 Well, good morning, ladies and gentlemen. Welcome to session number seven of our series of 10 presentations on the growth of government in U.S. history. I'm going to talk about World War II this morning, the greatest war of all time, greatest in the sense of most terrible most deadly, widest in scope, doing the most damage to the most human beings. I suppose in some military eyes that's great in another sense as well, but for those of us who think human life is worth preserving, it was a gigantic tragedy. As I mentioned earlier in talking about the Versailles Treaty, and as others have mentioned this week as well, World War II was seen as early as 1919 as well-nigh inevitable. Different people had different views on when the fighting would break out again, but a great many intelligent people were quite convinced that sooner or later Europe would go back to war. And certainly after the Nazis took control of the German state in 1933, then even more people began to see that war was inevitable. When the war finally did begin in September 1939, very few Americans desired to participate in it. I would guess that no more than 10 percent had any enthusiasm at all for becoming involved in that war. During the interwar period, many Americans had become disillusioned with the American engagement in World War I. They had come to see it as a gigantic mistake, as a tragedy, if not for the world, and certainly for the United States, even though our losses had been trivial compared to those of the European belligerents, they were of some consequence to the more than 100,000 men who died and several hundred thousand who sustained wounds. So Americans had taken considerable pain to prevent making that kind of mistake again. And the Congress had held extensive hearings in the 1930s investigating how the country had become involved in the war. And many people began to blame it on merchants of death, on arms dealers and bankers connected with them, and people who were seeking simply to profit in a commercial way from involvement in war. Although I think those hearings had some value, the so-called NIE Committee hearings make interesting reading even now. There are many, many volumes of testimony and evidence accumulated by the committee staff. I think the idea that became popular, that World War I was simply a conspiracy of merchants of death, was extremely simplistic. Not that there was not a grain of truth in it, but certainly I think had less weight than simply Woodrow Wilson's psychology, which shows a much more important factor in how the United States entered World War I. But in any event, the result of this inquiry was passage of a series of neutrality acts in the mid-1930s designed to prevent the kinds of engagements that might entangle the United States in future wars. So that was the climate of opinion in this country with regard to war. Americans were very anti-war in general in the 20s and 30s. And so in 1939 they wished very much to stay out. President Roosevelt made an announcement urging people to remain neutral, but he did not urge them to remain neutral in spirit. Unlike Wilson in 1914 who had urged people to be neutral all around in their sentiments as well as their actions. So Roosevelt made no secret of his hatred of Hitler and of his sympathy for the British and the others who were opposing Hitler. So it was quite clear already, and indeed the president made no attempt to conceal that his sympathies lay with the anti-Nazi forces. And during the next two years, although the president progressively revealed his own actions in moving the country toward more active involvement in opposing Germany, he was very, very cagey and deceptive and careful never to get too far out in front of public opinion. I think we always need to remember that Franklin Roosevelt was not an ideologue, he was simply an extraordinarily ambitious politician with no principles, whatever, and his major objective was always to personally succeed in retaining power and to augment that power and to use it in the service of crushing his political enemies. So he was working toward getting the country into the war in a variety of ways, and ultimately as we all know he succeeded by bringing the country into the war by the so-called backdoor, that being provoking the Japanese by a series of increasingly stringent trade restrictions and ultimatum until the Japanese were put in a position they regarded as desperate and from which they could escape only by attempting to stage a kind of blitzkrieg of their own that would so discourage the Americans that they would be willing to come to terms with Japan. And of course they knew themselves that was a gamble, but they felt they had no good choice, but to make that gamble and of course they lost. But when the Germans invaded the low countries in France and Norway in 1940 in the spring after the winter of so-called Sitzkrieg, I always love that term, the quick success of the German forces, we have to remember France was not regarded as a weakling country at the beginning of 1940. It was a major military power and the ease with which the German army rolled over the French defenses astonished the world and astonished many Americans and made many of them begin to change their ideas and to think that the Germans were really a more powerful threat than they had imagined and many people began to agree with the pro-war argument that the United States needed to do much more to build up its defensive capabilities. And from that point forward, Congress began to appropriate large sums of money for building up the U.S. Armed Forces and munitions industries here and U.S. preparation for war grew bigger and bigger and bigger from mid 1940 onward. So by the time the Japanese did attack Pearl Harbor in December 1941, we had increased the size of the army several fold and had instituted conscription and had begun systematically to develop industrial capacities viewed as necessary for supplying a large armed force and the present eventually not only provoked the Japanese but actually placed the United States Navy in a state of war against Germany. I believe Roosevelt hoped to provoke the Germans so that they would do something that he could use as a pretext for seeking a declaration of war. But the Germans refused to be drawn into that ambush as it were and despite provocations, despite U.S. naval actions, shooting, dropping mines on German submarines, assisting the British forces with information, hunting German submarines and so forth, none of this provoked the Germans to actually come out and either declare war on the United States or engage in some substantial military action against U.S. forces, although they did shoot back on some occasions. So this was the situation going on in 1941. 