing businesses or clients. Restricting them does existing businessmen a favor at very low political cost. Since the overvalued exchange rate has made foreign currency a scarce good, competition from manufacturers abroad can also be easily strangled in selected sectors as a favor to key existing businessmen.

These redistributions from the entrepreneurial cutting edge of the economy to politically powerful interest groups are particularly expensive in the long run because the social benefits from innovation, entrepreneurship, and enterprise are so high. Observers of Africa, in particular, find it hard to believe that the present set of policy régimes can last for long: it is so demonstrably and obviously irrational and destructive. But then the Soviet Union's centrally-planned economy operated for nearly seventy years before an ideological sea change led to large scale demands for reform; and whether reform in the Soviet Union will be successful is still an open question.

The natural conclusion from third world history is that successful economic development is difficult without either a limited government or a developmental state: the logic of politics is that of favors performed, wealth redistributed, infiuence exercised, and taxes collected; that is very different from the logic of economic growth. Only a state that is limited in the amount of damage it can do to the economy, or a state that is secure enough, independent enough, and committed to rapid economic growth can avoid this development trap.

Yet throughout the post-World War II period intellectuals on all sides have applauded the strength of the state, on the ground that only a strong state could perform the historical tasks necessary for economic development. As one usually clear-eyed observer, the political scientist John Hall, put it:

forced development is socially brutal. Such development cannot be achieved under the ægis of soft political rule, and this means that the chances of a transition to democracy are correspondingly at a discount. [M]odernization, under whatever politicial ægis, involves at least disciplining the peasantry and at most forcibly removing it from the land. the removel of tribalism, the destruction of rival cultures, the creation of a lingua franca, and the establishment of national bureaucracies. Third World countries have learnt with time that successful modernization is impeded by democracy. For people do not easily accept the loss of their land and of their customary ways of life: this requires force [and]a totalizing ideology."

If past patterns continue, the future of much of the third world is one of continued relative economic stagnation.

With some luck, however, an increasing relative gap does not mean absolute decline: instead, there ma well be absolute improvement in productivity levels and living standards--but not as fast as productivity growth in the industral core.
 
 

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Juan Peron and Argentina:

To see how these forces worked themselves out in the years after World War II, take a closer look at one instructive case: that of Argentina.

The first thing to know about Argentina is that it has no business being a third world nation today. In 1929 Argentina had appeared as rich as any large country in continental Europe. It was still as rich as Europe in 1950, when western Europe had for the most part reattained pre-World War II levels of national product.

In response to the social and economic upheavals of the Depression, Argentina adopted demand stimulation and income redistribution. These policies were coupled with a distrust of foreign trade and capital, and an attraction to the use of controls instead of prices as allocative mechanisms. Argentina's growth performance in the post-World War II period was very poor. Even in the 1950's, and even relative to Britain, Argentine growth was slow.

Carlos Díaz-Alejandro provided the standard analysis of Argentina's post-World War II economic stagnation. According to his interpretation, the collapse of world trade in the Great Depression was a disaster of the first magnitude for an Argentina tightly integrated into the world division of labor. While Argentina continued to service its foreign debt, its trade partners took unilateral steps to shut it out of markets. The experience of the Depression justifiably undermined the nation's commitment to free trade.

In this environment Juan Perón gained mass political support.

Taxes were increased, agricultural marketing boards created, unions supported, urban real wages boosted, international trade regulated. Perón sought to generate rapid growth and to twist terms of trade against rural agriculture and redistribute wealth to urban workers who did not receive their fair share. The redistribution to urban workers and to firms that had to pay their newly increased wages required a redistribution away from exporters, agricultural oligarchs, foreigners, and entrepreneurs.
 
 

The Perónist program was not prima facie unreasonable given the memory of the Great Depression, and it produced almost half a decade of very rapid growth. Then exports fell sharply as a result of the international business cycle as the consequences of the enforced reduction in real prices of rural exportables made themselves felt. Agricultural production fell because of low prices offered by government marketing agencies. Domestic consumption rose. The rural sector found itself short of fertilizer and tractors.

Squeezed between declining production and rising domestic consumption, Argentinian exports fell. By the first half of the 1950's the real value of Argentine exports was only 60 percent of the depressed levels of the late 1930's, and only 40 percent of 1920's levels. Due to the twisting of terms of trade against agriculture and exportables, when the network of world trade was put back together, Argentina was by and large excluded.

The consequent foreign exchange shortage presented Perón with unattractive options. First, he could attempt to balance foreign payments by devaluing to bring imports and exports back into balance in the long run and in the short run by borrowing from abroad. But effective devaluation would have entailed raising the real price of imported goods and therefore cutting living standards of the urban workers who made up his political base. Foreign borrowing would have meant a betrayal of his strong nationalist position. Second, he could contract the economy, raising unemployment and reducing consumption, and expand incentives to produce for export by decontrolling agricultural prices. But once again this would have required a reversal of the distributional shifts that had been his central aim.

The remaining option was one of controlling and rationing imports.

Not surprisingly, Perón and his advisors believed that a dash for growth and a reduction in dependence on the world economy was good for Argentina. Díaz Alejandro writes:

First priority was given to raw materials and intermediate goods imports needed to maintain existing capacity in operation. Machinery and equipment for new capacity could neither be imported nor produced domestically. A sharp decrease in the rate of real capital formation in new machinery and equipment followed. Hostility toward foreign capital, which could have provided a way out of this difficulty, aggravated the crisis...

Subsequent governments did not fully reverse these policies, for the political forces that Perón had mobilized still had to be appeased. Thus post-World War II Argentina saw foreign exchange allocated by the central government in order to, first, keep existing factories running and, second, keep home consumption high. Third and last priority under the controlled exchange régime went to imports of capital goods for investment and capacity expansion.

As a result, the early 1950's saw a huge rise in the price of capital goods. Each percentage point of total product saved led to less than half a percentage point's worth of investment. Díaz Alejandro found: "[r]emarkably, the capitalin electricity and communications increased by a larger percentage during the depression years 1929-39 than 1945-55," although the 1945­55 government boasted of encouraging industrialization. Given low and fixed agriculture prices, hence low exports, it was very expensive to sacrifice materials imports needed to keep industry running in order to import capital goods. Unable to invest, the Argentine economy stagnated.

In 1929 Argentina had appeared as rich as any large country in continental Europe. It was still as rich in 1950, when Western Europe had for the most part reattained pre-World War II levels of national product. But by 1960 Argentina was poorer than Italy and had less than two-thirds of the GDP per capita of France or West Germany.

One way to think about post-World War II Argentina is that its mixed economy was poorly oriented: the government allocated goods, especially imports, among alternative uses; the controlled market redistributed income. Thus neither the private nor the public sector was used to its comparative advantage: in Western Europe market forces allocated resources--even, to a large extent, for nationalized industries--the government redistributed income, and the outcome was much more favorable.

In the absence of the Marshall Plan in particular and of an internationalist United States interested in fighting the Cold War and restructuring western Europe in general, might have Western Europe followed a similar trajectory?

In 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 a generation.

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.
 
 

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The Case of Iran:

Could things have been better? The case of the Iranian Revolution suggests that in many cases the answer is "no." For the reasons that the Shah of Iran was overthrown in 1979 had relatively little to do with his faults (which were many), but had much to do with obstacles to successful economic development.

The Imperial Iranian government was a tyranny. It had a fierce and dreaded secret police. It used revenues from sales of government-owned oil to build up an impressive and powerful military. But these were not the reasons that the Shah was overthrown.

The Shah hoped to use the bulk of oil revenues to turn Iran into an industrial country in one generation. This meant, first, land reform: distribute land to turn tenants and sharecroppers into independent farmers, and compensate landlords with government oil revenues. But rapid population growth and a desire not to offend rich landlords too much meant that the plots distributed were small. The boom in oil exports and the rise in oil prices together pushed up Iran's exchange rate by a wide margin: and with an overvalued exchange rate, it became profitable to import food. So newly-propertied peasant farmers found themselves with small plots and facing declining prices for what they sold.

They were supposed to become bulwarks of the regime, grateful to it for distributing land. Instead, they scratched what they saw as an inadequate living off of too-small plots, or moved to the cities. While a large share of the Iranian population saw their incomes growing rapidly in the years leading up to 1979, a large share of the Iranian population did not.

Steps to emancipate women proved unpopular among traditional infiuence makers as well. Steps to boost education-and the Shah was truly and genuinely committed to turning Iran into a literate, educated, technologically-proficient country-also produced a large body of students and intellectuals attracted to revolutionary politics.

From exile, the Ayatollah Khomeini--a former opponent of land reform--lit the fuse, calling on the Islamic clergy and the people to seize power from the despot and make an Islamic revolution. A forty-day cycle of demonstrations began, during which young religious activists would be shot by the police, thus triggering another demonstration forty days hence to mourn their deaths. In January 1979 the Shah fied into exile.

Thereafter Iran's economy stagnated. The decade-long war with Iraq absorbed tremendous resources. And the newly-dominant religious government had little interest in economic development: "the Iranian people did not make the Islamic revolution to reduce the price of watermelons."

From a cynical perspective the interesting question might be not why was there economic stagnation in much and absolute economic decline in some of the third world, but why there was rapid growth in other portions. Brazil, Mexico, and Panama in Latin America; Morocco, and Tunisia in Saharan Africa; and Hong Kong, Malaysia, Singapore, South Korea, Taiwan, and Thailand in Asia are just some of the countries that have made impressive strides toward closing the relative material prosperity gap vis-a-vis the industrial west in the post-World War II era. How have they managed to do this? What have been the key factors separating successful from unsuccessful episodes of economic development?
 
 

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Patterns of Growth

Four simple factors together account for half of the variation in economic growth rates of developing countries since World War II:

First, equipment investment. Developing economies that devote a large share of their national product to investments in machinery and equpment grow rapidly. A one percentage point boost to the equipment investment share of GDP is associated with an 8 percent increase in GDP per worker over the time span of a twenty-five year generation.
Second, other forms of investment.
Third, initial output per worker: the poorer a country, the more room for technology transfer and the faster growth.
Fourth, labor force growth: the faster labor force growth, the more difficult it is to educate, train, and equip the labor force with capital, and the slower is growth.
 

But what reason is there to think that these factors--especially equipment investment--are determinants rather than consequences of growth. The chief reason is the law of supply and demand: where growth is high, the relative price of capital goods is low. High equipment investment, low equipment prices, and rapid growth go together. If rapid growth was the cause of high investment, then the chain of causation would run from rapid growth to high future profits, from high expected profits to a high rate of investment and a high demand for equipment, and from a high demand to a high quantity of investment and a high price of equipment.

A high demand will lead to a high quantity only insofar as the high demand raises the price, and so makes it profitable for domestic producers to expand production and importers to expand imports. If high machinery investment were an effect rather than a cause of rapid growth, we would expect to see a high rate of growth and of machinery investment also associated with relatively high prices of machinery and equipment.

By contrast, if high equipment investment drives rapid growth, then we would expect to see supply conditions (pro-growth government policies, and a favorable environment). Favorable supply leads firms and investors to migrate down and to the right along their demand-for-machinery curve, and leads to a high quantity of equipment only insofar as the price is lower. If a high quantity of equipment leads to a rapid rate of economic growth, and so we see a high rate of growth and of equipment investment also associated with relatively low prices of machinery and equipment.
 
 

The importance of equipment investment as a correlate of growth in is not new. There is a similar pattern in the long run growth record of industrialized countries. This suggests that the association of machinery investment and productivity growth is not a result of any particular features of the post-World War II period, but instead refiects a deeper structure that will be present in most cases of industrialization and development.
 
 

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The Key Role of Mechanization

Why should machinery play such a key role? It is, of course, no accident that the era in which European economic growth took off is called the Industrial Revolution. Blanqui, first to use the phrase in print, identified its beginnings in the invention and spread of those "two machines, henceforth immortal, the steam engine and the cotton-spinning [water frame]." Ever since, qualitative historical discussions of growth have emphasized the role of machinery investment in augmenting labor power. The statement that "the machine is at the heart of the new economic civilization" is typical of accounts that have assigned a central role to mechanization. Technology embodied in machinery has been"the lever of riches."

Historians of technology have argued that the capital goods industries are uniquely well suited to serve as centers for technological diffusion to other sectors of the economy where such knowledge had practical applications. Rosenberg cites the Brown and Sharpe milling machine, built during the Civil War to make twist drills required for musket production. The newly invented machine turned out to have uses far beyond its initial application. "[W]ithin ten years afterthe first machine in 1862," Brown and Sharpe "had sold similar machines to manufacturers of hardware, tools, cutlery, locks, arms, sewing machines, textile machinery, printing machines, professional and scientific instruments, locomotives" and in subsequent decades sold to " a succession of firms producing cash registers, calculating machines, typewriters, agricultural implements, bicycles, and automobiles." The new technology is largely embodied in the milling machine, and diffuses rapidly throughout the economy to the extent that other firms purchase the machine tool.

If the case studies cited by the historians of technology are representative, they suggest-like the international cross-section-that a high rate of machinery investment is necessary for rapid economic growth. Certainly an anemic rate of machinery investment has been associated with rapid relative economic decline in the past, notably that of Britain. In 1870 Great Britain was still the center of the world's most advanced technologies. But, as Arthur Lewis puts it, by 1913: "organic chemicals became a German industry; the motor car was pioneered in France and mass-produced in the United States; Britain lagged in the use of electricity, depended on foreign firms established there, and took only a small share of the export market. The telephone, the typewriter, the cash register, and the diesel engine were all exploited by others." This is certainly consistent with the hypothesis that a lack of intensive practice using the machines that embody cutting-edge technologies retards the development of the skills necessary to efficiently use such cutting-edge technologies.

This suggests a strong role for the right sort of government intervention to advance industrial development: the government should step in because private investors do not face the right incentives to invest early and heavily in modern machinery and equipment. The private market system is, on this interpretation of the way the world works, likely to do a relatively bad job in encouraging the pattern of economic activity that will lead to very rapid growth, because those whose decisions are key for growth--firms that purchase and use machinery and equipment--do not recognize and are not rewarded according to the total social return to their actions.

A government that could be trusted to concentrate on economic development, and not on state-building or on its own maintenance of power, should be capable of generating a rapid acceleration of economic growth.

