More on Alvin A. Hansen’s Prediction of a Post-1945 Boom

In a previous post I drew attention to Alvin A. Hansen’s prediction of a US boom after the Second World War in his chapter in Postwar Economic Problems (McGraw-Hill, New York and London).

Let us look further at his chapter.

On pp. 17–18, Hansen assumes a hypothetical model of postwar US GDP in which both private consumption and investment spending would rise considerably from 1943.

Hansen makes it clear that he regarded this as the most probable outcome for the US economy after the war:

“Altogether the various factors enumerated above indicate the great possibilities for the expansion both of consumption and of private investment during the transitional period. Indeed, the potentialities for expansion of consumption and private investment in the immediate postwar period are sufficient to indicate the possibility of a genuine and fairly prolonged postwar boom. The Federal government should, however, be prepared to play a balancing role, checking any temporary tendency toward an excessive boom, and, on the other hand, be prepared to go forward with large Federal expenditures on public improvement projects to compensate for any strong tendency toward deflation and depression.” (Hansen 1943: 18).

So, while Hansen did hedge his bets, in the sense that he thought that any tendency towards “deflation and depression” would require fiscal stimulus, nonetheless he felt there were “great possibilities [my emphasis] for the expansion both of consumption and of private investment during the transitional period. Indeed, the potentialities for expansion of consumption and private investment in the immediate postwar period are sufficient to indicate the possibility of a genuine and fairly prolonged postwar boom.”

Elsewhere, Hansen also made it clear that he was an optimist, and did not share the views of the pessimists about the post-war economy:

“The fact is that many people dread to think of what is coming. Businessmen, wage earners, white-collar employees, professional people, farmers—all alike expect and fear a postwar collapse: demobilization of armies, shutdowns in defense industries, unemployment, deflation, bankruptcy, hard times. Some are hoping for a postwar boom. We got that after the First World War. Not improbably we may get it again. If the war lasts several years, we may have at the end of the war sufficient accumulated shortages in residential housing, in durable consumers' good such as automobiles, and in the plant and equipment required to supply peacetime consumption demands, to give us a vigorous private investment boom. Indeed, we need to be on the alert to prevent a possible postwar inflation. If in fact we do experience a strong postwar boom, there is, however, the gravest danger that it will lull us to sleep. Sooner or later such a boom will end in a depression unless we are prepared. If appropriate action is taken, there is no necessity for a postwar collapse.

Everywhere one hears it said that, when this war is over, all countries including our own will be impoverished. This view is, however, not sustained by past experience. No country need be impoverished if its productive resources (both capital and human) are intact. The productive resources of this country will be on a considerably higher plane when this war is over than ever before. A larger proportion of our population will be trained to perform skilled and semiskilled jobs. We shall have enormous productive capacities in all the machine industries. And in special consumers’ durable industries where plant and equipment may have become deficient by reason of the war, we shall be able very quickly, with our large basic machine-producing industries, to expand to meet the peacetime requirements. We shall have, when the war is over, the technical equipment, the trained and efficient labor, and the natural resources required to produce a substantially higher real income for civilian needs than any ever achieved before in our history.” (Hansen 1943: 12–13).

What emerges from this is that opinion on what would happen after the war was divided. There was indeed some pessimism about the possibility of a severe slump after 1945 amongst certain “[b]usinessmen, wage earners, white-collar employees, professional people, [and] farmers.” It was not some opinion held merely by Keynesian economists (and even amongst Keynesians there were important optimists). In the end, Hansen did not share the pessimistic view, and explicitly stated that he thought the idea was not “sustained by past experience.”

Moreover, there was nothing inherently unreasonable about the idea that America might face severe unemployment problems and depression after the war. Business expectations are subjective. They can change rapidly in response to shocks. What happened to the private US economy after 1945 was dependent on expectations. Either a boom or slump was possible. The fact that some Keynesian economists did think a slump was coming does nothing to invalidate their underlying macroeconomic theory, for Keynesian economics (or at least that of Keynes himself and those heterodox varieties not compromised by neoclassical economics) stresses the uncertainty of the future. It is not possible to predict with certainty or with objective probability scores the state of certain future economic variables in market economies. All one can do is make forecasts qualified by assumptions about how expectations will play out. One’s assumptions may turn out to be right or wrong.

As it happens, Keynes, Hansen and Richard M. Bissell were right in their forecasts about the post-1945 US economy.


BIBLIOGRAPHY
Hansen, Alvin A. 1943. “The Postwar Economy,” in Seymour E. Harris (ed.), Postwar Economic Problems, McGraw-Hill, New York and London. 9–26.

Paul Samuelson on the Post-1945 Boom

I am back from holidays, and hope my readers had a good Christmas and a happy New Year.

My first post of this year: on Paul Samuelson and the post 1945 boom.

Paul Samuelson comes in for a lot of criticism about his allegedly failed predictions concerning America’s economy after WWII. I see there is further Samuelson bashing going on at the moment from the usual suspects. The following comments are based on an earlier post.