1941 was an extremely nervous year for Americans because they weren't at all sure what was going to happen. The President was not honestly revealing to people what his policies were and what the military was doing in the North Atlantic with regard to Japan. So people were in something of a fog. They had far fewer alternative news sources than we have today with the technology of our time, so they were much more dependent on what they were told by official sources. And I think many of them at least tended to believe what they were told quite naively at least nowadays. There are a few cynics in the public, although I suspect most Americans are just as naive now as they were in 1941. As I say, the draft was begun that was enacted in September 1940 and in the beginning it was a law that applied to just a one year period. A number of men were conscripted and trained for military service during that year. And as the year drew to a near close, people had to decide whether to use the authority of the draft law to extend the term of service, which could be done the original draft law of 1940 had a provision that if the President declared that national security required it, the men could be kept longer than one year. But people were leery of doing that for political reasons because that looked like going back on what had been promised these men. They had been told, look, we're dragging you into the Army against your will, but it's only for a year and then you'll be free. But then they were going to turn around and say, no, take it back. You have to stay in the Army. That might have created a lot of furor. So they were apprehensive about doing that at the same time by August of 1941, things looked very, very dangerous with regard to the security position of the United States, at least in some American eyes. And so they thought it was really imperative that they not disband this large Army that they had just put together and let these trained men go back to civilian life. Ultimately, they did extend the draft. They passed the new draft act in August 1941. But this was one of those rare examples where one vote was decisive, where literally every vote counted, at least every vote in the House of Representatives, because this draft extension law passed in the House by a vote of 203 to 202. So any members changing his vote in the majority would have transformed the majority into a minority. And the law did pass, the men were kept, new men were drafted. Once again, the draft system operated with local civilian boards doing the dirty work, selecting the specific individuals who would have to serve. It worked so beautifully in World War I. They put the same system back into effect. The law provided penalties of five years in prison, or $10,000 fine for draft evasion. And so the draft was a huge penalty at the time. And relatively few men in World War II evaded the draft compared to World War I, probably because this war was simply one that had more popular approval than World War I had. Some did evade the draft. I had an uncle that kept going away while timing again and spent quite a bit of time in prison as a result. He was a family disgraced, by the way. I was not brought up to regard him as a family hero. About 10 million men were drafted altogether during World War II, a total of 16 million who served at some time in the armed forces. So we've got the bulk of everybody who served actually drafted, and as I've mentioned before, many of those who joined voluntarily did so in order to avoid being drafted. Particularly people would join either the Navy or the Army Air Corps, and that meant, if nothing else, that they wouldn't be in the infantry stuck in a filthy mud hole with artillery shells exploding all around them. So they at least avoided that, although I would have to say that the ones who became an air crew in the Army Air Corps have made a very bad bargain so far as preserving their lives because the bomber crews over Europe sustained enormous casualties. And if you've never read Catch 22, I recommend it highly. It's one of the great war books. Unlike anything else I've ever read, I don't even know how to quite describe the kind of book Catch 22 is. It took me a little while to quite get in the spirit of the way it's written, but once I did it had a great effect on me. After the country entered the war, the Congress passed a War Powers Act in December and then a second one in March of 1942, and these acts gave a tremendous power to the President or his agents to, first of all, reorganize the government without any congressional approval. You may remember this is a power that was given to Wilson by the Overman Act during World War I, but at that time it was extremely controversial. Many people thought that the Overman Act made Wilson a dictator because it allowed him to rearrange the functions and duties of the executive branch of the government on his own without any congressional approval. He could create new agencies, shift the duties of agencies from one to another, and so forth, basically remake the government at his pleasure. But in 1941, Congress simply gave Roosevelt that power with hardly squeak. It uttered in protest, so it's an example of how once precedents have been set, then it becomes very easy to do the second time or the third time what has been done once before. The President was also given the power to make contracts for the acquisition of war material in a very flexible way. Before the war, there had been quite strict rules about how the government could contract with suppliers and requirements for competitive bidding and sealed bids and automatic selection of the lowest price bidder, and a variety of rules like that had been put into effect, again, to foreclose so-called war profiteering. That had seemed to many people to have taken place in World War I, but under these War Powers Act, the President was put in a position, not exactly to contract in any way he wanted, but to have much more flexibility and in particular to avoid a sealed bid, low price type selection of suppliers, and most of the contracts the government made with suppliers in World War II were negotiated contracts. That meant that one of the government procurement officers just sat down with General Motors and they put together a contract, and when they were happy with it, they signed their names, and that was that. There were some restrictions that the government was forbidden to make contracts on the basis of paying cost plus percentage of cost. Many such contracts had been made in World War I, and if you think about that for maybe two seconds, you see what kind of incentive it creates for the supplier. If the higher the supplier's cost, the greater the supplier's profit. So in World War I, many suppliers acted accordingly and ran a huge cost of producing whatever they supplied the government, and then added 15% of that amount on top as their fee. Well, contracts in World War II were usually cost plus fixed fee. That is the absolute amount of the profit, if you want to call it that, was set apart from whatever the cost turned out to be. And then supposedly, government overseers would try to make sure that the manufacturer kept his costs down to minimum levels, but in any event, the government was not going to be paying a bigger margin of fee on top of the costs if they did run up. As it turned out, the way they estimated the appropriate fixed fee was by applying a kind of percentage of the estimated cost. So in practice, the cost plus fixed fee contracts mimicked the old cost plus percentage of cost type contracts. And this switch did not make a great deal of difference. As it turned out, these contracts became extremely flexible. They were really not worth the paper they were written on, because if contractors got into trouble, a problem, their costs ran up, they would simply appeal for adjustments, and those adjustments would be made. So, as one historian of this episode wrote, contracting became a family affair, so that they all viewed themselves as working toward the same objective, and they weren't going to worry too much about formalities of containing costs or worrying about profits. But just to make sure that the government wasn't stolen blind by the suppliers, Congress created the renegotiation laws. And this was a way of making contracts even more uncertain, because under renegotiation laws, the government went back, examined contracts after they had been fulfilled, and then took some of the money back that it had paid to the supplier, saying, well, you got too much. Some of these renegotiation actions were contested in the courts, went all the way to the US Supreme Court, which ultimately ruled that the government's claims that some contract or profit was excessive didn't have to be defined. Normally when people go to court and talk about what is someone's obligation under an agreement, they say, well, what did the agreement provide? How did the government define excessive profit? How did it define what was