But how many governments can be so trusted? And what are the preconditions for the successful creation of a "developmental state"? These are questions to which no one has the answers.

Is a high rate of machinery investment sufficient for successful development? Clearly not. It is possible to commit very large portions of national output to equipment investment and yet to grow slowly. Equipment investment appears to produce large benefits only if market price signals--rather than administrative allocations--guide its use. Are the two factors of a high rate of machinery investment and a market economy together sufficient for rapid economic growth? Perhaps. At least, to date there are no strong counterexamples. And both the macroeconomic and microeconomic evidence can bear the interpretation that equipment investment, when the allocation of equipment is determined by market price signals, is the strategic factor in long-run economic growth.

Over the past two decades, many have argued that the typical systems of regulation introduced in developing countries to accelerate development were in fact retarding development. First, they were preventing the economy from responding to international price signals by shifting resources to activities in which the country had a long-run comparative advantage. Second, they were inducing firms and entrepreneurs to devote their energies to seeking rents by lobbying governments instead of seeking profits by lowering costs.

Critics of this line of thought have not been silent. They have pointed to countries-most notably Japan and Korea--that are by every definition prone to rent-seeking behavior, have explicitly eschewed laissez-faire development strategies, and yet have grown very rapidly. And they have argued that just because some cases of government regulation have been destructive does not mean that all will be, or that at the relevant margin a shift to an activist "industrial policy" will be harmful.

Noting the salience of machinery investment as a determinant of productivity growth points the way to a reconciliation. Countries like Japan and Korea have exhibited relatively low, not high, prices of machinery. This suggests that producers of capital goods have more often than not been on the losing side of rent-seeking coalitions in Japan and Korea. If equipment truly is an important factor in economic growth, then high growth is consistent with a policy régime that is susceptible to rent-seeking as long as interests seeking high prices and low quantities of equipment investment are on the losing side of political contests. But note that rent-seeking behavior has presumably had a significant negative impact on consumer welfare in Japan and Korea, by depriving consumers of access to imports and by preserving agricultural sectors that consume much land and yield relatively little by world standards.

The general conclusion is one that Adam Smith or Karl Marx would have found natural: market economies prosper and grow when they are managed in the interests of the business class. When governments intervene to shift prices and quantities in order to distribute income away from the productive and entrepreneurial classes-both current and prospective future members of the bourgeoisie-and toward others, whether urban consumers, bureaucrats, or small-scale inefficient rice farmers-economic growth and development suffers.

However, there are powerful pressures on governments, particularly on non-representative "modern dictatorships" peculiarly vulnerable to urban unrest and military coups, that push them in the direction of becoming anti-developmental states.

These pressures have, in the post-World War II period at least, been strong enough to counteract the natural tendency for poor countries to learn rapidly about technology and catch up to rich ones. There is no clear reason on the horizon for these pressures to diminish. Optimists hope that the record of economic failure provided by much third world experience in the past generation will lead to the creation of intellectual pressures for reform strong enough to overcome the bias for stagnation.

And if ideas truly are the decisive forces making history in the long run, perhaps the optimists are right.
 
 

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The Left in the Third World:

Yet another factor has made successful development difficult since World War II. The ideological currents of the post-World War II era have also made it more difficult for governments. Governments that listened to intellectuals from the left because the left had been anti-colonial--while the center and the right were, before World War II, imperialist. Thus the Indian National Congress would look to the British Labour Party--their friends in Britain--for advice on how to create the preconditions for successful economic growth.

And left wing political opinions throughout most of the twentieth century have been at least somewhat Marxist. Thus Marxist doctrines that markets are evil in their essence--that markets were bad, hence anything that replaced markets must be good--had a large influence on third world development policy in the first post-WWII generation.

The tying of left wing commitments first to the Leninist-Stalinist régime established in Russia after the Bolshevik Revolution, and then to the successor régimes that emerged from decolonization did harm to the political left as a moral entity. Marx had looked forward to immense material wealth evenly distributed, to freedom of occupational and residential choice, to representative governments, to free speech and free association. But the governmetns that the political left found itself associated with--the products of the Bolshevik revolution and of decolonization--had relatively little of these.

The commitment to representative government was the first commitment the political left threw overboard: only an educated and informed electorate could exercise its right to vote, and until such an educated and informed socialist electorate could be created, a centralized party was necessary in its place. To rank representative institutions high on any list of the criteria of a good society was, it was mistakenly thought, implicitly to attack decolonization and to defend the late colonial order. The commitment to free speech and free association went next. Nation-building required unity. If politicians and newspapers could whistle different tunes and criticize the government, this would disrupt the fragile unity of new nations. Then advocacy of private economic freedoms disappeared: all of the resources of society had to be mobilized according to a single plan for rapid industrialization.

As liberalism evolved in Europe, it proceeded from a demand for personal rights (freedoms of movement, of occupational choice, and of property, and rights against self-incrimination, against arbitrary arrest, and to justice) through political rights (freedoms of speech, of assembly, and of organization, and the right to choose one's governors) to social rights (to social insurance programs, to a relatively equal distribution of income, and to material wealth). All of these dropped away as the left found itself in an increasingly uncomfortable embrace with the regimes of "really existing socialism" and of post-colonial nationalism.

Thus the left-wing historian E.P. Thompson could write in the 1970s that:

...the Communists of the 1930's and 1940's were not altogether wrong, intellectually or politically.[the] visions [we feared] were of Panzers or of Sherman tanks rolling into the East, breathing racial purity or the freedom of capital down the barrels of their guns...

Put to one side the rhetorical pairing of Franklin Roosevelt and Adolf Hitler as exaggeration not meant to be taken seriously. Note instead that, in Thompson's mind, freedom of speech, freedom from arbitrary execution, freedom to elect the government, and material wealth orders of magnitude greater than that produced by Stalin's bureaucracy--all these piled together--count for little because they come tied to "freedom of capital."

Eggs are broken. The habit of breaking them on whim grows. But no omelet appears.

Perhaps the worst place to be in the third world in the fifty years after World War II was in the Communist regimes of Asia China. The Chinese Communist Party had won the civil war (which was interrupted for a while to fight the Japanese during World War II) because of its ability to create a hierarchical organization that could exert power in even the smallest of villages-a legacy that Mao owed to Lenin. Its opponent, the Chinese Nationalist Kuomintang, retreated to Taiwan, reformed itself (after an initial bloody massacre of Taiwanese), and became a model of post-World War II economic development. The People's Republic of China quickly became the personal dictatorship of Mao Zedong, and careened from disaster to disaster.

Chinese agriculture appears to have recovered from the devastation of World War II and the 1945-1949 civil war in the first years of Mao's rule. Official statistics--worth in this case what you pay for them--reported a seventy percent increase in wheat and rice production between the end of the civil war and the mid-1950s. The small share of China's population resident in the cities did worse, as private enterprise was destroyed and social parasites executed or sent off to concentration camps. Considerable technical and economic aid from the Soviet Union aided Chinese development before the Sino-Soviet ideological split in 1960.

The late 1950s, however, saw the beginning of a downward spiral. Agriculture was collectivized: individual farms replaced by village communes dominated by the local party official. The collectivization of agriculture was followed by the "Great Leap Forward": a policy that sprang from Mao's visionary inspiration to lessen China's industrial and human underdevelopment by making use of hte human resources of the whole country--to replace the "material" factor by the "spiritual". Never mind what the technocratic "experts" said could not be done; the "Red" revolutionaries would do it. People would make steel in backyard furnaces. China would industrialize village-by-village, without imports of foreign capital goods or the advice of foreign engineers.

Of course it was a disaster. To command--from the center--that peasants go out and build backyard blast furnaces guarantees that you will get little steel and less grain. Because the dictator had set out this policy on his own, everyone reported that the Great Leap Forward was proceeding magnificently. Perhaps forty million people died in the famine.

As the extent of the disaster became known, Mao's principal lieutenants moved slowly and cautiously against him. In December 1958 Mao was replaced by Liu Shaochi as head of state, with Deng Xiaoping as Liu's right hand man. In July 1959 Peng Dehuai, one of the highest ranking military officers and Minister of Defense, accused Mao of "subjectivism" and "petty bourgeois idealism", and sought Mao's effective retirement. Mao was retired, but Peng Dehuai was condemned for "rightism" and dismissed from the party and the government.

It took six years before Mao could arrange a counterstroke, using his power as symbol of the regime. His political counteroffensive was a call to destroy the leadership of the Communist Party, to "bombard the headquarters" in order to eliminate bureaucracy. Once again the "Red" was exalted over the "expert". Liu Shaochi was killed; Deng Xiaoping imprisoned for the heresy of claiming that it was more important to be competent than to be politically correct--"a good cat is not a cat that is red or white, a good cat is a cat that catches mice." Universities were closed; engineers were sent to the countryside to work with the peasants; technocrats of all kinds dismissed from their jobs. Mao's counterstroke was successful--although he then had to assassinate his new defense minister, Lin Piao, to keep Lin Piao from doing to him again what Liu Shaochi had done a decade before.

We do not know the human cost of the Cultural Revolution.

We guess that in 1970--after the first phase of the Cultural Revolution--that China's level of material prosperity was perhaps half that of India's, and was the rough equivalent of today's level of material well-being in Tanzania or Ethiopia or Mali or Madagascar, the poorest countries on earth.

XXII. The High Tide of Social Democracy-
J. Bradford DeLong
University of California at Berkeley and NBER

February 1997
 
 
 
 

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The Social Insurance State
Equality of Opportunity--and Perhaps Result
Blue Collar, White Collar, Pink Collar
Civil Rights
The Regulatory State
Further to the Left?
 

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The Social Insurance State

The popularity of social insurance
The amount of redistribution
Incentive effects of redistribution
Measuring the amount of social insurance
The growth of Keynesian doctrines of macroeconomic management as a result of the Great Depression carried with it an expansion of government social insurance spending: if the government was to be spending a fortune to stimulate the economy and avoid depression, then it should at least spend its fortune in a way that enhanced the general welfare. Few sought, after World War II, to see the government return to its pre-Depression role. Centrists feared that abandonment of social insurance would lead to abandonment of the Keynesian stabilization mission, and a return of the Great Depression. Left-wingers and unions saw in an expanded role of the government a way to eliminate, or at least to reduce, the evils of laissez-faire. Right-wingers and industrialists hoped that the "cooperative" social and production climate could be continued, and saw the social insurance state as offering the possibility of doing so at a low price in terms of taxes levied to finance the programs.

Herman van der Wee sees three variants of the fully-developed post-World War II "mixed economy," the social insurance state: a "neo-collectivist" variant (representative case: France), a "market-heavy" variant (representative case: ), and a "consultative" variant (representative case: Sweden).
 
 

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Equality of Opportunity--and Perhaps Result

Equality of opportunity
Education
Investment and debt guarantees
A level playing field
Affirmative action
Equality of result
On June 4, 1965, President Lyndon Johnson was scheduled to deliver a speech at Howard University....[The speech was] going to make the President who had completed the civil rights legislation call that achievement inadequate.... The right to eat at an integrated lunch counter, buy a home in an integrated neighborhood, go to an integrated school, join an integrated work force--all these things had been vindicated without giving men the money to buy hamburgers or a home....

The civil rights laws had been based on a concept of equal opportunity.... President Johnson... was going to move blacks straight from stage one (equal rights) past stage two (equal opportunity) to stage three (equal results): "You do not take a person who, for years, has been hobbled by chains and liberate him, bring him to the starting line of a race and then say, 'You are free to compete with all the others,' and still justly believe that you have been completely fair.'

'Not just equality as a right and a theory, but equality as a fact and a result.'

from Garry Wills, Nixon Agonistes.
 
 

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Blue Collar, White Collar, Pink Collar

In the 1950s trade unions seemed permanently established in the economies. of the industrial core.

Unions
Feminism and women's rights
Women enter the paid labor force
Discrimination
 

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Civil Rights

In 1940 the average African-American worker in the United States had three years fewer of education than the average white worker. A substantial majority of white Americans approved of discrimination--in employment, in housing, in education, and in voting. African-American men were concentrated in unskilled agricultural labor, primarily in the low-productivity and low-income (even for whites) south of the United States; African-American women were concentrated in unskilled agriculture and in domestic service. Both were extremely low-paid occupations: African- American men and women earned an average weekly wage some forty-five percent of their white counterparts. African-American male college graduates earned some $280 a week (in today's dollars); white high school graduates earned some $560 a week. In 1940 some 48 percent of white families fell below today's "poverty line" according to official statistics; some 81 percent of African-American families were in poverty.

All indications were that this combination of offical discrimination against African-Americans would continue to enforce relatively low rates of education, relatively low wealth, and rampant poverty into the indefinite future. As Gunnar Myrdal entitled his book, the inconsistency between an "American creed" of equality of opportunity and the actual position of African Americans was An American Dilemma. But there seemed to be no reason why the country could not live with this dilemma. The contradiction had been there in 1775. Yet it had managed to coexist with the institution of slavery for ninety years--and would have coexisted with slavery much longer had nto the issue of opposition to slavery become attached to the issue of preserving national union. President Abraham Lincoln could abolish slavery in the Civil War because it was seen as a means of preserving the nation in a strongly nationalist context. Myrdal's "American creed" managed to coexist with official state-sanctioned discrimination and disenfranchisement for another full century. There are still some who think that the Democratic Party's rejection at its 1964 convention of a Mississippi delegation with no African-American representation was an unconscionable mistake. Discrimination is still a reality in America today.

Yet by the end of the century things were very different. Virtually all whites would publicly espouse the principle of equal employment opportunity for African-Americans. Educational attainment by race was almost identical for those finishing school in the late 1980s and 1990s. African-American men's average weekly wages were two-thirds those of whites; African-American women's average weekly wages were more than ninety-five percent those of whites on average.

It is impossible not to credit the change to the extremely wise leadership and the extremely skillful use of moral force by the leadership of the African-American community. Martin Luther King Jr., Ralph Abernathy, Thurgood Marshall, earlier leaders like Booker T. Washington and W.E.B. Du Bois, and many others played an extremely weak hand with immense skill and patience, and with extraordinary long-run success. They are among the greatest of the heroes of the twentieth century.