The relevant article by Samuelson that is normally cited by his Austrian and libertarian critics is this:

Samuelson, Paul A. 1943. “Full Employment after the War,” in Seymour E. Harris (ed.), Postwar Economic Problems, McGraw-Hill, New York and London. 27–53.

It is perfectly clear that the critics have never really bothered to read what Samuelson said in the chapter in question. If they did, they would see that Samuelson was basically right in his assertions.

The point I have made before too is that Samuelson (1943: 37) was also clear that there were fellow economists who were optimistic about a post war boom, on the basis of “private demand alone,” and he listed three types of such economists. The second group of these “optimists” appear to have been some of his fellow Keynesians:

“[sc. the “optimists” argue that if] ... we add to this the forced saving plans which the future will certainly bring, as well as postwar tax refunds to corporations, it will be seen that the real backlog of deferred demand as a result of wartime depletion of capital will be accompanied by the financial means to make it effective.” (Samuelson 1943: 46).

That optimism about the post-war economy was shared by John Maynard Keynes:

“Keynes harshly rejected the risk of post-war stagnation, holding that because of Social security there would be a large reduction in private saving and so that would be no problem.” (Colander and Landreth 1996: 202).

But here is the crucial paragraph from Samuelson that must be read properly to understand his predictions:

“When this war comes to an end, more than one out of every two workers will depend directly or indirectly upon military orders. We shall have some 10 million service men to throw on the labor market. We shall have to face a difficult reconversion period during which current goods cannot be produced and layoffs may be great. Nor will the technical necessity for reconversion necessarily generate much investment outlay in the critical period under discussion whatever its later potentialities. The final conclusion to be drawn from our experience at the end of the last war is inescapable – were the war to end suddenly within the next 6 months, were we again planning to wind up our war effort in the greatest haste, to demobilize our armed forces, to liquidate price controls, to shift from astronomical deficits to even the large deficits of the thirties – then there would be ushered in the greatest period of unemployment and industrial dislocation which any economy has ever faced. This does not deny that there may be a boom after the war. In this the experts may still be correct. For the release of controls upon demand coupled with plentiful amounts of monetary demand might well give rise to price increase, inventory buying, feverish speculation and all the superficial earmarks of a boom. But it would be the antithesis of a prosperity period, constituting instead a nightmarish combination of the worst features of inflation and deflation. Nor, having spent itself, could it be expected to evolve into healthier channels. Instead, the final outcome would undoubtedly be a cumulative hyperdeflation from which, at best, we should lose a decade of progress and which, at worst, our democracy would not survive.

Of course, this is not intended as a picture of what will in fact happen. For there is every reason to believe that we shall not be lulled into a feeling of false security by the last war’s experience or by the half-truth that the end of the war will witness a boom. No doubt, we shall retain direct controls for a period after the conflict ends. We shall taper off war production gradually. We shall undertake income maintenance in the form of dismissal pay for soldiers, unemployment compensation, direct and work relief expenditure. It is probable, although less certain, that, in addition, the Federal government will initiate employment maintenance measures such as large scale public works, etc. But even these will not be adequate to maintain full employment or any approach to it.” (Samuelson 1943: 51).

Now note very carefully Samuelson’s explicit comment: “Of course, this is not intended as a picture of what will in fact happen.”

Samuelson’s prediction of the “greatest period of unemployment and industrial dislocation which any economy has ever faced” was dependent on certain assumptions as follows:

(1) the war ending suddenly within 6 months after 1943;

(2) very rapid termination of war effort and production;

(3) rapid demobilization and liquidation of price controls, and a sudden shift from astronomical deficits to the large deficits of the thirties, and

(4) absence of any “income maintenance in the form of dismissal pay for soldiers, unemployment compensation, direct and work relief expenditure.”

Now Samuelson was wrong in that he underestimated the scale and vigour of private sector investment and consumption spending after 1945. He was of course wrong in thinking that the post-1945 boom might be a hollow boom of mere inflation, inventory buying, and speculation to be followed by a hyperdeflation. Yet these remarks have to read in context and with the observations in the rest of the chapter (see below).

Samuelson was right on a number of other points. For example, the US did not suddenly dismantle price controls as soon as the war ended: it was not until 1946 that Truman lifted many of these controls.

Samuelson was right that dismissed soldiers would receive “unemployment compensation” and other support: for the Servicemen’s Readjustment Act (or G.I. Bill of Rights, July 1944) gave extensive unemployment benefits to demobilised soldiers. The act also gave soldiers four free years of college education, which must be counted as a significant measure that prevented unemployment from rising as well, since many returned servicemen took college degrees and did not seek work.

The US government still had massive budgets in 1946 and 1947: it did not suddenly reduce the amount of government spending to, say, less than 10% of GDP, where it had been in 1934–1935 and certainly historically pre-1914.

Samuelson was therefore correct in saying such measures would in practice avert the “greatest period of unemployment and industrial dislocation which any economy has ever faced.”

Samuelson was also well aware that pent up demand (or what he called “deferred demand”) would be a source of post-WWII growth (Samuelson 1943: 52), but argued that this would fade out after 18 months to 2 years. He must be judged essentially right on this point too, for the US slipped into recession by November 1948, as the post-war boom faded.

