Yves here. Please welcome Michael Perelman, a economics professor who is more an economist manque than the conventional sort. Perelman now focuses particularly on economic history, which consist in large measure of describing not just how older economic theories have been distorted or misrepresented, but how the conventional accounts of economic development too often contain significant omissions and misrepresentations. For instance, his book The Invention of Capitalism describes how proto-capitalists managed to seize former community resources (the best known being pastureland, but hunting and other rights also came to be restricted). Part of the legitimation of this effort was to present free peasants, who could live comfortably without working very hard, as being made morally deficient by having too much leisure time. They’d clearly become better people if they were made by their betters to apply themselves.
The post that follows is excerpted from a yet-to-be-published book by Perelman, The Matrix: An Exploration of the Surprising Interactions Between War, the Economy, and Economic Theory. Please note that I have edited out some fascinating sections that go a bit more into economic history in the interest of maintaining focus on the core arguments. So if any discontinuities have resulted, the fault is mine, not Perelman’s.
By Michael Perelman, a professor of economics at California State University, Chico
World War I provided a dramatic opportunity for the muscular Christians to display American power on a world wide stage although the population of the United States was not ready for another war, especially after the negative experience in the Philippines.
President Woodrow Wilson, previously a founder of the American Economic Association, president of Princeton University, and governor of New Jersey, was first elected president in 1912, before the war had begun. He ran for reelection in 1916, with a promise to stay out of World War I, angering Theodore Roosevelt who responded, charging that “professional pacifists, through President Wilson, have forced the country into a path of shame and dishonor” (Thayer 1919, p. 419).
Once safely reelected, Wilson, in the grand tradition of American politics, quickly broke his word, calling for an American entry into the war. Unlike Roosevelt for whom war was a romantic adventure, Wilson’s war promised great material benefits.
Running as a peace candidate had helped Wilson win reelection, especially in light of the sour taste left by the war in the Philippines. Neutrality, besides being popular, made good economic sense. The war was already bringing the United States out of the depression it had entered in 1913. Its future First World War allies purchased 77 per cent of U.S. exports in 1913, generating ‘the greatest industrial boom the nation had had until that time’ (Lens 2003: 253). Large conglomerates benefited disproportionately, expanding production of munitions and other exports (Desai 2013, p. 74).
Since the British had suspended gold payments and embargoed loans “for undertakings outside the Empire,” Wall Street was now the banking center of the world (Desai 2013, p. 74; citing Lens 2003, p. 252). American business also profited from the withdrawal of British and other European businesses from Latin America, allowing the United States to take center stage as a global financial power. American business benefited further from the withdrawal of British and other European businesses from Latin America.
This situation was too good to last. Because the war so fully depleted the Allies’ financial resources, European buying power could no longer buoy the U.S. economy. The US ambassador in London reported on the international situation, which he found “most alarming to the financial and industrial outlook of the United States.” He warned that British and French inability to keep up orders would surely mean “a panic in the United States.” The ambassador concluded, in a clear anticipation of military Keynesianism (to be discussed in the next chapter), that it was not ‘improbable that the only way of maintaining our present preeminent trade position and averting a panic is by declaring war on Germany’ (quoted in Lens, 2003, p. 260).
Wilson complied with the ambassador’s suggestion. In retrospect, Wilson timed his move very well. Keeping the United States out of the war until his second term gave the European powers time to exhaust themselves, leaving an opening for a fresh United States military to play a prominent, if not decisive, role.
Wartime conditions also proved to be a dramatic turning point in the financial status of the United States, which had always been a chronic debtor, dependent upon a considerable part of Britain’s capital exports. The sudden surge of wartime costs, including American exports, turned the tables, making the Allies dependent on external credit (Desai 2013, p. 75). Between 1914 and 1917, the years between United States’ entry into the war and the outbreak of the Russian Revolution, Europe’s need for wartime financing opened the door for U.S. banks, led by Morgan, to raise massive loans for the allied governments.
Waiting to join the war until the Allies were exhausted offered an enormous geo political victory well beyond what the use of military force could have brought. As Radika Desai observed: “The United States was far from isolationist when the First World War started: Wilson kept the United States out of the war initially to wait for a stalemate so that it could step in as arbiter and architect of a US centred postwar order” (Desai 2013, pp. 74).