The major sources of gains from 1940 to 1970 involved three factors: the end of formal, legal, state-sanctioned discrimination; the migration of African-Americans from the rural south to the urban north; and the associated shift from low-paid low-skill agricultural employment to industrial and service industries. The period was accompanied by large increases in African-American's educational levels, and high rates of employment growth and productivity growth in the rest of the economy.

Title VII of the 1964 Civil Right Act made employment discrimination illegal. There is every reason to think that civil right enforcement made a significant difference in speeding the economic advance of African Americans. Employment discrimination lawsuits acted as a spur to boost hiring. Government contractors expanded their African-American workforces much faster than did non-contractors.

The period from 1940 to 1970 was one of substantial relative advance. The picture from 1970 to 2000 was more mixed. By the end of the 1980s at least one in five of African-American prime-aged men (aged 25-54) reported no earnings in a given calendar year. Real per capita family income for African-Americans at the end of the twentieth century was some sixty percent of whites: almost exactly what it had been at the end of the 1960s.

The less favorable relative income performance of 1970 to 2000 had two causes. The first was a general, economy-wide cause: the growth in income inequality as changes in technology and production appeared to greatly diminish employers' relative demand for less-skilled and educated workers, and to greatly increase employers' relative demand for more-skilled and more-educated workers. The second were changes in family structure: the rise in divorce, the rise in births outside of marriage, and the consequent rise in single-parent almost inevitably female-headed households. The poverty rate for two-parent African-American families with children today is 12.5%. The poverty rate for single-parent African-American families with children today is 56.3%. More than half of African-American children in the last decades of the twentieth century spent more than half their childhood below the poverty line.

The traditional explanation for the decline in African-American two-parent families--the explanation provided by ideologists like Charles Murray and George Gilder--was that more generous welfare payments had triggered the collapse of the African-American family. But it was hard to escape the conclusion that those advancing this traditional explanation simply had not done their arithmetic. Welfare and food stamp payments for a mother with three children rose by one-third between 1960 and 1970, but then declined. By the mid-1990s welfare payments were lower in inflation-adjusted terms than they had been in 1960; real wages were some one-third higher--some fifty percent higher for African-American males. Maintaining a two-parent household was, in material terms, a much more advantageous option relative to split-up and welfare receipt in the 1990s than it had been in the 1950s and 1960s.

A better explanation was that African-American families were caught in the backwash of broader society-wide changes--but were especially vulnerable to them. The 1980s saw the election of America's first divorced president, Ronald Reagan. By the 1990s the children of one Speaker of the House of Representatives--the Republican Newt Gingrich--had grown up in a single-parent family. And trends in the 1990s suggested that a majority of white children in America would spend at least some time in a single-parent household.
 
 

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The Regulatory State

The old regulatory state: antitrust, utilities, railroads
The new regulatory state: environment, safety and health, antitrust, mandated benefits
Local regulation: zoning and land management
 

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Further Left?

Further to the "left", as the political spectrum was defined in the mid-twentieth century, were those coming out of a Marixist tradition who felt that Social Democracy was insufficient. What were the prospects of a shift from social democracy to something futher to the left?

The prospects were always small, in large part because of the intellectual reaction of the First World left to the economic history of the twentieth century.

The most powerful intellectul criticism of Marxism was the "it ain't so" line of criticism: that the claims of Marxism-as-social-science were simply ludicrously wrong. This criticism is powerful because true. And it is one that the far left has avoided answering. Instead, they have steadily retreated from the analysis of economic reality. This retreat has been a great irony: a thinker who spent his life trying to focus the attention of the left on the extraordinary economic revolution gathering speed has had his doctrines twisted into a knot that has crippled left-wing economic analysis for a century.

Since the lingua franca of the left has been this dialect of retreating and increasingly abstracted Marxism, those positioning themselves to the left of social democracy have remained committed to the principle that the essence of the market system is evil--as Marx intuited--and that the relevant task is to figure out just how. The puzzle is how to reconcile the evil essence of market capitalism with its relatively benign appearance in advanced industrial economies-rapidly growing wealth, steadily advancing real wage levels, no radical growth in the degree of inequality, and so on. This has kept the far left's attention away from real issues of reform and progress. It has had little constructive to say to the mixed economies and democratic governments of the industrial west in the late twentieth century.

The first stage on the retreat was to argue that the market had temporarily avoided immiserizing its own working classes by imperialism. This was always implausible from a quantitative standpoint: however large in proportion to peripheral economies were the spoils squeezed by imperial cruelty, the spoils were always small relative to production and investment in the core industrial west. From the seventeenth century on the west was too rich, and the non-west was too poor, for exploitation of the peripheries of empire to significantly affect the economic dynamic. This stage of the retreat added to the left's burdens a suspicion of international trade and investment as a form of "unequal exchange."

The second stage on the retreat was to argue that even though capitalism made workers productive, it "alienated" them from their true selves. In their advertising-induced thirst to consume, they sold their creativity and life-activity to become less than human cogs on the assembly line. But this ducked the question: people become cogs only if they have insufficient wealth and insufficient skills to live well while working at jobs that reward and nurture their creative impulses.

"Alienation" is a consequence of a skewed distribution of income. When society becomes richer and other opportunities become more attractive, people stop being willing to perform "alienating" jobs: the collapse of employment in domestic service in the industrial west in the twentieth century-the same collapse that helped convince Orwell that the system was impoverishing the upper middle class-is an example of how a richer and more equal society allows those close to the bottom of the income distribution to become more choosy both about the types of jobs they will take and about the terms under which they will take them.

But the major harm done by the retreat has been the stamping into the left of a fear of markets, and thus by default a love of hierarchies and bureaucracies. Marx showed that markets are bad, goes the current of thought, and lead to inhuman social outcomes. So whatever arrangement is chosen, it must be better if we avoid choosing the market.

But in practice the alternative has always been control by the government, or by some fraction of its administrative bureaucracy. And the government has limited administrative competence, limited degrees of accountability to those in whose name it is acting, and objectives other than that of providing for the general welfare. The tasks of designing institutions so that they advance the general welfare rather than the narrow power and wealth interests of those who hold positions that turn out to be key ones are very difficult.

Paul Baran and Paul Sweezy, Monopoly Capital (New York: Monthly Review Press, 1966). pp. 138-39:

One need not have a specific idea of a reasonably constructed automobile, a well planned neighborhood, a beautiful musical composition, to recognize that the model changes that are incessantly imposed upon us, the slums that surround us, and the rock-and-roll that blares at us exemplify a pattern of utilization of human and material resources which is inimical to human welfare.
 

XXIII. Inflation and Oil Shocks: The End of the Keynesian Era-
J. Bradford DeLong
University of California at Berkeley and NBER

February 1997
 
 
 
 

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The Misfortunes of Prosperity
Hubris
Stagflation
The Fall of Bretton Woods
Oil Shock and Productivity Slowdown
The Late 1970s
The Volcker Disinflation
 

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The Misfortunes of Prosperity

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.

The first sign that something had changed came during Richard Nixon's first term as president. He attempted to move the economy from the left to the right side of the 1954­69 curve, and found that it would not go. 1970­1973 saw unemployment and infiation both at high levels relative to the previous post-World War II experience (although still at low levels absolutely). After some thought, a consensus was reached: tight monetary policy and attempts to fight infiation by marginally increasing unemployment no longer worked because no one believed that such efforts would be continued very far.

Auto workers, say, believed that the government would not allow widespread unemployment in the automobile industry--that the government would pump up nominal demand to give people enough liquidity to buy cars if ever the industry's sales began to drop. This left the United Auto Workers, therefore, with no incentive to moderate its wage demands-it was not risking serious unemployment on the part of its members if it did so. And this left the automobile manufacturers with no incentive to resist demands for higher wages: they could simply pass them on in higher prices. And so the economy had grown "used to" steady infiation at five percent per year.

How to deal with this dilemma? One possibility was that the government should create a truly massive recession-should make it painfully obvious that if infiation rose too high and if wages agreed on by workers and firms rose too rapidly, the government would not accomodate, would not expand nominal demand, but would instead infiict unemployment and keep unemployment high until infiation came down. No president wanted to think about this possibility. It was, in the end, the road the United States took, but largely by accident and after many stopgaps. And taking this road led to the end of the most successful economic order the industrial world had seen.
 
 

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Hubris

In 1960 two prominent liberal economists--both future Nobel Prize winners--Paul Samuelson and Robert Solow wrote an article in which they attempted to quantify how low the government could push unemployment:

...In order to achieve the nonperfectionist's [emphasis added] goal of high enough output to give us no more than 3 percent unemployment, the price index might have to rise by as much as 4 to 5 percent per year. That much price rise would seem to be the necessary cost of high employment and production in the years immediately ahead.

All this is shown in our... Phillips curve [diagram].... The point A, corresponding to price stability, is seen to involve about 5.5 percent unemployment; whereas the point B, corresponding to 3 percent unemployment, is seen to involve a price rise of about 4.5 percent per annum. We rather expect that the tug of war of politics will end us up in the next few years somewhere in between...

The surprising thing is that three percent unemployment--a goal outside the historical operating range of the peacetime economy, a level of unemployment that had been reached in the United States only in response to the shock of a major war--as a "non-perfectionist's goal." If a non-perfectionist would demand that the economy do better than it ever had before in peacetime, what would a perfectionist have demanded?

Now Paul Samuelson and Robert Solow were not exceptional. In 1969, the former Chair of the Council of Economic Advisers, Arthur Okun, was publicly calling for a long-term "4 percent rate of unemployment and a 2 percent rate of annual price increase" as "compatible" what he called "an optimistic-realistic view" of the structure of the American economy--and as a target worth aiming at. The post-World War II U.S. had managed to attain his target in only one single year. Yet Arthur Okun believed that proper demand management of the economy could produce results better than had been achieved before

This is hubris: overpowering pride that sets itself up for nemesis, the revenge that things take because one's reach exceeds one's grasp. One explanation for this hubris--this belief that proper demand management policy could induce the economy to do things it had never done before--is that it was part of the legacy left by John Maynard Keynes's Theory of Employment, Interest, and Money. Indeed, Chicago-school economist Jacob Viner's review of The General Theory had forecast that:

In a world organized in accordance with Keynes' specifications, there would be a constant race between the printing press and the business agents of the trade unions, with the problem of unemployment largely solved if the printing press could maintain a constant lead...

And he gloomily called the General Theory a "book which is likely to have more influence than it deserves." You could not ask for a better prediction.

But it is more accurate to see the views of Arthur Okun and company as a consequence of the very long shadow cast by the Great Depression. The Great Depression had broken any link that might ever have been drawn between the average level of unemployment over any time period, and the desirable, attainable, or sustainable level of unemployment. With the memory of the Great Depression still fairly fresh, it was extremely difficult to argue that the normal workings of the business cycle led to fiuctuations around any sort of equilibrium position.

There was "frictional" unemployment--workers looking for jobs and jobs looking for workers before the appropriate matches had been made--which served as a kind of "inventory" of labor for the economy. There could be "structural" unemployment-- people with low skills in isolated regions where it was not worth any firm's while to employ them at wages they would accept--which could not be tackled by demand-management tools.

Everything else was "cyclical" unemployment: a smaller case of the same disease as the unemployment of the Great Depression, which could presumably be cured by the standard expansionary policy means that economists' believed would have cured the Great Depression if they had been tried at the time.

The Great Depression had taught everyone the lesson that business cycles were shortfalls below, and not fiuctuations around, sustainable levels of production and employment. As of the start of the 1960s, there was no good theory to explain why "frictional" and "structural" unemployment should even together add up to any significant fraction of the labor force. Thus anyone-it did not have to be John Maynard Keynes-developing a macroeconomics in a context in which the Great Depression was the dominant empirical datum would find that the path of least resistance led to expansionary policy recommendations: Depression-level unemployment certainly did not serve any useful economic or social function; the bulk of observed post-World War II unemployment looked like Depression-era unemployment; therefore policy should be expansionary.

Did economists' overoptimism matter? Did it make a difference that they were talking at the beginning of the 1960s of 3 percent unemployment as a "nonperfectionist" goal, and were arguing at the end of the 1960s that 4 percent unemployment and 2 percent infiation was likely to be a sustainable posture for the American economy over the long run?

During periods of Republican political dominance, perhaps not: the 1950s saw not gap-closing but rather stabilization policies of the kind that Herbert Stein had pushed for from the CED, as Eisenhower's economic advisers balanced between Keynesians to the left and residual Hooverites to the right. But during periods of Democratic political dominance, economists' overoptimism almost certainly did matter.

The core of the Democratic political coalition saw every level of unemployment as "too high." And economists' professional opinions about what was and was not feasible, given the policy tools at the U.S. government's disposal, were in a sense the only possible brake on the natural expansionary policies that would have been pursued in any case by the post-World War II Democratic Party.

Perhaps economic advisors would have proven irrelevant in any case. If the profession had been less heavily concentrated toward the Keynesian end of the spectrum, and if Walter Heller and James Tobin had possessed views on macroeconomic policy like those of Arthur Burns and Herbert Stein, perhaps President Kennedy's economic advisors would have had other names. For every conceivable policy there is an economist who can wear a suit and pronounce the policy sound and optimal, and that to a large degree Presidents and Senators get the economic advice that they ask for. Perhaps a less optimistic group of advisors drawn from the academic economics community would have had no more effect on macroeconomic policy in the 1960s than advisors from the academic economics community had on fiscal policy at the beginning of the 1980s when they pointed out that revenue projections seemed, as former Reagan-era CEA chair Martin Feldstein very politely put it, "inconsistent with the Federal Reserve's very tight monetary policy."

Sooner or later, the turning of the political wheel would bring a left-of-center party to effective power in the United States. And when that happened everything--the memory of the Great Depression, the elements of that party's core political coalition, the theories of economists in the mainstream of the profession--would push for policies of significant expansion.

If 4 percent unemployment had turned out to be consistent with relatively stable inflation, the cry would have arisen for a reduction in unemployment to 2 percent. Sooner or later a liberal government would have pushed total demand beyond the economy's capacity to produce without accelerating inflation. And it happened that this sooner or later turned out to be the late 1960s and eary 1970s.