Above all, the point that emerges from all this is that a number of other Keynesian economists did not share some of Samuelson’s more pessimistic views (and he cited their opinions as those of his second group of “optimists”).

Keynes certainly did not, nor did the Keynesian Richard M. Bissell (who is cited in Samuelson 1943: 53, n. 1, as holding an opposing view on the strength of “future private demand” post-1945).


BIBLIOGRAPHY

Colander, D. C. and H. Landreth (eds). 1996. The Coming of Keynesianism to America: Conversations with the Founders of Keynesian Economics, E. Elgar, Cheltenham.

Samuelson, Paul A. 1943. “Full Employment after the War,” in Seymour E. Harris (ed.), Postwar Economic Problems, McGraw-Hill, New York and London. 27–53.

The Post-1945 Boom in America

Russ Roberts drags up the mistaken prediction that Paul Samuelson made during World War II and complains:

“I don’t know what private aggregate demand means, or the phrase “pent-up” demand. The usual way that Keynesians explain the post-war expansion despite the huge cut in government spending is to say, well of course the economy boomed, there was a lot of pent-up demand. What does that mean? There is always pent-up demand in the sense there is a stuff I wish I could have but can’t. But the standard story is that people couldn’t buy washing machines or cars during the war–they were rationed or simply unavailable or unaffordable. So when the war ended, and rationing and price controls ended, people were eager to buy these things. But the reason these consumer goods were rationed or unavailable is because all the steel went into the tanks and planes during the war. So when the war ended, there was steel available to the private sector. That’s why cutting government activity can stimulate the private sector.”

Russ Roberts, “Keynes vs. Reality-2,” July 14, 2011

To which the response should be: and how is this inconsistent with Keynesian economics?

Americans had accumulated vast savings during the war: some $100 billion by 1944 including $43 billion in savings and money.

But American consumers could not spend the money on consumption during the war, owing to shortages, rationing and the fall in production of consumer goods. Unless you seriously believe that the desire to consume — to satisfy your subjective utility preferences by buying commodities — does not rise with income, then the meaning of “pent up” should be obvious: it means the desire to purchase consumer goods but being unable to buy them, even though you have the money.

When the war ended and the wartime command economy was dismantled, resources were freed up for reconversion to a peacetime consumer economy, and there was a totally atypical downturn in 1945 were GDP fell by 12.5% between February and October:

“The decline in government spending at the end of World War II led to an enormous drop in gross domestic product making this technically a recession. This was the result of demobilization and the shift from a wartime to peacetime economy. The post-war years were unusual in a number of ways (unemployment was never high) and this era may be considered a ‘sui generis end-of-the-war recession’.”
http://en.wikipedia.org/wiki/List_of_recessions_in_the_United_States

Samuelson feared that there might be a return to long-term depression after this conversion: he was wrong. There was the massive surge in consumption after 1945 using accumulated savings, and income rose even more after the 1945 tax cut of $6 billion, passed in November. The post-war growth to 1948 was an entirely predictable development consistent with Keynesian economics.

In 1943 — the same year Samuelson got it wrong — Keynes was giving a lecture at the Federal Reserve and was asked by Abba Lerner about the possible economic problems of the post-war period. Keynes’s reply is significant:

“Keynes harshly rejected the risk of post-war stagnation, holding that because of Social security there would be a large reduction in private saving and so that would be no problem.”
D. C. Colander and H. Landreth (eds), The Coming of Keynesianism to America, E. Elgar, Cheltenham. 1996. p. 202.

In other words, Americans now had the security of welfare programs that allowed them to free up more of their income in spending.

What kind of analysis of the post-war boom ignores what Keynes — the founder of Keynesian economics — thought about this question? Samuelson was simply wrong; Keynes was right.

Another problem for Austrians is this: there was a very sharp rise in government spending from 1948 to a 1953? Why?

The second post-WWII recession extended from November 1948 to October 1949. Truman’s budget surplus of 4.6% of GDP in fiscal year 1948 fell to 0.2% in fiscal year 1949, as spending went from $29.8 billion in 1948 to $38.8 billion in 1949, as automatic stabilizers kicked in. In fiscal year 1950 (July 1, 1949 to June 30 1950), the budget went into an actual deficit of 1.1% of GDP. Moreover, Congress had pushed through a tax cut in 1948, which boosted private spending in 1949. What we have here is classic Keynesian countercyclical fiscal policy.

Some of the increases from 1950–1953 were, of course, related to the Korean war, but also to new social, welfare and military programs enacted under Truman. Government spending in both absolute terms and as a percentage of GDP surged from 1948 to 1953, fell slightly from 1953–1954 as the Korean war ended, but remained between about 25% and 30% of GDP throughout the classic era of Keynesian economics (1945–1973), as can be seen here:

US Government Spending as Percent of GDP: 1903–2010.

Yet the economy continued to boom despite the historically unprecedented levels of government spending in absolute terms and as a percentage of GDP.