The 1960s “Recessions "are now generally considered fundamentally preventable, like airplane crashes and hurricanes." Arthur Okun A Setting for the Keynesian Experiment The BIG story of the 1940s and 1950s was war - WWII in the 1940s and the Cold War in the 1950s - which is why the course "skips" two decades and we pick up the story again in the 1960s. The Great Depression and WWII had "pulled" political leaders away from their comfort zone regarding the size and scope of government activity, and after a little backtracking in the 1950s, new leaders, led by "action intellectuals," pushed for a much more active role for government in the 1960s. This was to be the decade where the anti- depression policies of the 1930s morphed into anti-recession policies of the 1960s. First, however, we will fill in some background and look briefly at the 1940s and 1950s where the stage was set for the 1960s. We'll see a continuation of many of the earlier trends - industrialization, urbanization, globalization, regionalization, driven by demographics, technological change and public policies - and a reversal of a few including inequality, indebtedness, and concentration. We'll also see a new "force" that will prove to have a defining effect on the 1960s - militarization driven by the Cold War. First, though, a little history. World War II The 1940s opened with the US going to extreme lengths to avoid conflict in Europe and Asia as it reverted to its isolationist roots. The Neutrality Act of 1935 precluded any shipments of armaments to warring nations, the Neutrality Act of 1937 specified all sales to belligerents must be on a cash basis, and in 1939 arms sales were permitted only if they were not transported on American ships. With the US firmly on the sidelines, Japan embarked on its Asian land grab in 1931 when it seized Manchuria, and by 1937 it was invading China, a country in the midst of a bitter civil war. In Europe, Hitler had successfully taken Germany out of its depression by building an impressive military machine, and the West was not ready to stand in his way. In late1938 Hitler was given a piece of Czechoslovakia, the Sudetenland, on the promise this was his last land grab, and in Spain, Franco's fascists, with the support of Germany and Italy, won the Spanish Civil War. By the summer of 1939, Hitler had taken all of Czechoslovakia, and after signing a Treaty of Friendship and Alliance with Russia in August, Germany attacked Poland on September 1st. Within the` days Great Britain and France declared war against Germany and WW II had begun. In little more than a month Poland was defeated and after a lull in the action, Germany moved against Denmark and Norway in April of 1940, and Holland, Belgium, and France in May. By the end of June, France had signed an armistice with Germany, but the US remained on the sidelines. It was, however, preparing as if war was inevitable. The US adopted its first peacetime draft and sharply increased defense spending, which did precisely what Keynes predicted; it gave a direct boost to the economy through the surge in aggregate demand that produced the multiplier effect. In addition to increases in its own defense spending, the US was also supplying the Allies. Initially, England paid in gold for its supplies to conform to the “cash-and-carry” stipulations of the Neutrality Act, but by early 1941 it was unable to pay its bill and the US was constrained by the Neutrality Act not to lend money for Allied purchases. Roosevelt’s solution to the problem was the Lend-Lease program: the US would lend the Allies war material as long as it needed it, or until it was destroyed. Isolationists who did not want the US dragged into a European war opposed the policy, but in March of 1941 it became law and the basis for US supplies to the Allies through 1945. This action transformed the gold inflows into budget deficits as the US government financed the continued military "lending" to Great Britain and the other allies. The US economy continued to soar and by mid year the unemployment rate was nearing single digit rates and the automobile industry was finishing its biggest year ever. Anticipating further mobilization, the 1 government ordered a 50% reduction in auto production for the following year, but this became a non-issue by the end of the year as the US entered the war. There was no question about the magnitude of the demand surge accompanying the mobilization. Between 1940 and 1945 defense spending increased from $1.6 billion to $83 billion, an increase partly funded by increases in income taxes. In addition to raising personal income tax rates, in 1943 Congress instituted withholding of taxes so individuals would have taxes taken out of every pay check rather than one payment in March for the entire year. By the time the war was over the income tax rates ranged from 23 to 94% and the government’s receipts from the income tax rose from $.9 billion to $18 billion, excess corporate profits were taxed at rates up to 90% and corporate tax