It is well within the bounds of possibility that the U.S. might have avoided a burst of infiation in the late 1960s and early 1970s. But then it would have been vulnerable to an analogous burst of infiation in the late 1970s, or in the early 1980s. And if infiation had been avoided through the early 1980s, analogous policy missteps might well have generated infiation in the late 1980s. The "monetary constitution" of the U.S. at the end of the 1960s made something like the 1970s, at some time, a very likely probability. And I do not see how the "monetary constitution" could have shifted to anything like its present state in the absence of an object lesson, like the experience of the 1970s.
 
 

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Stagflation

From 1954 to 1968, the relative levels of infiation and unemployment in the United States moved back and forth along a stable curve that came to be called the "Phillips Curve." Democratic governments tended to want to position the economy at the left end of the curve, with relatively low unemployment and moderate infiation. Republican governments teneded to want to position the economy at the right end of the curve, with moderate unemployment and low infiation.

Few economists, politicians, or bureaucrats in the middle 1960's disagreed with Johnson economic advisor Walter Heller, who said that opinion now took it "for granted that the government must step in to provide the essential stability [of the economy] at high levels of employment and growth that the market mechanism, left alone, cannot deliver."

By the beginning of 1969, the U.S. had already finished its experiment: was it possible to have unemployment rates of four percent or below without accelerating infiation? The answer was reasonably clear: no. Average nonfarm nominal wage growth, which had fiuctuated around or below four percent per year between the end of the Korean War and the mid-1960s, was more than six percent during calendar 1968.

By the early 1970s the low-infiation low-unemployment Keynesian order had definitely broken down. As economist Robert Gordon wrote, looking back, "[t]his framework collapsed with amazing speed after 1967. My graduate school classmates and I were acutely aware of the timing of this turn of the tide, as we began our first teaching jobsand almost immediately found our graduate school education incapable of explaining the evolution of the economy." Kennedy and Johnson economic advisors had argued that a substantial reduction in unemployment could be achieved with only a moderate increase in infiation. But as Vietnam War spending overheated the economy from 1966­1969, unemployment did not drop much and infiation accelerated far beyond the expectations of Keynesian analysts.

The newly-elected Republican administration of Richard Nixon sought to move the economy back to the right end of the Phillips curve, and hoped to attain a cooling off of infiation at the cost of only a small increase in unemployment. But their policies only half worked: unemployment did indeed rise from 3 1/2 to almost 6 percent from 1969 to 1971, but infiation did not decline. The failure of infiation to fall led the Nixon administration to abandon its non-interventionist principles, and to impose stringent price controls for 90 days and then further "phases" of price and wage controls thereafter.

The period of price controls did see a small deceleration of infiation. It was, however, accompanied by a surge of demand pushed by an expansionary monetary policy: to some degree, the Federal Reserve misread how expansionary its policies were, and to some degree the Federal Reserve was anxious to please Nixon, who did not want to enter the 1972 election campaign season with a rising unemployment rate. Nixon recalled how in 1960 he and Arthur Burns--in 1972 Federal Reserve chairman--had gone to President Eisenhower, begged Eisenhower not to let unemployment rise during the 1960 year, and how Eisenhower had then turned him down.

Nixon had then lost the 1960 election to John F. Kennedy.

Thus President Nixon was extremely unwilling to back any moves toward placing reducing inflation ahead of reducing unemployment. Democrats in Congress agreed that Nixon's policies were too "deflationary". And Federal Reserve Chair Arthur Burns did not think that it was politically and economically possible in the early 1970s to fight inflation by inducing a recession.

Could such a reduction in inflation have been accomplished at the end of the 1960s? At a technical level, of course it could have. Consider infiation in the five largest industrial economies, the G-5. Before the breakdown of the Bretton Woods fixed exchange-rate system, the price levels in these five countries are loosely linked together. But the Bretton Woods system breaks down at the beginning of the 1970s, and thereafter domestic political economy predominates as infiation rates and price levels fan out both above and below their pre-1970 track.

West Germany was the first economy to undertake a "disinfiation." The peak of German infiation in the 1970s came in 1971: thereafter the Bundesbank pursued policies that accomodated little of supply shocks or other upward pressures on infiation. The mid-1970s cyclical peak in infiation was lower than the 1970-71 peak; the early-1980s cyclical peak in West German infiation is invisible. Japan began its disinfiation in the mid-1970s, in spite of the enormous impact of the 1973 oil price rise on the balance-of-payments and the domestic economy of that oil import-dependent country.

The other three of the G-5--Britain, France, and the United States--waited until later to begin their disinfiations. France's last year of double-digit infiation was 1980. Britain's last year of double-digit infiation was 1981. Certainly there were no "technical" obstacles to making the burst of moderate infiation the U.S. experienced in the late 1960s a quickly-reversed anomaly.

But Arthur Burns had no confidence that he could reduce inflation at a price in terms of higher unemployment that the economy was willing to pay. In 1959 Arthur Burns had given his presidential address to the American Economic Association. His presidential address was called, "Progress toward Economic Stability." Burns spent the bulk of his time detailing how automatic stabilizers and monetary policy based on a better sense of the workings of the banking system had made episodes like the Great Depression of the past extremely unlikely.

Toward the end of his speech, Burns spoke of an unresolved problem created by the progress toward economic stability that he saw: "a future of secular infiation":

During the postwar recessions the average level of prices in wholesale and consumer markets has declined little or not at all. The advances in prices that customarily occur during periods of business expansion have therefore become cumulative. It is true that in the last few years the federal government has made some progress in dealing with infiation. Nevertheless, wages and prices rose appreciably even during the recent recession, the general public has been speculating on a larger scale in common stocks, long-term interest rates have risen very sharply since mid-1958, and the yield on stocks relative to bonds has become abnormally low. All these appear to be symptoms of a continuation of infiationary expectations or pressures...

Before World War II such infiationary expectations and pressures would have been erased by a severe recession, and by the pressure put on workers' wages and manufacturers' prices by falling aggregate demand. But Burns could see no way in which such pressures could be generated in an environment in which workers and firms rationally expected demand to remain high and recessions to be short.

Burns's skepticism about the value of monetary policy as a means of controlling infiation in the post-World War II era was reinforced by the pressure for avoiding any significant rise in unemployment coming from his long-time ally, patron, and friend, President Nixon, and from the Democratic leaders of congress.

Arthur Burns played a key role in the Nixon administration's eventual adoption of a wage-price freeze in late 1971. The context was one of a Council of Economic Advisers averse to all forms of incomes policy, from guideposts on up, as "wicked in themselves and steps on the slippery slope... to controls"; of a President who "did not like 'incomes policies' and knew they did not fit with his basic ideological position"; and of an opposition party that had a "great interest in pointing out that there was another, less painful, route to price stability [than gradualism and recession], which Mr. Nixon was too ideological to follow." And Burns's intervention on the pro-controls side so that "every editorial writer who wanted to recommend some kind of incomes policy could say that 'even' Arthur Burns was in favor of it" led Stein to liken:

the administration...[to] a Russian family fieeing over the snow in a horse-drawn troika pursued by wolves. Every once in a while they threw a baby out to slow down the wolves, hoping thereby to gain enough time for most of the family to reach safety. Every once in a while the administration would make another step in the direction of incomes policies, hoping to appease the critics while the [gradualist] demand management policy would work. In the end, of course, the strategy failed and the administration made the final concession on August 15, 1971, when price and wage controls were adopted...

Rockoff (1984) finds nothing good in the 1971-1974 experience with controls. The controls did not calm infiationary expectations. Instead, they appear to have created them-with a general expectation that prices would rebound once the controls were lifted. The controls imposed the standard microeconomic, compliance, and administrative costs on the American economy. Perhaps most serious, the fact that wage and price controls were still in effect in the fall of 1973, when the price of oil jumped, created a substantial divergence between the cost of energy to U.S. users and the world price of energy, which slowed down the process of adjustment. Energy price controls remained, until eliminated as one of the good deeds of the Reagan administration in the early 1980s.

And perhaps the controls led to overoptimism, and hence to looser monetary and fiscal policy than would have otherwise been put in place, because of their apparent initial success.

If the apparent initial success of the Nixon controls program did lead to overoptimism about how much more monetary and fiscal restraint was necessary to contain infiation, the Nixon administration suffered less from such overoptimism than did its critics.Walter Heller, one o fhte most prominent Democratic economists of the early 1970s, testified before Joint Economic Committee on July 27, 1972 on how Nixon administration policy was too contractionary: "As I say, now that we are again on the [economic] move the voice of overcautious conservatism is raised again at the other [White House] end of Pennsylvania Avenue. Reach for the [monetary] brakes, slash the [fiscal] budget, seek an end to wage-price restraints."

And private-sector forecasters agreed. One of the striking features of the infiation of the 1970s was that increases in infiation were almost always unanticipated. The figure below plots the average forecast for the forthcoming calendar year, made as late in the year as possible, from the survey of professional forecasters alongside actual December-to-December GDP defiator infiation. In every single year in the 1970s, the consensus forecast made late in the previous year understated the actual value of infiation.

Even if the Johnson-era infiation had not already done so, the first Nixon administration destroyed investors', firms', and workers' confidence in the nominal anchors of the economy. Before the mid 1960's, infiation in the United States (outside of wartime) was something that academic economists worried, but was outside the realm of considerations important enough to enter the calculations of other people. As a result, the economy moved back and forth along the Phillips Curve-moving up and to the left with higher infiation and lower unemployment when total demand was high and wages rose, moving down and to the right with lower infiation and higher unemployment when total demand was low-which was set in its position because by and large investors, firms, and workers did not think that shifts in the rate of infiation were enough to worry about.

By the early 1970s this had changed: everyone knew that a raise or an interest rate of 6 percent over a year was no interest rate at all, because infiation ate away the whole increase. As a result, when demand was tight and workers could press for higher wage settlements, they would press for enough to cover expected infiation, plus a real wage increase-plus enough to cover the extra infiation that would come about in the economy as a whole because demand was tight. This meant that throughout the 1970's, any move to reduce unemployment would provoke an immediate upward jump in infiation and interest rates. President Carter thus went into--and lost--the 1980 election with 7 percent unemployment and 9 percent infiation. He was followed by a Republican administration that in many respects saw not only the 1970's but also the 1960's-and, indeed, the entire post-World War II Keynesian order-as a series of mistakes.
 
 

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The End of Bretton Woods

There were two other major events in the early 1970's that in prospect were seen as sideshows, but that in retrospect played as large or larger a role in the end of the great post-World War II Keynesian boom as the erosion of the Phillips Curve. The first was the casual destruction of the Bretton Woods arrangements, which had preserved almost all of the benefits of fixed exchange rates while granting the fiexibility to change exchange rates to adjust to major economic shifts that the gold standard had lacked. The system posed an obstacle to Nixon's and Treasury Secretary John Connally's plans to use price controls to reduce infiation while reducing unemployment to increase the chances of reelection: the resulting large trade deficit would either require higher interest rates to finance the balancing infiow of capital--which would tend to raise unemployment--or devaluation. Under the Bretton Woods system the United States could not devalue without the agreement of other countries because all other countries defined their currencies as given fractions or multiples of the dollar, and this agreement was not readily forthcoming. So it was abandoned and the U.S. forced the move to the current system of freely-fioating exchange rates, which has not served the world economy well.

Thus there is a very real sense in which monetary policy did not contain infiation in the early 1970s because it was not tried. And it was not tried because the Chairman of the Federal Reserve did not believe that it would work at an acceptable cost. Even the threatening breakdown of the fixed exchange rate system, which Burns "feared... with a passion," would not induce Burns to tighten sufficiently to risk a more-than-moderate recession. Paul Volcker reports an "interesting discussion with Arthur Burns" over lunch at the American embassy in Paris, at which "the Chairman of the Federal Reserve Board made one last appeal" to retain a system of fixed exchange rates (see Volcker and Gyohten (1992)). Volcker reports that:

To me, it simply seemed too late, and with some exasperation I said to him "Arthur, if you want a par value system, you better go home right away and tighten money." With a great sigh, he replied, "I would even do that..."
 
 

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The Oil Shock

The second event was the tripling of world oil prices in the fall of 1973. This sent the world economy into a major recession accompanied by rapid infiation, and pushed the world economy toward a much more energy-conserving pattern of production. Somewhat paradoxically, the rational-expectations school of economics that would have given advance warning of the breakdown of the Phillips Curve, and had as a result become dominant, believed that the tripling of world oil prices was macroeconomically irrelevant: the oil price would rise, other prices would fall, and the overall price level would be unaffected because the general price level was determined by the money supply and not by decisions of producers of individual commodities to raise prices. The tripling of oil prices sent the world economy into one of the deepest recessions of the post-World War II period, and left the economy with the legacy of high infiation that would in its turn lead to the 1980­82 recession, the deepest of the post-World War II era.

It is possible that the tripling of world oil prices was an intended result of U.S. foreign policy. Nixon's chief foreign policy advisor, Henry Kissinger, wanted to strengthen the shah of Iran as a possible counterweight to Soviet infiuence in the middle east. With the oil price tripled, the shah was indeed immensely strengthened-at the price of enormous economic damage to the industrial west and to the rest of the developing world, which saw its oil bill multiplied manyfold. It is certain that the economic repercussions of the oil price rise came as a surprise to the Nixon administration-Kissinger always thought economic matters were boring and unimportant in spite of the fact that the military and diplomatic strength of the United States depended on and should have been used to safeguard the liberty and prosperity of the United States.

It is most likely that the oil price rise struck the administration as not worth its concern, and certainly as not worth trying to roll back--it did, after all, strengthen the shah, few had any conception of the economic damage it might do, and those few were not listened to by the U.S. government.

Alan Blinder, Vice Chair of the CEA and of the Federal Reserve in the 1990s, argued that double-digit infiation in the 1970s had a single cause: supply shocks that sharply increased the nominal prices of a few categories of goods, principally energy and secondarily food, mortgage rates, and the "bounce-back" of prices upon elimination of the Nixon controls program. Such shocks were arithmetically responsible for, in Blinder's words, "the dramatic acceleration of infiation between 1972 and 1974....The equally dramatic deceleration of infiation between 1974 and 1976....[And] while the rate of infiation.... rose about eight percentage points between 1977 and early 1980, the 'baseline'... rate may have risen by as litle as three."