due in renegotiation? And it turned out the court just accepted a circular definition. Appropriate renegotiation was appropriate renegotiation. Whatever the government decided to do, the court would say was okay. But at all events, many of these contractors did very well in World War II. They made extraordinary rates of return, given that they were facing very little risk, because if they got in trouble, they renegotiated the deal. So in those circumstances, the risk was very low, and there was really no excuse for the high rates of return, given the low amount of actual risk. Strangely enough, the smaller contractors made even higher profits than the big ones. But the big ones did quite well also. The government's huge spending for war purposes began to drive up prices. They had been steady for almost a decade, but they began to go up rapidly in late 1940 and in 1941 and even quicker in 1942. So Congress passed price control legislation. Before that, some boards created by the President by Executive Order had been attempting to jawbone suppliers into holding down prices, not very successfully. A first price control act in early 1942 proved to be unsatisfactory. In October 1942, the Economic Stabilization Act was passed and that worked a little better at helping the government at least hold down visible price increases. I emphasize the word visible because what came into effect by the end of 1942 was a fairly effective, comprehensive price control system, very complex, full of exceptions and changes and continual juggling that affected virtually the entire civilian economy. Now by that time, more than a third of what was being produced was being sold to the military and all those prices are being determined by the military purchasers and the suppliers when they decide on their terms of contract. But the civilian economy is subject to price control and almost every respect even rents as well as the prices of ordinary goods and services. And the laws tempted a lot of evasion and avoidance in countless ways. If there's one thing people are clever about, it's avoiding price controls. So not only did they have the usual kinds of consequences, such things as people standing in long lines to buy goods that were priced below market clearing levels officially with all the kinds of discrimination that always go along with that. I've heard many of the older guys tell stories about how they'd say send their wives or girlfriends to the butcher shop to buy meat because if they themselves went in and asked for steak, the butcher said, I'm sorry, I don't have any. But if a good-looking woman went in and said, do you have any meat today, Mr. Butcher? They'd have a better chance that he would find some. So whenever price is not available to be used as a rationing device, that means sellers are in a position to use other criteria, whatever they happen to to find pleasing, whether it's selling to their relatives or friends or people of the same race or people who look better or whatever they choose. And World War II was rampant with all these different kinds of discrimination because of these price controls. In many cases, price controls created such shortages that people began to complain they could not get the essential consumer goods. And so the government's response to that was to equip every man, woman, and child with these ration booklets. I've brought mine today to be ready just in case. One never knows when the government's going to re-institute a program. This one was issued to a child aged two, or ages written on the booklet, and most of these coupons were never used. They're still in the booklet. There were several different kinds. They came in different colors depending on what they were to be used for. And rationing was applied to a variety of consumer goods such as meats, clothing, shoes, sugar, canned goods, butter, lard. So when you went to buy any of these rationed goods, there was still a money price. So you had to pay the money price, which is supposed to be the controlled official price permitted by the government. Plus you had to surrender the second price, a certain number of these rationed coupons. And by that means the government attempted to make available to everybody at least a minimal amount of all of these essential consumer goods. Even with rationing, a lot of consumer goods were very, very scarce, particularly shoes and gasoline and tires for automobiles. And so people had to make do. They had to make repairs to old cars or to keep fixing their tires even though they were worn out and kept failing time and again. One of our great family stories has to do with my father's moving right after I was born in the beginning of 1944 to Oregon to work in a shipyard there. And on the trip from Oklahoma to Portland, Oregon in a Model A Ford with worn out tires, they had 40-some flat tires along the way. And every time they had a flat, they would have to stop and my dad would jack up the car and take off the tire and take out the tube. In those days tires had rubber tubes inside them and he would get out his patch kit, find where the hole was, put a patch on, take a pump, dump the tire back up, get in the car and continue the trip. And he had to do that more than 40 times to get from Oklahoma to Oregon. But that was the situation that people had to endure during the war because of the shortage of tires. On one occasion when they passed through Salt Lake City, they stopped and had lunch at a drugstore lunch counter. Some of you older fellows remember when they used to have those. And after they got up and left, they drove down the road and 30 or 40 miles later, my mom suddenly realized she had left her purse sitting on the counter and it had all their ration coupons. So they had to turn around and go back. Fortunately, they got the purse. But these things were essential. You couldn't go through even normal life without having the access that they gave you to necessities. There was much counter-fitting. The mafia got heavily involved and not only dealing in ration coupons, stealing the real ones, reselling them, entering into schemes where they weren't collected when they should have been, making false reports. So naturally whenever you have laws that distort what people want to do in an open market, criminality is encouraged. And that was an effect that was quite serious in World War II. Some historians like to tell stories as if everybody fell in line with doing patriotic duty during World War II, but that's a complete myth. Many people were looking out for themselves just as many people always do, no matter what the situation. The attempt to control the economy extended to trying to allocate raw materials so that they would be made accessible, first of all, to people producing essential war materials. The government instituted a new priority system similar to the one the War Industries Board had used in World War I and almost immediately concluded, as I suggested the War Industries Board would have concluded if the war had lasted a little longer in 1918-19, that this was a bad system. Priority inflation began to occur. The system broke down. It really wasn't serving to distinguish different demanders by their military urgency. Too many exceptions were made. Continual requests for higher priority ratings and adjustments. And over the war years, the government constantly juggled its control apparatus. It was almost on a daily basis, altering the requirements and the way the system operated. A big change was made in 1943 with something called the Controlled Materials Plan and many historians still write this up as if it were a raving success and really won the war for the United States. Under this plan, three key commodities were controlled in a particular way, steel, copper and aluminum. Aluminum had become a critical material because aircraft during World War II were almost all made with aluminum fuselages. And the aluminum industry boomed. It had been a fairly small industry before the war, but it grew very big during the war in response to an enormous growth in the aircraft industry. Military suppliers supplied something like 300,000 aircraft to the government during the war. If you think now about how many Lockheed Martin produces in the given year, it's a few dozen. And I grant the modern airplanes are a lot more technically advanced than the ones of World War II. But nonetheless, the difference in scale is mind-boggling. 