Making the World Safe for War
Wilson’s victory was short lived. To begin with, Wilson suffered a debilitating stroke that removed him from the political scene. Public knowledge of the human costs of World War I was temporarily limited because of intense censorship. Even though the armistice came relatively fast after the United States entered the fray, the country still lost 100,000 troops. The prosperity that massive spending on World War I brought was only temporary. By 1920, the economy experienced the second most severe depression of the Twentieth Century.
Had Wilson’s health held up, a reelection campaign would have been doomed from the start. The unpopularity of the war, the depression that followed, as well as Wilson’s internationalist vision, symbolized by his plan for the League of Nations, created a political atmosphere that allowed the Republicans to regain their longstanding political control, which they had exercised throughout most of the late Nineteenth Century.
Because a high degree of economic planning was key to the American success in the war, the belief in market efficiency waned; however, the postwar depression revived support for market fundamentalism, allowing the Coolidge administration to win election on a platform of doctrinaire laissez faire policy, despite the highly regarded performance of economic planning during the war.
The Tragic Imperial Dance
Wars, of course, always have unforeseen consequences. In a biblical sense, wars beget more wars. Consider the case of World War I. In the lead up to the war the same war which was sold as a war to end all wars three challengers United States, Germany, and Japan were already nipping at the heels of the great imperial powers of France and England. All three were experiencing very rapid economic growth without enjoying comparable political and economic influence around the world. Germany was the great looser in the conflict, although the Ottoman Empire lost the most territory. The resulting instability in the Middle East has troubled the world ever since.
Germany’s military defeat and the even more humiliating conditions of its surrender set the stage for a far more devastating challenge to the world order. Crushing reparations, along with the loss of territory, created untenable political conditions. As John Maynard Keynes, a major representative of the English government during the peace negotiations, predicted: “(People in) their distress may overturn the remnants of organization, and submerge civilization itself” (Keynes 1919, p. 144).
Conditions in Germany eventually led to the rise of the Nazis. France and England suffered lesser setbacks. Besides their human and economic costs of the war, the United States demanded that they repay their immense war debts to American creditors, allowing the United States to gain power and influence at their expense. This demand was part of the United States’ effort to use its postwar power to dislodge the colonial holdings France and England.
Japan, following its defeat of Russia in the early part of the century, was not involved in World War I, sparing her the heavy costs experienced by the great European powers. Instead, Japan was busily building up its military power and extending its sphere of control. Most worrying was its expanding occupation of China, a country lusted after by all of the five rival imperial powers. Unlike France, England, Japan, and Germany, which already had beachheads in China, the United States had only gotten as far as the Philippines.
After the War, the United States, concerned about Japan’s rising influence in the Pacific, used embargoes of strategic materials, such as petroleum, tin, and rubber to strangle the Japanese economy. Eventually, Japan responded in the attack on Pearl Harbor. Germany began carving out territory in Europe to regain and expand its prewar powers.
When the United States entered the war, just as was the case in World War I, the country’s intentions were to elevate its degree of international influence. In particular, the United States was intent on ramping up its efforts to strip France and England of their colonies, especially in the case of India. The American goal was not to create its own traditional colonial empire, but to build a new kind of empire based on trade rather than direct colonial authority. Opening the previously colonial territories to American trade would give the United States what it wanted. It could dominate territories by virtue of its economic muscle without incurring the expense of administration. This kind of policy was expected to be capable of displacing much of the French and English power, without the need to resort to military force – an ideology that came to be known as free trade imperialism.
Because the expected benefits from American market efficiency in the new territories turned out to be insufficient to create conditions in which the territories were free from effective resistance to American influence, the United States lacked a means of control that would serve as an alternative to direct colonial rule.
The experience in the Philippines, where extensive military surveillance allowed the United States to shame or blackmail people to refrain from challenging the power of the United States proved to be extremely effective. After World War II, the CIA raised this practice to a much higher level, but the agency never acquired the means to operate as extensive a network of informants that the military had in the Philippines.
As a result, the CIA frequently resorted to overthrowing uncooperative governments. Doing so also gave considerable force to threats of installing a new government. Such actions frequently created blowbacks that worked against the interests of the United States.