Arithmetic decompositions of the rise in infiation into upward jumps in the prices of special commodities were never convincing to those working in the monetarist tradition. As Milton Friedman asked:

The special conditions that drove up the price of oil and food required purchasers to spend more on them, leaving them less to spend on other items. Did that not force other prices to go down, or to rise less rapidly than otherwise? Why should the average [emphasis in original] level of prices be affected significantly by changes in the price of some things relative to others? (Friedman (1975), cited in Ball and Mankiw (1995))

But the missing link in Blinder's argument can be provided by noting that the oil price increase entailed large increases in the prices of goods in a few concentrated sectors. They reduce nominal demand for products in each unaffected sector by a little bit. Small administrative or information processing costs might plausibly prevent full adjustment in many of the unaffected sectors, leaving an upward bias in the overall price level. Concentrated shocks that are (a) significantly larger than the average variance of shocks but (b) not so large as to require relative price movements that overwhelm administrative and information processing costs in all sectors appear to have the best chance of generating large upward boosts in infiation.
 
 

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The Productivity Slowdown

Possible causes
The oil shock
Environmental spending
The exhaustion of the Great Depression's backlog of inventions
A low pressure economy
Effects
Politics turns nasty
The crisis of the social welfare state
 

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The Late 1970s

Each surge in infiation was quickly followed by--or in the case of the mid-1970s oil shock infiation cycle roughly coincident with--an increase in unemployment. Once again, each cycle in the late 1960s and 1970s was larger than the one before: unemployment peaked at around 6 percent in 1971, at about 8.5 percent in 1975, and at nearly 10 percent in 1982-83.

The recession of 1974-1975 made it politically dangerous to be an advocate of restrictive monetary policy to reduce infiation. Near the trough of the recession, Hubert Humphrey and Augustus Hawkins sought to require that the government reduce unemployment to 3 percent within four years after passage, that it offer employment to all who wished at the same "prevailing wage" that Davis-Bacon mandated be paid on government construction projects, and (in its House version) that individuals have the right to sue in federal court for their Humphrey-Hawkins jobs if the federal government had not provided them. In early 1976 the National Journal assessed its chances of passage as quite good-though principally as veto bait to create an issue for Democrats to campaign against Gerald Ford, rather than as a desirable policy.

Arthur Burns tried to avoid getting sucked into what he saw as a no-win situation:

Humphrey-Hawkins... continues the old game of setting a target for the unemployment rate. You set one figure. I set another figure. If your figure is low, you are a friend of mankind; if mine is high, I am a servant of Wall Street.... I think that is not a profitable game... (Wells (1994))

Humphrey-Hawkins eventually generated significant opposition from within the Democratic coalition. Labor would not support the bill unless Humphrey-Hawkins jobs paid the prevailing wage (fearing the consequences for unionized public employment if the "prevailing wage" clause was dropped); legislators who feared criticism from economists'--even Democratic economists'--judgment that Humphrey-Hawkins was likely to be very infiationary would not support the bill unless the "prevailing wage" clause was removed.

The bill that finally passed and was signed in 1977:

Set a target of reducing unemployment to 4 percent by 1983.
Elevated price stability to a goal equal in importance to full employment.
Set a goal of zero infiation by 1988.
Called for the reduction of federal spending to the lowest level consistent with national needs.
Required the Federal Reserve Chairman to testify twice a year.
In other words, the bill that was signed did nothing.

Economists' instincts are that uncertainty about current prices, future prices, and the real meaning of nominal trade-offs between the present and the future; distortions introduced by the failure of government finance to be infiation-neutral; windfall redistributions and the focusing of attention not on preferences, factors of production, and technologies but on predicting the future evolution of nominal magnitudes must degrade the functioning of the price system and reduce the effectiveness of the market economy at providing consumer utility. The cumulative jump in the price level as a result of the infiation of the 1970s may have been very expensive to the United States in terms of the associated reduction in human welfare.

By the end of the 1970s average nominal wage growth was some eight percent per year rather than six percent per year, and the wedge between nominal wage and nominal price growth had vanished as a result of the productivity slowdown. Thus Paul Volcker and his Open Market Committee at the end of the 1970s faced the problem of how to slow the rate of nominal wage growth, and thus the rate of core infiation, by some five percentage points per year or so. Arthur Burns and his Open Market Committee at the beginning of the 1970s faced the problem of how to slow the rate of nominal wage growth, and thus the rate of core infiation, by two percentage points per year or so.

Such a permanent deceleration in nominal wage growth might have been accomplished by shifting infiationary expectations downward directly (so that a lower rate of nominal wage increase would have been associated with the same rate of increase in real wages), or by triggering a recession sufficiently deep and sufficiently long that fear of future excess supply in the labor market would restrain demand for rapid wage increases.

Nevertheless the existence of Humphrey-Hawkins, and the consequent commitment of first the Carter administration and then Carter's selection as Arthur Burns's successor, G. William Miller, to returning the economy to full employment had unpleasant consequences. To a small degree it was a matter of bad luck: senior Carter economic officials have talked of the year "when our forecasts of real GNP growth were dead on-only the productivity slowdown meant that the end-of-year unemployment rate was a full percentage point below where we had forecast." To a larger degree it was the result of the lack of interest and focus in the Carter White House on infiation, in spite of efforts by economists like Charles Schultze to warn that infiation was likely to suddenly become a severe surprise problem in 1979 and 1980 unless a strategy for dealing with it was evolved earlier.

Infiation did become a surprise severe political problem in 1979. And this generated the only episode in history in which a Council of Economic Advisers Chairman (Charles Schultze) and a Treasury Secretary (Michael Blumenthal) waged a campaign of leak and innuendo to try to get the Federal Reserve Chairman (G. William Miller) to tighten monetary policy (Kettl (1986)).

No one is willing to say a good word about G. William Miller's tenure as Chairman of the Federal Reserve. He lasted sixteen months, and then replaced Michael Blumenthal as Secretary of the Treasury.

G. William Miller's successor as Chairman of the Federal Reserve Board was Paul Volcker.
 
 

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The Volcker Disinflation

Could the Volcker disinfiation have been undertaken earlier? Had Gerald Ford won reelection in 1976 and reappointed Arthur Burns, would we now speak of the Burns disinfiation? Or would the same political pressures that had driven Nixon into wage and price controls have driven a second Ford administration into an overestimation of the available room for economic expansion? Herbert Stein, at least, is skeptical: "We do not know whether a Ford administration...kept in office... would have persisted" in a course that would have kept infiation declining, "...but we do know that the basis for the persistence of such a course had not been laid." And he attributes the failures of the Carter administration and the Carter-era Federal Reserve at infiation control "not... chiefiy a refiection of the personalities involved... [but] a response to the prevailing attitude in the country about the goals of monetary policy." In Stein's opinion the Federal Reserve did not as of the mid-1970s have a mandate to do whatever turned out to be necessary to curb infiation.

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Conclusion

Examine the price level in the United States over the past century. Wars see prices rise, by more than fifteen percent per year at the peaks of wartime and decontrol infiation. The National Industrial Recovery Act and the abandonment of the gold standard at the nadir of the Great Depression generate nearly ten percent infiation. But aside from wars and Great Depressions, at other times infiation is almost always less than five and usually two to three percent per year-save for the 1970s.

The 1970s were the world's only peacetime outburst of infiation in this century. The 1970s was the only era in which business enterprise and financing transactions were also "speculation[s] on the future of monetary policy" (Simons (1947)) and concern about infiation was an important factors in nearly all business decisions.

The truest cause of the 1970s infiation was the shadow of the Great Depression. The memory left by the Depression predisposed the left and center to think that any unemployment was too much, and eliminated any mandate the Federal Reserve might have had for controlling infiation by risking unemployment.

The Federal Reserve gained, or regained, its mandate to control infiation at the risk of unemployment during the 1970s as discontent built over that decade's infiation. It is hard to see how the Federal Reserve could have acquired such a mandate without an unpleasant lesson like the infiation of the 1970s.

Thus the memory of the Great Depression meant that the U.S. was highly likely to suffer an infiation like the 1970s in the post-World War II period-maybe not as long, and maybe not in that particular decade, but nevertheless an infiation of recognizably the same genus.

At the surface level, the United States had a burst of infiation in the 1970s because no one--until Paul Volcker took office as Chairman of the Federal Reserve--in a position to make anti-infiation policy placed a sufficiently high priority on stopping infiation. Other goals took precedence: people wanted to solve the energy crisis, or maintain a high-pressure economy, or make certain that the current recession did not get any worse. As a result, policy makers throughout the 1970s were willing to run some risk of non-declining or increasing infiation in order to achieve other goals. After the fact, most such policy makers believed that they had misjudged the risks: that they would have achieved more of their goals if they had spent more of their political capital and institutional capability trying to control infiation earlier.

At a somewhat deeper level, the United States had a burst of infiation in the 1970s because economic policy makers during the 1960s dealt their successors a very bad hand. Lyndon Johnson, Arthur Okun, and William McChesney Martin left Richard Nixon, Paul McCracken, and Arthur Burns nothing but painful dilemmas with no attractive choices. And bad luck coupled with bad cards made the lack of success at infiation control in the 1970s worse than anyone had imagined ex ante.

At a still deeper level, the United States had a burst of infiation in the 1970s that was not ended until the early 1980s because no one had a mandate to do what was necessary in the 1970s to push infiation below four percent, and keep it there. Had 1970s Federal Reserve Chairman Arthur Burns tried, he might well have ended the Federal Reserve Board as an institution, or transformed it out of all recognition. It took the entire decade for the Federal Reserve as an institution to gain the power and freedom of action necessary to control infiation.

And at the deepest level, the truest cause of the infiation of the 1970s was the shadow cast by the Great Depression. The Great Depression had made it impossible for almost anyone to believe that the business cycle was a fiuctuation around rather than a shortfall below some sustainable level of production and employment. An economy would have to have some "frictional" unemployment, perhaps one percent of the labor force or so, to serve the "inventory" function of providing a stock of workers looking for jobs to match the stock of vacant jobs looking for workers. An economy might have some "structural" unemployment. But there was no good theory suggesting that either of these would necessarily be a significant fraction of the labor force. Everything else was "cyclical" unemployment: presumably curable by the expansionary policies that economists would now prescribe in retrospect for the Great Depression.

Sooner or later in post-World War II America random variation would have led the economy to fall off of the tightrope of full employment and low infiation on the over-expansionary side. Although there was nothing foreordained or inevitable about the particular way in which America found itself with strong excess aggregate demand at the end of the 1960s, it was foreordained and inevitable that eventually some combination of shocks would produce a macroeconomy with strong excess demand. And once that happened--given the shadow cast by the Great Depression--there was no institution with enough authority, power, and will to quickly bring infiation back down again.

It took the decade of the 1970s to persuade economists, and policy makers, that "frictional" and "structural" unemployment were far more than one to two percent of the labor force (although we still lack fully satisfactory explanations for why this should be the case). It took the decade of the 1970s to convince economists and policy makers that the political costs of even high single-digit infiation were very high. Once these two lessons of the 1970s had been learned, the center of American political opinion was willing to grant the Federal Reserve the mandate to do whatever was necessary to contain infiation. But until these lessons had been learned, it is hard to see how the U.S. government could have pursued an alternative, earlier, policy of sustained disinfiation in response to whatever shocks had happened to create chronic excess demand.

A mandate to fight infiation by inducing a significant recession was in place by 1979, as a result of a combination of perceptions and fears about the cost of infiation, worry about what the "transformation of every business venture into a speculation on monetary policy" was doing to the underlying prosperity of the American economy, and fear that the structure of expectations was about to become unanchored and that permanent double-digit infiation was about to become a possibility.

But the process by which the Federal Reserve obtained its informal mandate to fight infiation by inducing significant recession was a slow and informal one. Part of its terms of existence require that it never be made explicit. It is difficult to imagine it coming into being-and thus the Federal Reserve's "independence" being transformed from a quirk of bureaucratic organization into a real and powerful feature of America's political economy-without some lesson like that taught by the history of the 1970s.

Today many observers would say that the costs of the Volcker disinfiation of the early 1980s were certainly worth paying, comparing the U.S. economy today with relatively stable prices and relatively moderate unemployment with what they estimate to have been the likely consequence of business as usual: infiation slowly creeping upward from near ten toward twenty percent per year over the 1980s, and higher unemployment as well as infiation deranged the functioning of the price mechanism. In the U.S. today infiation is low, and the reduction of infiation to low single-digit levels has been accomplished without the seemingly permanent transformation of "cyclical" into "structural" unemployment seen in so many countries of Europe.

Nevertheless, other observers believe that their ought to have been a better way: Perhaps infiation could have been brought under control more cheaply by a successful incomes policy made up of a government-business-labor compact to restrain nominal wage growth (which certainly would have been in the AFL-CIO's interest, as it is harder to think of anything worse for that organization's long-term strength than the 1980s as they actually happened). Perhaps infiation could have been brought under control more cheaply by a Federal Reserve that did a better job of communicating its expectations and targets; but note that the dispute over whether "gradualism" (in the sense of the British Tory Party's Medium-Term Financial Strategy; see Taylor ()) or "cold-turkey" (see Sargent (1982)) was the most cost-effective way of reducing infiation has not been resolved; it is hard to fault those who made economic policy decisions when even those economists with ample hindsight do not speak with one voice.

XXIV: Rolling Back the Welfare State-

J. Bradford DeLong
University of California at Berkeley and NBER
 

February 1997
 
 

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Elections: Margaret Thatcher and Ronald Reagan
The Supply Side
The Medium Term Financial Strategy and the Falklands War
Weak Claims and Weak Claimants
The Social Insurance State under Seige
 

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The diagnosis of American economic distress that the Republican coalition elected in 1980 carried with it had several parts. The first part was that the U.S. in the late 1970's had a high rate of both infiation and unemployment because earlier governments had been unwilling to accept moderate unemployment. As Herbert Stein wrote in the late 1970's:

the main reason we have such a high rate of infiation difficult to reduce, is that we now have a history of a high rate of infiation and that the announcement of government intentions to curb the infiation has little credibility.I think theemphasis on fiscal and monetary restraint was correct and our mistake was in not realizing how critical it was. We did not recognize how difficult it would be to reverse course once we had gotten on to the infiationary path, and therefore how essential it was not to set foot on that path. This isa reminder of how essential it is to get off that path before we move much further along it

The first principle, therefore, was to fight infiation, and to accept whatever unemployment was necessary no matter how high it might go in order to reduce infiation from nearly 10 percent to a level at which it would once again be so low as not to be a major element in workers', firms', and investors' calculations. Monetary policy was to be turned over to Federal Reserve chairman Paul Volcker-who had already decided that his job was to lower infiation no matter what the cost-and he was to be allowed free rein. Soon, the administration and its supporter believed, the fact that a strong Federal Reserve chairman had been given a blank check to stop infiation would lead people to expect that infiation would be stopped, and so they would no longer be building infiation premia into their demands for wage raises or interest payments.