300,000 airplanes in five years, all kinds, everything from a little trainer aircraft to B-29s. And in the last year of the war, even jet fighter planes were being made. And the B-29 was a technologically very advanced aircraft. It was the most advanced aircraft ever built to that time. But all this required a huge demand for aluminum. Copper was used in many industrial purposes, and all these shell casings were made of brass. So there was that in steel, of course, went into a multitude of different uses from building ships and tanks, guns on down the line. So what the government did was it decided to give a fixed amount of each of these three materials to each of the three main military demanders, the War Department, the Navy Department, and the Maritime Commission. The Maritime Commission was the old shipping board. The name had been changed during the 1930s. And just as the old shipping board had been building merchant ships through the Emergency Fleet Corporation during World War I, the Maritime Commission engaged in building or contracting with shipbuilders on a massive scale during World War II to crank out thousands of merchant ships. Because remember, this is an overseas war. Everything that's produced here in the United States and all these men who are trained here have to go forth. And the only way they can get there, at least in any large numbers, and be supplied appropriately is through ocean shipping. And the United States didn't have much of a merchant fleet when the war began. So they had to create that again almost from scratch, just as they had back in 1917. This time, however, they were much more successful. I mentioned that in World War I, very few of the ships hit the water by the end of the war. In World War II, thousands of them were completed. And in fact, mass production techniques were devised so that they could actually put together these ships in a few weeks normally. They welded them together, rather than riveting them. And it was a much quicker way. They weren't very good ships, but then they were probably just going to be torpedoed anyhow. So they produced a lot of these shoddy, slow-moving merchant ships. They might only make 10 knots speed, but if they just kept steaming along, they'd eventually get to Guam. And so they consumed a lot of steel. So the Maritime Commission and the two military departments were given certain amounts of aluminum, copper, and steel. And then they, in turn, made assignments down the chain to their contractors, and the contractors then divvied up their amount to the subcontractors, and the allocations flowed down in that fashion. Now notice this is physical allocation. This is classic central planning. You say, where's the price system? And the answer is it doesn't exist. This is an attempt to allocate resources without the use of prices. The first decisions made up here at the top are made entirely on the basis of technical and military information. There's no economic information, properly speaking, involved at all. And in fact, this whole control apparatus amounted to a massive system of central planning. Because we had a centrally planned system, not that there weren't any prices out there, there were still prices. They just weren't market prices. They were arbitrary prices, controlled prices, set prices, government-negotiated prices. In other words, prices with no economic rationality underneath them. So this whole apparatus cannot be understood in a way that's comparable to the pre-war economy or the post-war economy, where most of the prices did result predominantly from market forces. And that's been a difference that very few economists and economic historians have understood. They've tended to look at events and to track macroeconomic indices right through the war as if you could draw smooth series. But anything that relies on prices has a discontinuity once we get to 1942, because the validity of the price system dissolves and becomes spurious at that point. Well, of course, what most Americans liked about the war was the fact that unemployment disappeared. And one can understand that. A lot of people had been unemployed, at least at some time during the 1930s, some of them for a long time, and even those who were working in the 1930s tended to live in fear that they too might lose their jobs at any moment. So apprehension about unemployment had become pervasive among Americans after 10 years of the Great Depression. And when the defense build-up began to absorb the labor force and to provide opportunities for people to go into shipyards or bomber plants and get what seemed to be good-paying jobs, people were happy. They had the feeling that good times were here again. And in fact, there was constant complaining by the military authorities that people were too happy that they're forgetting that there's a war on. And in fact, that was one of the slogans of the day. Don't you know there's a war on, as if people were so content with their state of affairs that they didn't care what was going on in New Guinea. Well, that was somebody else's problem. Well indeed, that was one way to think about it and I'm sure a great many people did think about it that way. Now, this is itself an overdone interpretation because as I mentioned, life was not all that great. You might have had a good job in a bomber factory, but this factory remained. You couldn't get new tires for your car. You couldn't get a new car because no new cars were made after March 1942 until late in 1945 when they started being manufactured again on a very small scale. So you couldn't live a normal life in terms of civilian goods and services, but it's nonetheless, people could say I'm making a lot of money every week and I'm putting it in the bank or I'm buying government bonds and so even if I can enjoy a better life right now, at least I'm building up my financial wealth so that someday in the future I'll be able to cash in and get the goods. Well, this whole disappearance of unemployment phenomenon has been almost completely misunderstood by macroeconomists. This is really a very simple story and it doesn't require any macroeconomic theory whatsoever. All it requires is recognizing how many people were drawn into the armed forces and to demonstrate that for an article I wrote more than ten years ago I used this table in which I divided the employment and unemployment up in such a way as I have the proportion of the total labor force that's persons in the civilian labor force plus persons in the armed forces. I divided that whole group up and this is the percentages here. That's a percentage in non-defense employment. So if we start here in 1940, only 82% of the total labor force is engaged in non-defense employment and that's mainly because 15.7% are unemployed and you'll see there's a small percentage, less than 2% in defense employment at that time. That included the armed forces and the people working in arms industries. Now look what happens as the war buildup proceeds. Yes, indeed, a civilian unemployment. This is the thing that the economists normally look at. It disappears. By 1944 it's 1%. That's no unemployment and it seems to correspond with reality because if you go back and read the news events of the day you find that labor was extremely scarce. Employers would hire anybody. They did extraordinary things. I read of one case in which agents went out in the streets of Detroit and cruised around looking for street walkers and when they saw a girl they would pull over and ask if she wanted to come work in the factory. So this was not the normal way of acquiring factory workers but employers were desperate. Anybody, you know, get a warm body into the plant. Anybody who could work. Young kids. Kids who otherwise would have still been in high school. Instead they dropped out and found what seemed to be fairly good paying jobs. Old people who had been retired decided, oh, I'm going to go back to work. Women who were normally expecting to stay at home and take care of children decided instead they'd go out and take a job in a plant somewhere. So unusual opportunities did exist so it looks as if, yeah, there was no unemployment. Booming economy. The likes of which were never seen before or since but that's because never before or since were the likes of this scene. Defense employment. The armed forces went from less than half a million officers and men altogether in 1940 to more than 12 million in 1945. 