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World War II as a Fiscal Stimulus - Part II

By February 17, 2010

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In the form of a blog comment in response to World War II As a Fiscal Stimulus?, reader Trevor leaves some terrific data:
You Are Missing Facts.

Government Spending By Year/National GDP By Year

1925: 3.6 Billion / ? (no data)
1931: 4.1 Billion / 76.5 Billion
1932: 4.3 Billion / 58.7 Billion
1933: 5.1 Billion / 56.4 Billion
1934: 5.9 Billion / 66 Billion
1935: 7.5 Billion / 73.3 Billion
1936: 9.2 Billion / 83.8 Billion
1937: 8.8 Billion / 91.9 Billion
1938: 8.4 Billion / 86.1 Billion
1939: 9.2 Billion / 92.2 Billion
1940: 10.1 Billion / 101.4 Billion
1941: 14.2 Billion / 126.7 Billion
1942: 35.5 Billion / 161.9 Billion
1943: 83 Billion / 198.6 Billion
1944: 100 Billion / 219.8 Billion
http://www.usgovernmentspending.com/
and
http://www.bea.gov/national/
1. Government Spending was increasing rapidly before the war. It went from $5.1 Billion in 1933 when FDR was elected to $9.2 in 1939 (your year of growth). That is an 80% increase.
2. Growth from 1938-1939 was 7.1%
Growth from 1939-1940 was 10%

Yes, BUT

Growth from 1937-1939 was less than 0.5%.

(You ignored the dip that took place just before 39′ & 40′)

Effectively there was no change in spending between 37′-40′ but also there was very little change in growth between 37-40 as well. And much of the growth itself was probably fueled on a lag from the massive jumps in spending between 1934-1936. You know that-you are a trained economist-you just chose to ignore it.

3. When government spending during the war started to kick in the economy grew incredibly rapidly. From 1941-1944 the GDP effectively doubled as government spending shot up rapidly. You can't deny that spending=growth in this instance and WW2 spending had an incredible stimulating effect on the economy.

4. After the war, and the government spending, there were no significant economic problems for 30 years. In other words, massive government spending didn't lead to problems later.
This is terrific data, though I am not sure how Trevor draws the conclusion that World War II acted as a fiscal stimulus to get the U.S.A. out of the depression. A straight-forward reading of the data looks as follows:

  1. Government spending ramped up from 1934 to 1936.

  2. There was a short lived but severe recession (depression from 1936 to 1938.

  3. There were two rapid years of economic growth in 1939 and 1940.

  4. U.S. government spending started to ramp up in 1941 and exploded in 1942.
Can anyone explain to me how on earth this shows that World War II spending ended the depression? I just don't see it. In fact, a strict reading of the data could imply that the rise in government spending from 1934-1936 caused the 1936-1938 recession! It didn't, of course, but the fact there's more evidence for that hypothesis than the World War II ended the depression hypothesis is telling.

Comments

February 18, 2010 at 1:16 pm
(1) Lord says:

Unemployment never dropped below 10% until 41 when 50 billion in lend lease spending hit. That is as good an end to the depression as any.

February 18, 2010 at 3:33 pm
(2) Bo Saunders says:

The most common error in economics is confusing economic activity with prosperity. Measuring prosperity is probably beyond the capability of economics.

February 18, 2010 at 8:47 pm
(3) Jon says:

Maybe we should add the annual unemployment figures into this…assuming that they go back far enough.

February 19, 2010 at 4:48 pm
(4) Kevin Sutherland says:

Thanks for starting an analysis of whether World War II is a fiscal stimulus. Your two posts and the comments have provided some interesting and important information on this important point of history and economics.

I think the key to understanding why GDP did not appear to increase much during the war is rationing. Krugman points this out in his post that is the subject of this discussion, and in several other posts, most notably this one: http://krugman.blogs.nytimes.com/2008/12/11/dont-know-much-about-history/

As other commenters pointed out, the Unemployment Rate is probably the best statistic to follow when trying to determine if World War II ended the Depression. A massive drop in unemployment from 15% to less than 5% in about a year’s time is a tremendous result!

However, those newly employed people weren’t necessarily spending their earnings immediately and generating further economic activity (and increasing GDP). Instead, that money was saved and led to an explosion of economic activity in the late 40s and early 50s. The 50s became the era of the middle class where everyone owned a home, a car and cutting edge technology like refrigerators, TVs and other appliances.

The BLS has historical data on Unemployment available here: http://www.bls.gov/cps/cpsaat1.pdf
The URate dropped from 14.6% in 1940 to 4.7% in 1942 and then stayed around 1-2% from 1943-1945. Remember that economists generally consider the normal rate of unemployment to be around 5%, so a URate of 1-2% is extraordinary, in fact it’s never dropped below 2.9% (in 1953) since WWII.

February 19, 2010 at 5:05 pm
(5) Kevin Sutherland says:

Thank you for starting a discussion analyzing World War II as a fiscal stimulus, I think it is an important topic and your thoughts and the thoughts of the commenters have brought some important points and statistics forward.

I think the key to understand why GDP did not rise extraordinarily during World War II is rationing. Paul Krugman points this out in his post that sparked this discussion as well as several others, most notably: http://krugman.blogs.nytimes.com/2008/12/11/dont-know-much-about-history/

As other commenters have mentioned, I think the Unemployment Rate is probably the best indicator to look at to see when the Depression ended and how World War II spending affected the economy. The incredible drop from 15% to less than 5% in just over one year’s time is a tremendous result of the increased defense spending!

However, those newly employed people were not spending their money immediately, therefore not creating additional economic activity and increasing GDP. Instead the money was saved up and led to an explosion of economic activity in the late 40s and 50s. This made the 50s the era of the middle class, where most people owned a home, a car, and modern technology like refrigerators, TVs, and other appliances.

The BLS has historical Unemployment Rate data here: http://www.bls.gov/cps/cpsaat1.pdf
Unemployment was at 14.6% in 1940 before plummeting to 4.9% in 1942. It then stayed between 1-2% from 1943-1945. Remember that most economists believe unemployment normally stays around 5%, so this type of employment was extraordinary. In fact, unemployment has never fallen below 2.9% (in 1953) since WWII.

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