The second principle was that much of what had gone wrong in the 1970's was the fault of too large a government. Therefore the government needed to shrink. Too many of its policies and programs were destructive. As Martin Feldstein put it:

Expansionary policies were adopted in the hope of lowering the unemployment rate but without anticipating the infiation. High tax rates on investment income were enacted and social security retirement benefits were increased without considering the subsequent impact on investment and saving. Regulations were imposed to protect health and safety without evaluating the reduction in productivity that would result or the effect on an uncertain regulatory future on long-term [activities].[T]he government never considered that [high]unemployment benefits would encourage layoffsthat Medicare and Medicaidmight lead to an explosion in health care costs; that welfare programsto help [the] poormight weaken family structures; or that federal aid through the tax lawsto encourage [suburban] homeownership would have such adverse effects on the cities, precipitating relocation of businesses [to the suburbs] and [creating] poverty and other problems for those left behind...

The perception that there were substantial fiaws in the fabric of the welfare state was not wrong. Why, in Britain, did social democratic education policy turn out to give children of doctors and lawyers the right to go to Oxford without paying for it? The system was fiawed when social democratic industry policy used the nationalized "commanding heights" of the economy not to accelerate technological progress and keep employment high, but rather to retard the shift of labor out of "sunset" industries.

The sociologist T.H. Marshall had looked forward to an extension of the concept of equal rights to equal social and economic rights: the right to work, the right to an education, the right to a fair and equal share of what society can produce. This extension stalled: you had a right not to a share of society's wealth but to opportunity and to social insurance. You can only buy insurance in proportion to your resources. And opportunities can either be seized or missed. Taken all in all, it was possible to argue that late twentieth century social insurance states placed most of the tax burden on the relatively poor, while providing services-subsidized higher education systems, air traffic control systems, subsidized broadcasting systems, unemployment insurance payments that varied proportionately with pre-unemployment wages, and so on-that were at least as much use to the rich as to the poor.

The chosen instrument to use to enforce a reduction in the size of the government was a tax cut. Tax cuts are always popular. A new tax cut enacted by a new president would be very popular and, politicians and strategists calculated, would greatly weaken opposition to subsequent spending cuts: for the alternative proposed by those who wished to maintain spending would then necessarily include large budget deficits as a consequence. This tied into the third principle: tilt the distribution of income in favor of the rich. Industry should be rewarded, and sloth punished. The rich were industrious. Moreover, the rich saved and invested, thus enriching everyone in the future. The third principle, therefore, was to tilt the distribution of income in favor of the rich by cutting their taxes most.

Things did not work out well. Two other considerations got added to the political stew at the beginning of the 1980's. The first was the the partisan claim that the Carter administration had dangerously weakened the U.S.'s defenses vis-a-vis the Soviet Union. Ironically, the decade to follow would see the weakness of the Soviet Union become obvious as the process of reform began. Steps would be taken by Republican administrations to gradually cut the defense budget as a share of total national product far below what the Carter administration had planned. And the rapid restoration of the emir to Kuwait would show that the technology gap between NATO and Warsaw Pact equipment had always been immense, and thus that NATO forces in Europe had always been far, far stronger than necessary to stand off a Soviet offensive.

In the short run of the early 1980's, however, the Reagan administration planned a massive buildup of the armed forces, and thus an expansion-not a contraction-of the size of the government.

The second consideration was the unwillingness of the administration to be to identify in advance which programs and subsidies would be cut in the shrinking of the government that the administration to be had planned. To reduce anxiety, politicians looked benignly on and encouraged the growth of the story that no spending cuts at all would be required: the tax cut alone and the lifting of the hand of regulation from the economy would create such a spur of economic growth that even domestic programs could be expanded, not contracted.

No one with a quantitative grasp of the government's budget and its pattern of change ever meant this story to be taken seriously. But administration makers welcomed its dissemination. Policy elites assured each other that their candidate would say a lot of silly things before the election, but that the candidate and his principal advisors understood the important issue. Tax cuts were to be followed by a ruthless attack against "weak claims" on the federal budget: programs like farm subsidies, subsidized student loans for the relatively rich, the exemption from taxation of social security income, the subsidization of the southwest's water projects, and so forth would themselves be slashed in order to balance the budget after the tax cut. "Weak claimants"-people for whom government subsidies and assistance truly served as a "safety net"-would be protected, while "weak claims" would be reduced.

But too many of the Reagan administration's allies and supporters claimed, after the election, that they had taken this story seriously. They would not support spending cuts, for they were the "weak claimants" whose subsidies and programs were to be targeted for reduction. These two factors-the expansion of the military budget and the claim by key legislators and infiuence peddlers that the Republican trip they had purchased was not for a tax cut and spending cut, but just for a tax cut-left the United States with large and only gradually controlled budget deficits throughout the 1980's. Previous decades had seen one or perhaps two years of large budget deficits in recessions. Previously, large budget deficits had been seen only in years of deep recession. But the 1980's saw budget deficits, very large by the standards of the post-World War II era, persist throughout years of prosperity and low unemployment as well.

Large budget deficits threatened to become a drag on the American economy. Funds saved might not now be invested-they might be borrowed by the government and used for current spending. The large budget deficits of the 1980's thus threatened to seriously reduce the rate at which the United States' capital stock grew. This would have had extraordinarily destructive effects on economic growth.

This was especially bitter for those who had worked very hard to elect a Republican administration because they thought that Democratic administrations were pursuing policies that reduced investment in and thus impoverished America's future because"the long-run benefits" of investment "apparently lie beyond the political horizon"-beyond, that is, the Democrats' political horizon. They had hoped to elect an administration committed to increasing savings and investment-to lowering taxes on those who did save and invest-in order to empower America's future. Yet the large budget deficits of the 1980's created by Reagan's administration threatened to be an order of magnitude more destructive of America's economic future than any of the infiationary, redistributive, or regulatory policies pushed by Democrats had been.

The deficits did, however, do substantial indirect harm: for more than half of the 1980's the U.S. dollar was substantially overvalued as the U.S. budget deficit sucked in capital from outside and raised the exchange rate. When a domestic industry's costs are greater than the prices at which foreign firms can sell, the market is sending the domestic industry a signal that it should shrink: foreigners are producing with more relative efficiently, and the resources used in the domestic industry should be transferred to some sector where domestic producers have more of a comparative advantage. This was the signal that the market system sent to all U.S. manufacturing industries in the 1980's: that they should cut back on investment and shrink. In this case, it was a false signal, sent not by the market's interpretation of the logic of comparative advantage but by the extraordinary short-run demand of cash to borrow from the U.S. government. But firms responded to this signal even so. The U.S. sectors producing tradeable goods shrank. And some of the ground lost would never be recovered.

Given the high cost of capital seen in the U.S. in the 1980's, the uncertainty about whether investments in the U.S. were worth making because of the unstable exchange rate-all due to false steps of economic policy-and also other, outside factors like the rapid growth of the labor force as the baby boom generation became adults, it is not surprising that productivity growth in the United States lagged during the Reagan years. Figure 3 shows that the upward pace of productivity growth in the United States, which had averaged two percent per year for a century and came to an end in 1973, did not resume in the 1980's. Compared to what might have been reasonably anticipated from the 1948­1973 or the 1880­1973 pace of productivity growth, the U.S. in 1991 fell more than thirty percent low.

Other countries did not see such stagnation in productivity over the 1980's. At the end of the 1980's the U.S. still had the highest standard of living among the industrial nations of the world because of its immense spaces: people in the United States live in large houses and have ample lawns. But the U.S.'s edge in living standards over the rest of the industrial west comes from of the luck of its location rather than, as it came before, from of the skill and industry of its people. At current exchange rates, the United States ranks not first but ninth among industrial nations in total economic productivity: behind Switzerland, Japan, Iceland, Sweden, Norway, Finland, Denmark, and West Germany.

Around 1970, at least, the two income gaps were of about the same magnitude. Skilled workers earned about thirty percent more than unskilled workers, and young college graduates then earned about thirty percent more than high school graduates.

Around 1980 the income differential takes a substantial leap upward. In no more than five years, by far the larger part of the 1929­1950 equalization of the U.S. income distribution is reversed among young workers. This shift toward greater inequality should not be overstated. So far the shift to inequality is much greater among workers with less than ten years' employment experience than among older, more experienced workers. Perhaps the gap will narrow as the present group of young workers ages. Moreover, while class and education-based income differentials have widened, status and race-based differentials have continued to fall at least through the end of the 1970's.

Moreover, this shift should be viewed with some skepticism: it is not certain that the college-high school wage differential plays the same role in the American economy today as the skilled-unskilled wage differential had at the beginning of this century. And it is not certain that the shift will be permanent. It is, however, clear that there is no longer any reason to believe that the wage distribution will narrow in the future. In the first two thirds of the twentieth century, both market forces-a shift to more balanced technological change and a declining ratio of less-skilled to more-skilled workers-and wage setting institutions-minimum wage laws and a strong union movement-worked to reduce income differentials. This allowed the relatively poor and unskilled would share fully in modern economic growth.

The determinants of the sudden upward leap in income inequality, especially among the young, in the 1980's are also somewhat uncertain. There are three possible causes: a rise in the relative numbers of the unskilled, the near-collapse of the private sector union movement under the pressure of the 1982 recession and of governmental hostility, and the large shift in the U.S. pattern of trade that came about in the 1970's and 1980's and led to the transfer to overseas of jobs for the less-skilled (and the transfer to the United States of jobs for the more skilled). Whichever of these factors is most important, there is no reason to expect the near future to see any reversal of the leap in inequality. International trade is likely to continue to increase, further reducing the employment of the less-skilled in high-wage sectors. The union movement is unlikely to recover. And the labor force is likely to continue to see a disproportionate growth in the numbers of the less skilled.

The 1970's and 1980's also saw rapid growth in the number of Americans whose households did not have access to the labor market. Divorce reduced the number of adults per household and multiplied the number of households. People choose to get divorced, and would most likely not appreciate being forced to stay together. But two households cost more to maintain than one; divorce is usually followed by a substantial drop in living standards for women and children (and a rise in living standards for men); and one parent living as the sole adult in a household trying to raise children has a very difficult time taking advantage of whatever opportunities can be found in the labor market. The declining economic position of lesser-skilled males, coupled with the rise in female-headed households with no access to the labor market and with reductions in public sector support together caused something extraordinary to happen in the 1970's and 1980's: the proportion of the population living in poverty increased.

The "poverty" line, as calculated by the U.S. government, does not shift upward as time passes and as expectations of what is needed to maintain a minimum decent standard of living rise. The poverty line is that amount of money required to purchase a fixed basket of commodities: the proportion living in poverty is the proportion of the population that do not attain a fixed absolute level of material well being. The proportion of the U.S. population falling below the poverty line in 1990 was about 13 1/2 percent-as large a proportion as it had been in 1966. The two decades from 1949 to 1969 saw the poverty rate using the official definition fall from about 32 percent to about 12 percent; the two decades of the 1970's and 1980's saw the poverty rate remain stagnant or rise.

This was the first two decade period in United States history in which anything at all similar had happened: previous decades that saw poverty rise, like the disastrous Great Depression-ridden 1930's, were followed by decades like the 1940's which saw tremendous economic growth and poverty reduction. The 1970's and 1980's marked the first time when, over the span of a generation, the rising tide of economic and productivity growth had failed the lift the boats of America's poor.

The 1980's also saw the halting of Black Americans' progress toward economic equality with white Americans. This did not seem to be due to a resurgence of official, open racism and discrimination. Instead, Black Americans were caught up in the widening of the income distribution. Since more of them were poor, a larger proportion of Black Americans than whites lost ground in the 1980's because the poor lost ground. Because more Black Americans lived in female-headed households, a larger proportion of Black Americans than whies lost ground in the 1980's because female-headed households lost ground. Because more Black Americans lived on the edge of poverty, a larger proportion of Black Americans fell into poverty in the 1980's because those on the edge of poverty did badly during the decade.

From the perspective of many Black political leaders, the fact that the relative decline in the economic status of Blacks was not the result of official, open racism was cold comfort. Official, open racism in the past had put Blacks on the bottom of the American income pyramid. White society owed them redress. And for white society to adopt policies that moved the distribution of wealth and opportunity against those at the bottom-and then to claim that such policies were no racist-appeared a sick joke: analogous to first firing you and then foreclosing on your house because you don't have a job, all along claiming that the foreclosure is not aimed at you and is nothing personal.
 
 

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Ideologies

The fist is the "so what?" school made up of thinkers like Friedrich Hayek. They argued that the market's distribution of income and wealth is the just distribution: it is the distribution that arises if everyone uses their own powers and capacities to produce and then to voluntarily exchange commodities with one another. Each gets to keep the work of his own hands or to freely dispose of his wealth to his heirs or whoever else he wishes to bless, and each exchanges his goods for others only when it seems advantageous to do so. What could be fairer than this?

According to this school, concern over the distribution of income is motivated by ideological envy of the smart and productive. According to Kristol, economists study the income distribution not because it is or ought to be a matter of public concern, but because they have been distracted from their proper tasks by ideological "quasi-socialist conceptions of justice" that are "destructive of economics as a scientific discipline." Attempts to shift the distribution of income, by incentives or taxes, away from what the free market produces is unjust, leading inevitably to totalitarianism, according to Hayek. Even if market capitalism did produce a grotesquely inegalitarian distribution of wealth, according to this school, it would still be the right system for producing and allocating goods. Levelling policies have no economic justification and have only a shaky political or moral one as well, for it is not clear whether equality is "an ideal or a nonideal for a good society."