12 million out of a total labor force of only about 54 million men and women. That's a gigantic number of people in the armed forces themselves and then we've got a comparable number of people working in defense production facilities. So by the time we get to the peak years of the war here, 43, 4, 5, we've got 4 out of every 10 members of the total labor force engaged directly or indirectly in producing war goods and services. Well, of course we didn't have any unemployment. But what we had, I created this final column to make the point a little more obvious. Let's call this Residuum Everybody Who's Not in Non-Defense Employment. What happens to the Residuum during the war? Do we diminish it? No, actually we increase it hugely. It's just that we take people who weren't doing anything and put a lot of them to work building the means of destruction. So if you're making war that's a good move but if you're thinking about human well-being that's a very questionable kind of move. That's certainly not an index that you've moved into a more prosperous condition of economic life when you're shifting major parts of the labor force into producing the means of death and destruction. This apparent economic prosperity shows up in a lot of standard measures of what's happening to the economy. If you look at the upper line here we've got your orthodox measure of the size of the economy. A gross domestic product adjusted for changes in the price level. So we've got here what appears to be this gigantic boom during the war. But underneath it I've charted government spending. And what we can see very clearly is that the boom consists of nothing but government spending. And if we look at what the government was spending for we find that it's almost all to produce war goods and services. Here we've again shown government spending. That's the dark bars. And we see this gigantic jump during World War II. And I've measured it here as a percent of gross domestic product. So it's not only becoming bigger in absolute terms but even though the whole GDP is growing the proportion of that bigger GDP that comes from government is growing also until it jumps up to some 45, 46 percent during the peak years of World War II. Again there was never, ever before or since any experience comparable to this or even close to this. This was a completely militarized economy. Now the light colored bars in this chart show private investment spending. I was mentioning yesterday that one of the major reasons for the prolongation of the Great Depression was the failure of private investment spending to revive particularly spending for long term capital. And you see that here back in 1929 about 16 percent of the GDP came from private investment spending was typical of the latter part of the 1920s. That's what you might call a normal proportion of investment in the American historical experience. It of course collapsed during the Great Depression and then it comes back, it never comes back to 16 percent even here in 1937 before it collapses again. And so it's not until we get to the war here that we're just about to get private investment back to where it was in the late 1920s but then what happens? There's a second great contraction if you want of private investment during World War II and it's a kind of mirror image of what the government is doing. Now this government spending includes everything but in fact the government did engage in what I call the socialization of investment taking that turn of phrase from Cain's famous plea in the final chapter of the general theory that in order to guarantee full employment the government would have to undertake a socialization of investment. Well, that's what the United States did during World War II. Private investment plummeted partly because private investors simply were unable to get raw materials assigned to them in order to undertake any investments and partly because there was no incentive to invest in anything but war plants in the circumstances and why would you want to invest private resources in war plants given all the risks of recouping the investment? You don't know how long this war is going to last. You don't know how much of your profits will be taken back by renegotiation officers. It's just too risky for private individuals to tolerate in most instances and even when they want to do it, it's not clear they can because the government might not permit them to undertake certain kinds of investments. So private investment almost disappears and it's replaced by government investment who pays for all these war plants, these shipyards, these bomb factories. Well, the taxpayers pay for them. The money comes out of the Treasury Department and is spent by the War Department and the Reconstruction Finance Corporation through its subsidiary, the Defense Plant Corporation and altogether during the war, the government itself expended about $17 billion just on industrial facilities, steel mills, shipyards and so forth. Now, if you look at the official data, I've just written an article on all of this. If you're interested, it's available on the Independent Institute's website. You'll find that the official data are still the ones you find if you go to the Commerce Department's website for national income and product accounts. If you follow those data on government investment, what they'll tell you is all together during World War II, the government invested about $100 billion. You would say they were adding that much to the capital stock. I just said 17. What's the difference? Well, in the official data they count as investment what the government spent for purely military installations, bases, training grounds and all the rest of it. And they spent about $15 billion on those things. Remember, we've got an armed force that went from almost nothing to $12 million. It took hundreds and hundreds of bases and barracks and military hospitals and parade grounds and gunnery ranges and so forth to house and train, equip all of these people. So they spent a huge amount just to build up that infrastructure that has no purpose other than military purpose. In that neighborhood, it's about equivalent to what the government spent on industrial projects. I'd have to check my figures to be precise about it, Brad. But even you add those two together, they're only adding up to $35 billion. What's the other 65 that the official data tell us the government invested? Well, that turns out to be purchase of so-called military durables. That's weapons platforms and ammunition. The stuff doesn't wear away real quickly, so it's regarded as durable and the Commerce Department decided to call it capital. So the government's official investment consists overwhelmingly of B-29s, battleships, destroyers, canisters of poison