receipts rose from $1.2 billion to $16 billion. Profiteering from the war was to be limited by these confiscatory taxes. Despite the tax increases, taxes were substantially lower than expenditures so the government ran a large deficit that peaked in 1943 at $54 billion, almost one-third of the entire nation's production (GDP). This deficit was financed with borrowing heavily marketed by the government with their "Buy Bonds" campaign, and the Fed did its share by keeping interest rates low so early investors would not lose as interest rates rose as they did in WW I.i Another lesson learned in WWI was that war creates inflation, so now prices were to be restrained by the Office of Price Administration.ii A combination of price controls and rationing managed to keep inflation negligible for the duration of the war, with any real scarcity reflected in the black market prices or shortages. It was also a time of forced savings, with workers unable to spend their income due to limited supplies of consumer goods. The war made very clear the power of aggregate demand. Between 1938 and 1944, increased spending on the war was the driving force behind a surge in GDP. After the downturn in 1938, US GDP growth averaged about 13% a year through the war’s end, which was about four times the long-term growth rate of GDP. As you can see in the graph before, prior to the US entry into the war GDP growth was in the high single- digits, and once it entered the war GDP growth averaged 17% a year.iii 2 The rapid growth in the economy was also reflected in a rapidly declining unemployment rate. The US unemployment rate in late 1939 - at the outset of WW II when Germany invaded Poland – was 15%, down from the Great Depression peak of 25%. In the following two years before the US entered the war, when it acted as what Roosevelt described as the “Arsenal of Democracy,” the unemployment fell to 3.5% and by mid 1942 it was less than 1%. As for inflation, it remained under control during WW II. Inflation in the US during its involvement in WW I (April 1916 – November 1918) averaged 16%, but during US involvement in WWII inflation averaged less than 5%. What remained unresolved as WW II drew to a close was whether the inflation-free expansion of the war years could be repeated in a peacetime setting when none of the extraordinary measures - price controls, rationing, and confiscatory taxes - could be expected to be left in place. The concern was that in the absence of these external controls, expansionary macro policies would produce less of an output effect and more of a price effect - fewer jobs and higher prices. These fears were heightened in the post WWII period when the unemployment rate rose sharply, GDP declined, and inflation soared. Post World War II By the end of WW II in August of 1945 there was need for a new world order, and with the leadership of the US, this is exactly what it got. What eventually emerged victorious from the wreckage was a hybrid system that combined political liberalism with a mixed economy. As the political scientist Sheri Berman has observed, “The postwar order represented something historically unusual: capitalism remained, but it was 3 capitalism of a very different type from that which had existed before the war -- one tempered and limited by the power of the democratic state and often made subservient to the goals of social stability and solidarity, rather than the other way around. It offered neither salvation nor utopia, only a framework within which citizens could pursue their personal betterment. It has never been as satisfying as the religions, sacred or secular, it replaced. And it remains a work in progress, requiring tinkering and modification as conditions and attitudes change. Yet its success has been manifest -- and reflecting that, its basic framework has remained remarkably intact.iv The major battles about how to structure modern politics and economics were fought in the first half of the last century, and they ended with the emergence of the most successful system the world has ever seen. In fact, at the end of the 20th century “The world order created in the 1940s [was] still with us, and in many ways stronger than ever.”v So what was this new world order that has been deemed so successful and what role did economic policy play in it? In 1942, only months after the US had entered the war, two American economists wrote, “It is increasingly understood that the essential foundation upon which the international security of the future must be built is an economic order so managed and controlled that it will be capable of sustaining full employment and developing a rising standard of living as rapidly as technical progress and world vi productivity will permit.” Within two years, at a meeting of the allies in Bretton Woods, New Hampshire, the details of the international financial system that would facilitate the growth deemed necessary in the new world order was agreed upon, and in the 1970s unit we will examine this in some detail.