This school is such as to make refutation difficult: their universe of values and assumptions has so little in common with the one that the rest of us take for granted that it is hard to determine what arguments will have purchase.

XXV. East Asia's Rise-

J. Bradford DeLong
University of California at Berkeley and NBER
 

January 1997-
 
 

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Japan:

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South Korea and Other Dragons:

No one watching South Korea in the 1950s anticipated that it would become one of the world's fastest-growing economies. It has been devastated by a bitter war that had seen its capital and major industrial center, Seoul, change hands four times. Its savings rate was low. Its exports were low. More than half of imports in the late 1950s were paid for by U.S. assistance, either foreign aid or the expenditures to support the U.S. military presence in South Korea.

The government of Syngman Rhee sought to control the flow of foreign affairs and imports. They overvalued their currency (so as to charge the U.S. as much as possible for support of its military), they imposed high tariffs and they imposed stringent quantitative import restrictions as well. The result was slow and erratic growth, and continued dependence on the flow of resources from the U.S.

With the takeover of the government by Chung Hee Park in 1961, everything changed. Chung Hee Park was a somewhat brutal (although quite ordinarily so by the standards of the twentieth century) but remarkable leader who shifted Korea's development strategy to one of export-led industrialization, rather than import-substitution. The consequences were astounding. The growth rate of income per capita averaged more than 7 percent of GDP for the three decades after 1960. Exports grew from three percent of GDP to forty percent of GDP.

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The Era of Deng Xiaoping:

Mao Zedong's reconquest of power and dominance over the Chinese Communist Party was an extraordinary political accomplishment, but a disaster for China. Higher education nearly ceased for a decade--with a concommitant delay in establishing the human capital infrastructure needed for industrial development. Mao's principal lieutenant in the launching of the Cultural Revolution, Lin Piao, was assassinated--probably by Mao--under mysterious circumstances at the beginning of the 1970s.

The factions of the Chinese Communist Party were unable to coexist after Mao's death. The "left" wing--Chiang Ching, Chen Pota, (those who were soon to be reviled as the "gang of fou"--demanded that Hua Guofeng, the compromise party chairman appointed by Mao, purge Deng Xiaoping once again. The Canton military district, in which Deng had taken refuge, professed to be unable to find him for shipment to Beijing and a subsequent show trial. China came very close to Civil War.

By December 1978 Deng Xiaoping had sufficient control to begin dismantling the Maoist central planning apparatus. Per capita grain production at the end of the 1970s was the same as in the mid-1950s. By contrast, all of China's immediate capitalist neighbors had leaped ahead.

As Dwight Perkins has written:

Where Deng Xiaoping differed from his successors was in the strength of his desire to turn China into a wealthy and powerful state, and his lack of interest in Maoist ideas of a new kind of society, where such things as material incentives would play little or no role.

By luck China stumbled on a strategy for moving away from a command economy that has proved extraordinarily successful--both for the country, and for the Communist Party. Economic growth in GDP per capita appears to have averaged some 7.0% per year since the beginnings of reform in 1978. By contrast, output per capita over 1952-78 grew by at most 2.5% per year.
 

In the countryside the agricultural collecties were dismantled. In the late 1950s nearly all chinese agriculture had been gathered into people's communes and people's production teams of some fifty people. But within five years after the beginning of reform, household agriculture was once again the rule in China.

Up until 1985 the state maintained and effective monopoly over "key" agricultural commodities like grain. Peter Timmer estimates that only some eight percent of agricultural output was sold on an open market in 1978; some eighty percent was traded on relatively free markets by 1990. The response of agricultural production to the end of collective farms and to the use of the market to allocate agricultural productivity was enormous. Agricultural output doubled between 1978 and 1992, with most of the gain coming in the first six years.

Karl Marx had, in his economics, inherited a previous distinction between "productive" labor--which made things--and "unproductive" labor: the service sector, including not just services as final outputs but distribution as well. The Soviet Union and then China inherited this distinction: private restaurants and personal services were suppressed, made illegal, before 1978. After 1978, the service sector grew by leaps and bounds.

The proportion of the labor force employed in agriculture dropped from 71 percent in 1978 to 54 percent in 1994. The proportion of real GDP exported rose from 5 percent in 1978 to 23 percent in 1994. And the proportion of non-agricultural commodity output produced by the command economy's government-run enterprise dropped from four-fifths to one-third.

XXVI. The Fall of the Soviet Union-

J. Bradford DeLong
University of California at Berkeley and NBER
 

February 1997
 
 

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Leonid Brezhnev:

The person who saw this most clearly was the German classical liberal Max Weber. He saw that socialism would become nothing but a synonym for bureaucratic despotism. And:

History shows that wherever bureaucracy gained the upper hand, as in China, Egyptit did not disappear. A progressive elimination of private capitalism is theoretically conceivable. What would be the practical result? The destruction of the [dehumanizing] steel frame of modern industrial work? No! [S]imply that also the top management of thesocialized enterprises would become bureaucratic.[T]here is even less freedom, since every power struggle with a state bureaucracy is hopeless.

State bureaucracy would rule alone if private capitalism elminated. The private and public bureaucracies, which now check one another to a degree, would be merged into a single hierarchy. This would be similar to the situation in ancient Egypt, but it would occur in a much more rational[ized]-and hence unbreakable-form.

[Bureaucracy t]ogether with themachineis busy fabricating the shell of bondage which men will perhaps be forced to inhabit as powerless as the fellahs of ancient Egypt. Who would want to deny that such a potentiality lies in the womb of the future

This was written in 1917. Weber was right. From the perspective of 1990 there is little to add. One slogan of the turn of the century American labor movements was "one big union." The slogan of twentieth century socialism might as well have been "one big bureaucracy."

Weber did not note the corruption (and the related economic disruption and waste) that would come to dominate "socialist" economies, and Weber had no inkling of the periodic waves of mass terror required to preserve Communist Party power in the face of the enormous gap between the party's official ideology and its actual practice. In fact, socialism turned out in the direction that but much worse than Weber had anticipated beforehand.

The principal reason that Marx feared market economies turned out to be false: they did not have a powerful inner dynamic leading to a polarization of the distribution of wealth. This had become clear by 1883, or at least by 1900, even though it had not been clear in 1848. The appropriate reaction to the fact that growing material wealth was trickling down should have been enthusiasm. Markets are powerful instrumentalities for controlling and guiding persons and organizations. They generate a rapid pace of innovation, provide for efficient recombinations of factors of production into new enterprises, and pressure large organizations toward effective fulfillment of their productive missions. To the extent that markets can be harnessed for the purpose of building Utopia, scarce public administrative capacities and competencies can be redirected to other uses. A society that can harness markets uses a form of sociological judo, applying small amounts of pressure at key points to make inertia push results in desired directions.

But the response of those who had positioned themselves left of social democracy was not enthusiasm that it would be easier to approach utopia than Marx had expected. Instead, the response was the continued denigration of systems that assigned a prominent role to either private production or market exchange, and a worship of hierarchical administration and bureaucracy-under the name of "conscious social control and administration of production for use"-as the answer to all problems. Whatever utopia is, it does not consist of one big corrupt bureaucracy. And so the left has had little constructive to offer social democrats and others trying to manage and reform the "mixed economies" of the twentieth century.

XXVII. Ecology and Population-

J. Bradford DeLong
University of California at Berkeley and NBER
 

February 1997
 
 

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Ecology
Pollution
Managing International Resources
Changing the Global Climate
How Many People Can the Earth Support?
 

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Ecology

Human beings' activities have been affecting the rest of the ecology and the global environment since well before the beginnings of recorded history. The appearance of migrants from Siberia to the Americas some fifteen thousand or so years ago was soon followed by the elimination of many of the larger mammals on the American continent: the mammoths, the large predators, and the American horse. The colonization of Australia some forty thousand years ago was followed by the extinction of a similar class of very large marsupials.

Similar extinctions and reductions of range occurred in Eurasia as humans, armed with the then "modern" technologies of fire, fur, and flint, moved into the northern latitudes. Where is the Siberian woolly rhinoceros? Where is the Eurasian mammoth? In myth Hercules fought lions: there are no lions in Greece today, and the range of the lion is restricted to a relatively small belt in the African savannah.

We do not know about the impact of the evolution of humans on the relatively tropical climates of Africa and Asia because humans have been there so long. All we can even roughly track is the impact of the spread of technologically proficient humans--with stone tools, fire, and needles--into north temperate latitudes, and into Australasia and over the Beringia land bridge to the Americas. Everywhere we look humans--even at the stage of fire and tool-using hunter-gatherers have had profound effects on the ecology.

Things have accelerated as human numbers have grown from a few million to six billion, and as human technologies have advanced from hunter-gatherer to agricultural to industrial and post-industrial. Today there is barely a place on the globe where the local ecology is not profoundly affected by the presence of six billion human beings on the planet

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Pollution

Local pollution has always been worst in cities. Pre-industrial cities, however, had pre-industrial pollution: the enormous concentration of human and animal wastes in plces with insufficient runoff. As a result pre-industrial cities were unhealthy places for humans and animals: no pre-industrial city managed to have more births than deaths. All grew in population--all were kept from population collapse and desertion--by migration in from the countryside for those seeking better work or a more exciting (if more disease-ridden) life.

With the industrial revolution the pollution threat changes. Public hygeine improves enormously as sewage systems and modern hospitals make cities, for the first time, healthier places than the countryside. But other threats emerge: industrial rather than pre-industrial pollution. Heavy, poisonous metals in the earth; smog in the air; leaking oil in the water.

In the first century or so of industrialization, industrial pollution was not a menace seen as worth combatting: coal smoke and fouled rivers were seen as signs of prosperity-- smokestacks that failed to belch smoke were signs of depression and unemployment. People were applauded for filling in swamps, not scorned for destroying wetlands.

There is reason to believe that democratic politics are capable of making more-or-less appropriate decisions as to what tradeoffs to make between material production on the one hand and environmental quality improvement on the other. People care about the environment--and are willing to vote for politicians who pledge environmental cleanup once basic material needs have been met.

Today, it is not obvious to us that the economic problem has been solved. The moral and psychological transformation that Keynes expected to see is not here, and there is no reason to believe that it will come.

The past century has seen the industrial core of the world economy move closer to utopia. Most people in industrial nations are richer, freer, better educated, and better able to plan their lives and accomplish their purposes than in any previous time or other place. Whether the next century will see still more progress is in our hands. Many things could stop it: war, environmental catastrophe, or the collapse of representative governments are clear possibilities. But another thing that could stop it would be if we do not use our wealth thoughtfully. Wealth, after all, is power to accomplish our goals. And goals are not always chosen wisely.

If John Maynard Keynes or Edward Bellamy could see us, they would see us as a mixture of extraordinary wealth and refinement with brutal barbarity. Although we have far outstripped the imaginings of previous utopians in technology, we have not reached the level they expected in psychology or sociology. It has turned out to be much easier than expected to make humans rich, and harder than expected to make them wise. Multiplying wealth has been straightforward. Making people happy, or ending poverty has not.

Expect the same thing to hold at the end of the twenty-first century. The wealth required to feed, clothe, and educate everyone to the standards of the relatively rich in the twentieth century would consume only a small part of the resources available to the end of the twenty-first. But of our grandchildren, some will be homeless, and those who are bankers will still step over the sleeping bodies of those who are the homeless on their way to work. Those of our grandchildren who are rulers will still find building flood shelters and levees a lower priority than subsidizing the army or accumulating foreign bank accounts against the day of their overthrow.

XXX. Looking Forward-

J. Bradford DeLong
University of California at Berkeley and NBER
 

February 1997
 
 

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Critics of Marx's attack on market capitalism's alleged inability to distribute income equally have tended to fall into two schools. The _rst is the "so what?" schoolmade up of thinkers like Friedrich von Hayek, Irving Kristol, and Robert Nozick. They argued that the market's distribution of income and wealth is the just distribution: it is the distribution that arises if everyone uses their own powers and capacities to produce and then to voluntarily exchange commodities with one another. Each gets to keep the work of his own hands or to freely dispose of his wealth to his heirs or whoever else he wishes to bless, and each exchanges his goods for others only when it seems advantageous to do so. What could be fairer than this?

According to this school, concern over the distribution of income is motivated by ideological envy of the smart and productive. According to Kristol, economists study the income distribution not because it is or ought to be a matter of public concern, but because they have been distracted from their proper tasks by ideological "quasi-socialist conceptions of justice" that are "destructive ofeconomics as a scienti_c discipline." Attempts to shift the distribution of income, by incentives or taxes, away from what the free market produces is unjust the equivalent of theft, according to Nozick; and leading inevitably to totalitarianism, according to Hayek. Even if market capitalism did produce a grotesquely inegalitarian distribution of wealth, according to this school, it would still be the right system for producing and allocating goods. Levelling policies have no economic justi_cation and have only a shaky political or moral one as well, for it is not clear whether equality is "an ideal or a nonideal for a good society."

This school is such as to make refutation dif_cult: their universe of values and assumptions is "crazy" in that it has so little in common with the one that the rest of us take for granted that it is hard to determine what arguments will have purchase. One argument that should have purchase is that all social orders have at least a part of their foundation in acts of violence. Northerners forcibly con_scated thefor the most part peacefully inheritedslave property of southern whites during and after the Civil War even though those holding slaves had for the most part acquired them "justly"through purchase freely agreed to by both buyer and seller, through free gift, or through inheritance. Slave property was fruit of a poisoned tree.

Similar conclusions would apply to other forms of property that trace their roots back to violence. But consequences ramify. It is impossible to say what items of property would exist, and who would own them, had the slave trade and the Civil War not happened. All we possessincluding our literacy, and the prenatal and neonatal diets rich in protein to which we owe our "natural" intelligencewould not be ours if it not for some past unredressed violence. All we can produceexcept what food we could gather and catch with handmade stone tools alonewe owe to technological knowledge developed by previous generations of humanity that we have not paid for.

It is not possible to say what the state of things would be if all past violence were fully redressed. To say that the present distribution is just because it is the result of just exchanges and transfers starting from some just earlier position is meaningless. The earlier position from which the just exchanges have proceeded is just only by the principal of force majeurethat we had the might to create the earlier position and declare it just, and that what we say still goes because you are too weak to change it. The principle that "justice consists solely of justice in exchange" is a cloak for the principle that "the strong do what they can, and the weak suffer what they must."

