Did the New Deal or WW2 end the Depression, Pt. 2 by mattsteinglass
February 18, 2009, 9:11 am
Filed under: Uncategorized

Megan McArdle responds that, no, it really was WW2 that ended the Depression. She makes some convincing points, and some which seem a bit off. First point: Christina Romer thinks it was monetary expansion through gold flows into the US that did the trick, and this was partly due to war anxieties. (I wish she’d provided links to the paper!) But Romer’s claim (in this summary) is that it was monetary expansion beginning in 1933 that led to the recovery from 1933 on, rather than FDR’s fiscal policies – the New Deal – which she thinks never did enough deficit spending to have much of an effect. So this really has nothing to do with Megan’s claim that high unemployment in 1939 shows that the US wasn’t out of the Depression yet. Romer’s timeline is basically the same as Paul Krugman’s: the economy began recovering in 1933, had a short but sharp recession in 1937 when FDR tried to balance the budget, and then grew even faster after mid-1938, returning to trend production level in 1942. Defense spending, Romer agrees, was not significant until 1941. Romer also notes that in the only two countries that did try significant, consistent deficit spending — Germany and Japan — it worked. Which helps explain why Romer is one of the architects of the US’s current fiscal stimulus plan.

Megan also says “Commodity prices spiked in 1939 due to the war, which was good for the resource-rich American continents.” This is fine, but any growth benefits should show up as increased exports, and as I’ve said before, exports didn’t increase enough (just 1% of GDP per year) to account for much of the US economy’s 8.8% growth in 1940 or its 17.1% growth in 1941. (A spike in domestic commodity prices doesn’t increase GDP; it’s just inflation.)

“American labor started leaking abroad as foreign labor markets tightened.” This is interesting, but I’d like to see some references, and I’m not clear what the claim she’s making here is. Is she saying remittances were a significant source of GDP growth in the US in 1933-40? This seems hard to believe. If she’s saying that war-induced exported labor helped bring unemployment down…I don’t know. It’s hard for me to believe that the 4% drop in unemployment in the US in 1940 was in any large degree due to emigration.

“Undoubtedly a lot of firms who made things that warring Europeans needed saw a dramatic improvement in their optimism.” This seems like a way of getting around the moderate export growth by hypothesizing that business sentiment improved due to the war, even if the bottom line didn’t. But besides the speculative claim, Romer notes that the New Deal is also said to have had a strong effect on business and consumer optimism. The issue seems a wash at best, and  I’m skeptical that fear of a global war was on balance a positive spur to investment.

“One thing that makes the question difficult to answer is that it’s hard to know when to date the beginning of the recovery.  Matt prefers 1940…” This isn’t quite right either. We all agree the recovery started in 1933, or in mid-1938 if you’re talking about the recovery from the recession of ’37. The question is when to date the point at which the US economy had recovered — had returned fully to long-term trend production. Romer says 1942. And we know that WW2 spending was not a factor until 1941; even in 1941, the 3.9% growth in defense spending can’t account for the US’s incredible 17.1% GDP growth.

What Megan is arguing is this: “Absent the war, would the economy have grown in 1939 and part of 1940, then sunk back into the doldrums?  I don’t think we know.” (Again, on the dates — why “part of 1940”? We certainly both agree we’re talking about all of 1940.) I just don’t see any reason to believe that an economy which grew at barn-burning rates all through late 1938, 1939, and 1940 would have suddenly sunk into the doldrums. Particularly since that economy then grew in 1941 at over four times the rate of the added defense spending in 1941. It seems to me that the normal assumption when you see an economy growing at a terrific pace is that it’s healthy.


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