One of the most embarrassing episodes in the relationship between war and economic thinking came at the end of World War II. The combination of the Great Depression followed by World War II led to a period of unparalleled economic success in the history of the United States. However, few economists recognized the role of the Depression in eliminating old and obsolete businesses, clearing the way for this period of prosperity. Alexander Field has recently made a powerful case for the rapid productivity gains during the Depression (Field 2011). The Depression set the stage for the New Deal, which put the economy on more solid ground – a thesis that has become increasingly controversial in the face of growing market fundamentalism.
Instead, most economists emphasized how World War II created enough government spending to rescue the economy. This perspective gained powerful support in John Maynard Keynes’ influential book, The General Theory of Employment, Interest and Money (Keynes 1936), which laid out the case for government intervention during economic downturns. However, doctrinaire supporters of laissez faire still believed that depressions should be allowed to run their course. Other than giving tax cuts, the best government policy would be to remain neutral, allowing market forces to make the necessary corrections.
Antagonists of government activism tarred Keynes as a socialist, or even worse, a communist. In reality, Keynes was hardly attempting to lay out a roadmap to socialism; Instead, Keynes himself was deeply conservative, writing once: “[T]he class war will find me on the side of the educated bourgeoisie” (Keynes 1925, p. 297).
Seeing how the Great Depression unleashed a powerful disgust with what markets wrought, Keynes had feared that capitalism was threatened, especially since the Nazi takeover in Germany and the communist revolution in Russia were elevating the role of the state relative to private business. This trend was not limited to these two dramatic examples. All of the great capitalist states were increasing the role of government relative to the market. In that environment, Keynes saw his work as an effort to safeguard capitalism by stemming the growing tide of socialism.
Because Keynes’ American followers mostly advocated a relatively a crude application of his work, narrowly emphasizing government spending alone, without taking Keynes’ far broader approach into account, they were partially responsible for business’ hostile response to Keynes. Keynes expressed his distance from the crude version of American Keynesian in 1944, when Lady Keynes enquired after some prominent Keynesians gave a dinner for Keynes in Washington, “How was it?” Keynes replied, “I was the only non Keynesian there” (Ballard 1995, p. 335; citing Robinson 1972).
Business leaders as a whole initially appreciated the immediate beneficial results of the New Deal in healing some of the wounds that the Depression caused. However over time, many of them became increasingly suspicious of government involvement in the economy. In addition, while business had also been supportive of the government’s economic activism during World War II, they also realized that successful government wartime planning had improved the public’s faith in the government’s capacity to manage the economy. Given the woeful performance of business leading up to the depression business had good reason to be nervous about public opinion.
As a result, the political climate became increasingly antagonistic to the gains of the New Deal and unreceptive to Keynes’ analysis. Shortly after the war, business interests began a concerted effort to undo some of the gains of the New Deal, beginning with the weakening of the labor movement. For this reason, the opening shot in the attack on the New Deal was the Taft Hartley law, which greatly weakened the power of unions. Business’ support for this measure was strong enough that Congress was able to override a presidential veto.
McCarthyism made the political atmosphere poisonous. Economic issues became framed in terms of patriotism rather than serious economics. Economists soon became reluctant to advocate anything that could be even remotely associated with socialistic tendencies, learning from the case of a Canadian economist, Lorie Tarshis, who wrote the earliest textbook that included Keynes’ economic theory. A firestorm pressured universities to cease assigning it. Paul Samuelson, who later became an advisor to Presidents Kennedy and Johnson in addition to being the first American economist to win the Nobel Prize in economics, followed with his own offering, which became the most popular introductory economics textbook in the United States.
The attack on Samuelson’s book was fierce. The Veritas Foundation was a leader in this war on Samuelson’s book (Leeson 1997, p. 125). A commentator in the right wing Educational Reviewer asked: “Now if (1) Marx is communistic (2) Keynes is partly Marxian, and (3) Samuelson is Keynesian, what does that make Samuelson and others like him? The answer is clear: Samuelson and the others are mostly part Marxian socialist or communist in their theories” (quoted in MacIver 1955, p. 128). Despite Samuelson’s long history of antagonism to Marxian ideas, tarring him along with Keynes was effective.