John Maynard Keynes in the early 1930's forecast the economic possibilities for his grandchildren. He looked forward to tremendous growth in wealth, and to sociological and moral transformation. The tremendous growth in wealth has taken place. In large part the sociological and moral transformation has not. But the twentieth century has still seen marvels: it is no exaggeration to say that it has seen as much economic history take place as the previous three centuries, and more than took place in any millenium ending before 1600.
 

Overview
The twentieth century has seen the pace of accumulation and productivity growth in the industrial core ratchet up by a few notches. The nineteenth century saw material wealth within rich countries more or less double. The twentieth century has seen material wealth multiply more than tenfoldby so much that it is doubtful that the rate of total productivity growth over the century has a meaning. This multiplication of wealth has goven many of the relatively poor in modern industrial economies standards of living comparable to, and in some dimensions far exceeding, those that the rich of a century ago experienced.

The twentieth century has seen the substantial reduction of racism as an of_cial ideology and has seen an enormous transformation of the gender division of labor, at least within the industrial core of the world economy. The extreme reduction in fertility, the expectation that women will spend considerable portions of their adult life in the paid labor force, and the opening of educational and employment opportunities to women have worked at least half of a profound transformation of the economic roles of the sexes.

The twentieth century has seen a rising tide lift most boats, at least within the industrial core. There are still homeless, beggars, and hungry. But the widening of the distribution of income and wealth feared by Marx has not taken place within industrial economies. However, the "convergence" of nations toward approximately equal levels of productivity has not yet begun. John Stuart Mill's optimism was as misplaced as Karl Marx's pessimism. While there is substantial reason to believe that all, or almost all, nations will be richer at the end of the twenty-_rst century than they are now at the end of the twentieth, there is little reason to believe that the distribution of incomes and wealth across nations will be any tighter in relative terms.

The twentieth century has seen the decline of agriculture. Agriculture used to absorb half or more of a nation's household. In advanced industrial economies, agriculture is the activity of only a tiny minority. For most of the twentieth century the decline of agriculture was matched by the rise of industry. Manufacturing became the largest single sector measured either in terms of production or in terms of employment. Now manufacturing employmentespecially assembly-line and craftwork manufacturing employmentis declining, while the various sub-components of the service sector grow larger and larger.

The twentieth century has seen governments that rank among the worst in human history. It has seen wars that have killed soldiers and civilians in numbers that previous centuries could not have imagined. Democracy and representative governments did not _ourish for most of the twentieth century. The interwar period saw more than twenty nations try and then abandon parliamentary institutions. The post-World War II period has seen many more do the same. Today democracies are at a high point, with the fall of most Latin American dictatorships and juntas in the past half decade. But democracy is not secure.

The most destructive government of the twentieth century was the aggressive, highly nationalistic régime that ruled Germany from 19331945. Hitler's National Socialism in_icted extraordinary slaughter on its own and its neighbors' populations. Perhaps _fty million were killed by the Nazis and in the European portion of World War II. Barely behindwithin an order of magnitude of the slaughter brought about by Hitlerwere the governments of Stalin and Mao. Other Communist governmentsfrom the bureaucratic despotisms of eastern Europe to the famine-inducing régimes of Ethiopia and Cambodia to the unholy cross between Leninism and absolute hereditary monarchy found in North Koreahave been tolerable only by comparison with Stalin and Mao. In all cases, Communist governments have brought political unfreedom and material impoverishment in their wake.

Many other governments have, to a lesser degree, consciously or unconsciously sacri_ced economic growth to the perceived necessities of state building and to the task of maintaining the current régime. The result has been disappointment in development: in spite of the openness of the storehouse of industrial technology to all and the extraordinary returns to be gained from borrowing from this storehouse, the poor countries of the world show no sign of having begun to catch up to the richer in the twentieth century. This would have come as no surprise to Karl Marx. Social formations in which the dominant powers have a strong interest in rapid growth and development are rare: only the merchant and businessman-dominated societies of western Europe had such a tendency before the industrial revolution. And so it is not surprising that bureaucracy and army-dominated régimes do not have such a dynamic of rapid growth and development.

The twentieth century has also seen, in some countries, some of the best governments known to world history. The social democratic mixed economies and welfare states of the industrial core have laid the foundations for human happiness to a greater degree than any previous régimes. The mixed economies are far from being utopias. It is sobering and yet gratifying to know that they are as close as any segment of humanity has yet come.

The twentieth century has seen the United States gain and lose its position as the standard-bearer of the new age. For most of this century, Europeans, Asians, South Americans, Africans, and Australians wanting to see what the future is like have travelled to the United States. They will not do so in the future. The features that gave America its industrial predominance relative to other advanced industrial economiesits extraordinary land, its well-educated and skilled labor force, the enormous extent of its market in a world hedged by trade barriers and tariffs, its concentration on the "American system" of mass production through interchangeable parts (which turned out to be the principal locus of technological advance in the twentieth century), and its high quantity of investment in the machines that embody modern industrial technologieshave passed or are passing. Europe today has as large a tariff and trade barrier-free market. Germany has a superior educational system. Japan invests moreinvests twice as much per capitain machinery and equipment. The next century will probably see no country play the role of path_nder to the future that the U.S. played in the twentieth and that Britain played in the nineteenth century.

Will America fall far behind other countries? It is doubtful: too much of the basic research and development that underlies new technologies is still done in America. It is still too large a market. Its economy is still open to new entrepreneurs and innovations, and this seems unlikely to change.

The distribution of income within America, however, is likely to move in an unfavorable direction. The unskilled have done very well in America in the twentieth century because their labor was essential to the productivity of the land, capital, and skills owned by those at and near the top of the income distribution. As communications improve and the effective size of the world shrinks, the advantage of unskilled workers in New York vis-a-vis unskilled workers in Mexico City or Bombay is likely to decline. Just as _rms have learned to weave their webs of production across continents and countries in the twentieth centuryreducing differentials in wealth between regions of the United States and countries of the EEC by an order of magnitudeso _rms will learn to weave their webs of production across oceans in the twenty-_rst century.

The regions of the United States are much more equal, although New York City is no more equal, today than it was at the turn of the century. Gaps in wealth between nations are much, much larger than gaps in wealth within nations have ever been. So the increasing span of control exercised by _rms over the next century is likely to see a reduction in wealth inequality between nations, and an increase in wealth inequality within industrial nations, in the next century. Either educational systems in the industrial core will become much better and essentially all work in the industrial core will either be skilled work or untraded services, or the relatively unskilled will _nd themselves under extremely heavy pressure in the labor market and their wages will drop in relative terms.

The only edge that unskilled workers in the United States in the next century will have over unskilled workers elsewhere will be their knowledge of the English language. This will give them a powerful edge, but it may well not be enough. America's image of itself as an egalitarian country, where "making it" is easy for those with industry and enterprise, may not survive long into the twenty-_rst century. The economic prospects of our grandchildren who will be in America are bright, but their prospects are much much brighter if they make sure to be counted among the educated and the skilled.
 

The Pace of twenty-_rst Century Growth
What else does the twenty-_rst century hold? Will the pace of economic growth continue? In all likelihood yes. The underlying engines of development that have forced the pace of twentieth century economic growth in the industrial west are still there. Innovation is still a key road to market dominance and pro_ts. Research and development are still being carried out. Governments are still willing to provide the public goods of infrastructure and organization without which market economies cannot function. The most likely future sees a turn of the 22 nd century in which life in the industrial westwhich will then have changed its name because it will encompass the Paci_c rim as wellis as different from today as life today is from life a century ago at the turn of the twentieth century. Could we see it, we would be in the position of Edward Bellamy: having our technological imaginings in all likelihood outstripped by reality. Every reason that John Maynard Keynes gave, 60 years ago, for expecting economic growth to continue and compound at an exponential pace is still valid.

Does the twenty-_rst century inevitably hold a continuation of the trends of the twentieth? No. At least three things could stop the wave of increasing wealth: wars, governments, and environmental catastrophes. War today could annihilate human civilizations and severely reduce human populations in a week or less. It is unlikely that anyone will start a war certain to end in the mutual destruction of the contending parties. It is much more likely that someone who believes they have a sound grasp of situations and psychologies will _nd out, too late, that it is not so. A large war is not likely in the next century, but there seems to be no reason to run the risk. A far-sighted political strategy in the post-World War II period would have long since taken many more steps to reduce the possibility of even limited nuclear war than have been taken to date.

More likely than a single, civilization-destroying, worldwide nuclear war are a series of small wars, each affecting a relatively small part of the world. The destructiveness even of modern conventional weapons is such that little industrial infrastructure will survive. Civilian populations may well not survive as other than refugees either. Such wars may well impoverish those who survive them for a generation. But they are unlikely to reach into the industrial heart of the world economy. The rich nations are too well defended, and know that they have too much to lose.

There is one major caveat: writing a century ago, in the late nineteenth century, I would have said the same thing. I would have said that the industrial world had outgrown war, that wars had been fought for dynastic monarchs and conquerers but now representative governments were in the saddle and would _ght defensive but not offensive wars, and that modern wars were too expensive and destructive to be contemplated. They were too expensive: civilization in Europe was nearly destroyed by World Wars I and II. But the rise of militant nationalism meant that offensive wars to avenge imagined insults against the nation were conceivable, and were in fact fought with deadly skill and extraordinary enthusiasm. Just as the cautious, limited war politics of Bismarck was followed by the rash, total war politics of Hitler, so the cautious politics of Bush and Gorbachev may be followed by something else, that _ghts destructive wars for causes we can barely imagine, in the next century.

Governments will, in many corners of the world, continue to impoverish their peoples in the interest of securing the short-run power of the current régime. The number of such governments will with luck diminish. But they will not disappear. The anomaly in historical perspective is not rule by bureaucrats and soldiers interested in power and luxury, and not in economic growth. The anomaly in historical perspective is rule by merchants, industrialists, and workers who do have a primary interest in rapid economic growth. But governments will not stop economic growth altogether. There are too many countries with too many governments. Some of them will play the role of Britain in the nineteenth century or Holland in the 17 th , and become _rst homes for entrepreneurship and innovation and second objects of emulation by other nations.

Environmental degradation is the most likely problem to halt, or severely retard, economic growth in the twenty-_rst century. Market economies are excellent tools for _nding resources, superb incentive mechanisms for organizing production, but they are unlikely to be successful at preserving environmental quality. Industrial civilization now has reached the stage where its activities may well signi_cantly alter the world's climate in poorly understood ways. The market will be excellent at _nding scarce resources and at responding to demands generated by environmental change. But it will have no mechanism to balance off prosperity and sustainability.

Governments are unlikely to do much better. There are too many governments divided into too many factions with too many grievances against one another. Each government will bene_t only marginally from its own restraints on its people's pollution. Yet few governments will yield up enough of their sovereignty to allow for signi_cant sanctions to be applied to reduce pollution. The poor periphery will demand the right to use the dirty technologies the rich core used when it industrialized. The rich core will plead for cooperation on the grounds that sustaining the environment is a precondition for anyone's success. Mutually agreeable bargains are far from assured.

The twentieth century saw market economies generate immense wealth. The twenty-_rst century will see whether governments can agree on enough to sustain environmental quality. The odds do not appear to be as good as one would wish. Pre-industrial civilizations were for the most part unable to avoid running up against the limits of their available resources, no matter whether the most binding constraint was wood, land, or water supplies. It would be surprising if a group of governments, some governing very rich nations and others governing very poor nations, could do better and avoid running up to or over the edge of environmental catastrophe.
 

Approaching Utopia?
The twenty-_rst century will, if disaster is avoided, see material wealth de_ned as power over nature continue to increase rapidly, at least in the industrial core. Its end will be as much ahead of us in technological power as we are ahead of the end of the nineteenth century. And to the extent that this material wealththis power over natureis used to worthwhile ends, it will greatly enlarge the possibilities for human happiness just as the possibilities for human happiness today are much advanced over the late nineteenth century.

But the history of the twentieth century teaches us that material wealth, wealth understood as command over nature, is of limited use in building utopia. It is an essential prerequisite. But it is far from suf_cient. Of the four freedoms that Franklin Roosevelt thought ought to be every human's birthrightfreedom of speech, freedom of worship, freedom from want, and freedom from fearonly freedom from want is secured by material wealth. The others remain to be secured by other means.

John Maynard Keynes believed that increasing wealth would trigger a moral and psychological transformation: people would begin to concentrate not on producing more material wealth but on using their material wealth to attain psychological and social ends. After all: "the economic problemis not the permanent problem of the human race." Keynes thought that this would be obvious by the time society attained the levels of wealth that we have attained. Yet it is not obvious to us that the economic problem has been solved. The moral and psychological transformation that Keynes expected to see is not here, and there is no reason to believe that it will come.

The past century has seen the industrial core of the world economy move closer to utopia. Most people in industrial nations are richer, freer, better educated, and better able to plan their lives and accomplish their purposes than in any previous time or other place. Whether the next century will see still more progress is in our hands. Many things could stop it: war, environmental catastrophe, or the collapse of representative governments are clear possibilities. But another thing that could stop it would be if we do not use our wealth thoughtfully. Wealth, after all, is power to accomplish our goals. And goals are not always chosen wisely.

If John Maynard Keynes or Edward Bellamy could see us, they would see us as a mixture of extraordinary wealth and re_nement with brutal barbarity. Although we have far outstripped the imaginings of previous utopians in technology, we have not reached the level they expected in psychology or sociology. It has turned out to be much easier than expected to make humans rich, and harder than expected to make them wise. Multiplying wealth has been straightforward. Making people happy, or ending poverty has not.

Expect the same thing to hold at the end of the twenty-_rst century. The wealth required to feed, clothe, and educate everyone to the standards of the relatively rich in the twentieth century would consume only a small part of the resources available to the end of the twenty-_rst. But of our grandchildren, some will be homeless, and those who are bankers will still step over the sleeping bodies of those who are the homeless on their way to work. Those of our grandchildren who are rulers will still _nd building _ood shelters and levees a lower priority than subsidizing the army or accumulating foreign bank accounts against the day of their overthrow. And so _oods will still kill others of our grandchildren in the hundreds of thousands.