gas, and so forth. Talk about weapons of mass destruction. We had arsenals. One of them I looked up a website for Huntsville here in Alabama and there's interesting data about the history of it and what they did when they decommissioned it after World War II. They were making mustard gas and all kinds of poison gas mortar shells and just a litany of horrible weaponry there in World War II. In the event, probably, that the other side began to use them. The main reason poison gas is not used in warfare is entirely because it's a lousy weapon. It's too hard to control. It's not really that effective and so it's just not an effective weapon. That's why it died out as it was a technique of war. But it makes great propagandas, we all know. This display is one that I think tells a lot of story very quickly. What I've done here is to show, first of all, in the solid line the standard measure of gross domestic product adjusted for changes in the price level. This is so-called real GDP and it follows that profile and what we see here, if we build in a trend line, if the economy were to have grown smoothly between 1929 and 1948, so we connect these two business cycle peaks, instead of going through all these gyrations in order to get there, it would have followed this trend line and that's the kind of way statisticians determine what the economy's capacity to produce is in the event that it deviates from that. Normally it can only deviate downward because how can you produce more than your capacity? That doesn't make a lot of good sense. So what we see if we look here at these deviations from the growth trend and where the economy actually went is the Great Depression. All this shortfall here running up to 1942 and that makes sense to us. But now look what happens. During World War II, we have this big bulge above trend. Well, how can you produce more than your capacity? How is that conceivable? What is going on in these data? Well, what is going on is a statistical artifact. What economists have, for the most part, accepted as the reality of a production boom during World War II, is a complete statistical fiction. And the reason this apparent boom is shown in the data is that the economy is being treated as if it could be measured in the same way during World War II that it's measured during peacetime periods. That is, all of these goods and services are being priced somehow in order to be added up into GDP. And the rationale of a normal GDP calculation is we use market prices to weight the quantities of goods. So if we're going to add apples and oranges, we add them according to their market price. And that supposedly gives us some kind of aggregate of value that is being produced. So we do that during World War II, but since we don't have a market economy anymore, the prices we use are not really market prices. What the government statisticians have done is just pretend that they are. They've treated these artificial prices that were the result of all this bureaucratic pulling and hauling during the war as if they still gave us measures of relative valuation for different goods and services. So here during the war, if we produce 100 B-29s, how much do we add to GDP? Well, how much was paid for each one? We use that price. Similarly, right down the line for all the howitzers and bazookas and canisters of poison gas, use all the government official bureaucratically determined prices and added all up. And that's where we get the war boom. This is just one gigantic piece of fiction. And it's, except for a handful of people, most of them Austrian economists, it's simply not been recognized and to this day it's still not recognized as not just an anomaly, not just something that has a straightforward, sensible explanation like people working harder during the war. It's just an illusion. Now to some extent we can get around that and I've tried to show, make an important point, by taking all the government output away from GDP, subtract that, and just take the private part of GDP. That's what I show in the dark bars charted here. Now if we do that, our trend line is now this lower one, the dashed line connecting 1929 and 1948 here. If the private economy had grown smoothly between those two years, instead of falling short as it did, it would have moved along that path. But instead we have the Great Depression and the private output falls drastically, recovers some, not fully, falls back, recovers. And then after 1941, when it's just about recovered, not fully, say there's still a shortfall here between private output and 41 and where it ought to have been had it grown smoothly, then it falls back again. This is a decisive refutation of all these claims about carnivals of consumption during World War II. Historians have looked around and said, people never had it so good. Literally, that's what they say. People never had it so good. Well, I say that people in 1943 had it much better in 1941. And that's apart from the further adjustment that needs somehow to be made for the fact that many of their choices have been taken away from them totally. The things they are consuming in 1942 and 43 are not the things they would choose to consume but for government restrictions. Many people wanted to buy a new car in 1943 but couldn't because none were permitted to be produced by the government. Many people wanted more than two new pairs of shoes that year for their children but they couldn't because rationing only gave them that much claim on shoes. So it was worse than the graph makes it seem to have been but even the graph shows that during the war years things were worse than they had been in 1941 for the private economy which even then hadn't fully recovered. And that of course to 1946 in the end of the war and government war spending falls back drastically it looks as if the whole economy is plummeting. Indeed, if you had been an honest mainstream macroeconomist you would always have referred to the Great Depression of 1946. In fact, Lole Galloway and Rich Vetter wrote an article in the Review of Austrian Economics by that title, The Great Depression of 1946 to make the point that why isn't it known as that? The data show it. That's a bigger collapse than you had back here. Much steeper. Why does nobody talk about the Great Depression of 1946? It's because it's not a Great Depression. You don't go back and hear people moaning and groaning if you read the news of 1946. They're happy. They're delighted. Not only are they not going to get killed in the war but they're home. They're not living in a mud hole. They're able to hope that they can improve their lives. And look what happens to the private economy. It jumps up by this measure it jumps up in the neighborhood of 30% in one year. There was never ever a year like that in our history. 30% increase in private output in one year. But that's an understatement of the reality. Because in 1946, if you wanted an extra pair of shoes you could go down to the store and buy it. And you didn't have to have these damn things to do it either. So people were much better off at the end of the war. This was the most splendid year in all of American economic history. Although standard data tell us it was a great depression. Because the standard data have misled the economics profession for more than half a century. I've been on a kind of crusade throughout my career as an economic historian to make these points to my colleagues and I haven't won this battle yet but I think I'm making some progress actually. My 1992 article has actually had some impact on teaching among economic historians. So I'm still hopeful that this lesson will get through eventually to everybody. These are hard to see probably from the back of the room but I want to call these income tax data your attention because they're important both for understanding how the war was financed and for understanding how we got where we've been ever since. Before World War I, as you can see here not even 15 million people filed an income tax return. And most of those owed very little federal income tax. The income tax even after the New Deal's efforts to soak the rich which were strenuous but didn't reach very far down into the middle class had left most people out of the reach of the income tax collector. Rates were fairly low at the bottom still. But with the war, Congress changed the nature of the federal income tax in a decisive way from still what we might call a class tax. Not so much as the class tax before World War I but still pretty much of that sort to a mass tax. By the time we get to the end of the war we've got 50 million people filing income tax returns and they're not paying trivial amounts any longer either even at the bottom. If you look at the first bracket here if you made over $4,000 in 1940 your marginal tax rate on the excess is 4.4%. Well just in a few years if you made $1,550 your marginal tax rate was 19% then up to 23%. So even ordinary working people were quickly encountering tax rates that took a quarter of their earnings away in federal income tax. An income of $2,000 a year was not very much during World War II so most people were making more than that well over that and therefore paying a lot of income tax. At the top here you see soak the rich really comes in with a vengeance so that the top rate goes all the way up to 94% in the latter years of the war and you only have to make $200,000 to encounter that rate. So it was the occasion for using the tax system not only tax everybody but to virtually confiscate all incomes above a fairly low level. Roosevelt proposed seriously on more than one occasion during the war to actually use a 100% tax on everybody above very low levels maybe $50,000 or $100,000 that the government would just take everything above those amounts of income. Congress never was willing to go so far but as you can see from what was done it went quite far nonetheless. Now I've put in the data down here below for 1950, 60 and 70 to show you that after the war ended the tax system was retained pretty much as it had come to be at the peak of World War II. Low levels of income for the first bracket, pretty high rates even at the first bracket, the 15% to 20% neighborhood and very high marginal tax rates for high income people. So even as late as 1970 we still had the 72% marginal rate on earnings above $100,000 and thanks to inflation $100,000 wasn't all that much in 1970. It was more than I was earning but nonetheless there were a great many people who were earning at that rate and being subjected to a 72% marginal tax rate. That's European style taxation. So this wartime shift of the income tax system lasted a long time. It was one of the major legacies of the government's command economy. Now to some extent it was still used after the war to bankroll military spending because we had the Cold War and I'm going to talk about that this afternoon. But to a large extent this tax system that had been created for purposes of funding the war turned out to be just a wonderful thing for the government to use to fund many other kinds of purposes and increasingly to fund the welfare state in all its guises. In 1946 Congress passed the Employment Act as a way of formally acknowledging what many people had come to demand which is that the government take responsibility for maintaining high levels of employment and production in the economy. It was a kind of vow that hence forward we in the federal government will oversee the economy in the sort of Keynesian interest of propping it up and making sure we never have another great depression or even a serious recession. And you can read that act and it looks a really flabby language in a way but it meant something I think. It was a recognition in law that never again would the federal government say what the Cleveland administration had said back in the 1890s that this is not our business to give people work or to provide for economic misfortune. That's simply not an appropriate constitutional function of the federal government. Now it was formally accepted as a function. During the war about 50 billion dollars of the 300 or so billion spent on the war took the form of so-called lend lease which is to say it was given mostly to Britain and the Soviet Union so that they could get on with their engagement in the war. And that too set a precedent. On the one hand we got the Marshall Plan in 1948 a program for transferring large amounts of money to Western European countries ostensibly to help them revive their economy so they would be more resistant to communism. But the Marshall Plan easily, even after it ended formally transmogrified into foreign aid in general. And so for the past 50 years the United States has been routinely engaged in collecting money from taxpayers and giving it to dictators in Zaire and Nicaragua and other places but the State Department and the CIA and their wisdom needed the taxpayers money. So we got that legacy as well directly out of World War II. We got many others and the one I'll just mention in closing here is that I think because of this great event and the way it had affected everybody and because at the end the United States came out on the winning side in a sense the Soviet Union was the big winner but the Americans could properly consider themselves among the victors and take great credit for being there. People looked at the federal government and said it accomplished this amazing thing. It built up this great military machine. It crushed the Japanese and Nazi aggressors. It sent troops all over the world. It aided allies. It rescued people from the oppression of dictators. The federal government has done something magnificent. If it can do that, well, surely it can do lesser tasks. It can eliminate poverty or provide decent housing to everybody or make sure that the educational system is improved or that people's health care is attended to. People took away from World War II a kind of faith in the capacity of the federal government to do great things. And beyond the faith that it could an expectation that it should. It can. Let's get it going. Let's get started here. Why let this magnificent potential go to waste? So the ideological change that resulted from American involvement in World War II was in some ways the most auspicious of all its consequences, I believe. Even business people, many of whom have been hostile to the federal government as late as 1940, 1941, after working with the government for four years and often making a lot of money in the process, they had come to take a more benign view of the federal government and of its involvement in the economy. They didn't all like it, but far more of them accepted it and a great many of them had discovered they could work with it and make money by doing so. So the one sector of our economy that has had the potential to successfully resist the growth of government stopped trying to do so in any mass fashion from 1945 on. So that since that time business resistance is ad hoc. It's episodic. It's focused on the fire that they want to put out today. But to say that business in general is a serious hostile opposition force to government would be a false statement for any time in the past 50 years. And I believe that the bulk of that switch in business sentiment is owing to the experience of World War II. Well, let me quit here and entertain your questions or hear your comments. Yes, sir. Can you comment on the monetary policy throughout the period that's been looking out of the graphs here? I'm just curious as to the rapid growth we've seen on some of the graphs at the end of the war, let's say 46, as opposed to periods of the Great Depression and even parts of the war. And is that due to pumping up the money supply by the Federal Reserve or what changes are taking place through that period? The Federal Reserve was actively injecting reserves into the banking system throughout the war and in addition owing to changes in its authority by one of the War Powers Acts at the beginning of the war it was directly purchasing U.S. government securities which is to say it was paying for the amount of thin air by writing down deposits to the credit of the Treasury Department. So the money supply during the war years grew about 20% per year. So that was essential. The government paid for about 60% of its war spending by borrowing. So what was happening, in effect, was that the Fed was pumping up bank reserves and either the banks themselves or their customers were buying government bonds. And so that was a critical part of the whole war, economic management. Now what happened when the war ended is that this Fed activism slowed down drastically. And so you have an episode there in 1946 that doesn't jive at all with the monetarist ways of thinking about what's driving the macroeconomy because that magnificent economic recovery in 1946 took place notwithstanding a drastic deceleration of the Fed's increases in the money stock. Now what a monetarist would say to me at this point, indeed some have said to me in the past, is that, no, go back and look at the graph. What you see in 1946 is what a monetarist would expect from a deceleration of the money stock. A big downward lurch and GDP. But even the monetarist had trouble accounting for that transition period between 1945 and 47 because in general there are many, many deviations from their forecast. When did the deceleration start? When was the economy allowed to liquidate, so to speak, to allow for real growth? Well, what was going on in that period right after World War II? I've written another article about it and it's fairly complicated so I probably shouldn't try to summarize it here. That article is called From Central Planning to the Market and it was published in the Journal of Economic History in 1999. It's available at the website onpower.org if you want to look it up there. The transition, which was tremendously successful, I think owed everything to just the removal of controls which was quite rapid in late 45 and early 46 and the financing came very largely from the fact that the saving rate, which had been running at about 25% in the last three years of the war, fell back to ordinary levels of 5 to 10% per year and so those funds, as it were, were removed from bank-rolling government bond market and made available for a combination of consumer spending and private investment. So we were able in 1946 to simultaneously have a private investment boom and to increase consumer outlays at the same time. So that's part of what was happening then but the aggregate monetary situation doesn't really, I think, have a lot to tell us about why the transition went as it did. Brad? I have a couple questions on the first thing you covered. The Neutrality Acts in the 1930s, were those signed by Roosevelt or were they before that? No, they were all during Roosevelt's term. They were in 1934, five and six, as I recall. There was another one in 1939 but in a way it was a neutrality act that took away some of the restrictions put in place by the preceding ones and put in place the so-called cash and carry provision which meant that you still couldn't give credit to foreign purchasers of arms in this country. They had to pay for them and they had to take them away in their own shipping. So again, the idea was let's not get American ships out there carrying munitions torpedoed and that then become a pretext for the U.S. going into the war. By that time people realized that the sinking of the Lusitania and the Sussex and those kinds of events had been used for propaganda purposes to help persuade Americans to go into World War I and so the idea was we'll help the British, we'll let them come over here and buy military goods but that's all we'll do. Presumably we were also in a position, at least according to these laws, to sell military goods to the Germans but of course it was perfectly clear to everybody that wasn't going to happen because if nothing else the Roosevelt administration would not have permitted any of our arms companies to sell arms to the Germans and there's now available collections of correspondence between Roosevelt and Churchill, a huge, huge book before the war so you've got all the correspondence of those two and what's it called, Joe? Something like Churchill-Rosevelt correspondence I think or some such title. It's a huge edited volume and this is extremely revealing of how closely the United States and the British were working on purely military arrangements before the United States ever declared war. They were working absolutely in harmony equipping one another, passing information back and forth. The United States was at war. You read this correspondence, it's undeniable, the United States was actively at war by cooperating in a multitude of ways with the British and in supplying them so this neutrality was opposed in 1941. I think at that time he really wasn't much interested in this subject, it didn't seem very important. Roosevelt was very focused on his New Deal policies when those neutrality acts were passed. He decided to switch over and become doctor when the war or at least doctor rearrange the world after 1938 because by 1938 the New Deal had been brought to a halt by the so-called conservative coalition, a combination of Southern Democrats and Northern Republicans by that time decided to join forces and prevent the enactment of further New Deal type legislation. This was in part a reaction to that recession that began in 1937 which persuaded many people that the New Deal had completely failed. If you look where things were in 1938 even if you look at these standard data, here's 1929 and here's 1938. Well, we're a long way from prosperity and we're going in the wrong direction in 1938 so many people said enough is enough. This is not what we any longer want to support and Roosevelt's court-packing plan alienated many people because it made it seem correctly that he was really seeking to acquire dictatorial power and even many Democrats at that point said we really don't want Roosevelt as a dictator. The World Power is that. Yes. Not those particular ones. They expired after the end of the war but there are other acts that give some of the same powers to the president. There are a number of emergency powers laws that are currently enforced. The laws were amended in the late 1970s after the Church Committee hearings that revealed so many foreign policy abuses but the laws that are still in effect now permit presidents to basically take over the bulk of economic life simply by declaring an emergency. Those laws are used for various purposes whenever a trade sanction is put into effect or the continuing sanctions against Cuba or the sanctions we have against Libya and North Korea and Vietnam and so forth all grow out of those emergency powers laws which allow the president to cut off trade or financial flows or travel by Americans to designated countries. The Trading with the Enemy Act that was passed in 1917 is still enforced as amended but under that law that president can and sometimes does simply decree that certain international financial transactions may not be made or must be made in a certain way or can be made only under license by the federal government. I wrote a couple of articles about those with Charlotte Twight and she actually did the research for the most part involving those emergency laws of the 1970s so if you want to find them they're again available online at onpower.org and from the titles you can easily identify what they are. Onpower.org Let's see where we are. I think we'd better quit now ladies and gentlemen. I've run you over time.