Samuelson recalled how much he felt the pressure, “having tasted blood in trying to root the Tarshis text out of colleges everywhere, some of the same people turned toward my effort” (Samuelson 1997, p. 158). Samuelson succeeded at defending his work, but at a serious cost. In a 1977 lecture, Samuelson described how he felt compelled to go to great lengths to make his book less controversial, undermining its quality:
… if you were a teacher at many a school and the Board of Regents of your university was on your neck for using subversive textbooks, it was no laughing matter. Many months were involved in preparing mimeographed documentation of misquotations on the part of critics and so forth. Make no mistake about it, intimidation often did work in the short run …. My last wish was to have an intransigent formulation that would be read by no one … As a result I followed an Aesopian policy of paying careful attention to every criticism of every line and word of my text …. In a sense this careful wording achieved its purpose: at least some of my critics were reduced to complaining that I played peek a boo with the reader and didn’t come out and declare my true meaning. [Samuelson 1977, pp. 870 72]
In the United States, during the end of the 1950s, the economy was showing signs of sluggishness. Economists took to heart Keynes’ idea that special efforts are necessary to revive the economy when demand is insufficient.
Cold War antipathy toward anything even vaguely related to socialism made one vulnerable to accusations of dangerous political sentiments. While support for government spending might be dangerous, military spending was patriotic because it was largely directed against the Soviet Union.
In addition, much of the anti-government rhetoric in the United States was built on a dogmatic insistence that government spending is, by its very nature, an unproductive drain on the economy, while private business spending alone is productive.
Given this environment, many of the leading Keynesian economists in the United States learned to avoid the scrutiny that Samuelson and Tarshis experienced, shielding themselves from any taint of socialism by using the military as a cover. Either because they succumbed to the anticommunist climate of the day or because they feared they had no chance of stimulating the economy through any productive government spending, they recommended unproductive spending. These Keynesians adopted a stunted version of their master’s approach to immunize their brand of economics from the charge of socialism or communism. They did so by restricting their calls for increased spending to military programs, presumably intended to assist in the fight against communism – an approach that became known as military Keynesianism.
The underlying principle of military Keynesianism was not new, as shown by the advice of the ambassador in the last chapter; however the benefits of advocating military Keynesianism were undeniable. Military Keynesianism allowed economists to burnish their patriotic credentials while getting credit for improving the economy at the same time. In this way, economists could win the gratitude of powerful interests in government, business and the military.
Here is Business Week writing about the position of a one time radical, but highly respected economist, Lawrence Klein:
Some Keynesian economists adapted nimbly to the Pentagon State, touting warfare for work relief. They earned the name of “Keynesian Hawks”. Here is model building Lawrence Klein, President of the American Economic Association, 1976: “Defense spending … has been a large part of the whole expansion of the American economy since World War II.” The key question is “whether we should hold down defense spending for either economic or security reasons, and I think not, on both counts …. Every cutback of a dollar in defense will cut two dollars from overall GNP and drag down a lot of jobs …. If we were to hold spending to $395 billion, the recovery of the economy would fade away (Anon. 1976, pp. 51 52).
Klein’s example suggests how thoroughly McCarthyism still affected the political climate, long after the senator had faded from the scene. The leading U.S. Keynesians also proceeded as if they could ignore the relative merits of different kinds of spending, treating military spending as the default. Although Keynes himself preferred that the government spend its funds on productive activities, his theory offered few specifics to dissuade the new cold warriors who acted in his name (Perelman 1989).
Leading Democrats followed a similar trajectory, becoming closely associated with military contractors, so much so that Eisenhower’s farewell address, warning about the Military Industrial Complex (Eisenhower initially intended to condemn the Military Industrial Congressional Complex), referred to the Democrats’ defense spending.
To be fair, Keynes’ General Theory blandly looked at the economy as a whole, paying no attention to what was produced. To make matters worse, Keynes’s followers could take heart from Keynes’ humorous aside about burying bottles of money and then digging them up, suggesting that society could disregard the direct benefits from any particular program. Economists often fell back on saying that a rising tide supposedly lifts all ships. According to this line of thinking, spending of any kind – even wasteful military spending – stimulates the economy.
The Democratic Party followed a similar line of retreat, casting aside the occasional daring ideas that had bubbled up during the New Deal and the early postwar period. Instead, the party almost completely purged itself of leftist or even progressive influences, largely pinning its hopes on increased government spending – all too often military spending.
In his widely praised, but largely unheeded Farewell Address, President Eisenhower warned of this unprecedented power of the military industrial complex in American life: “In the councils of government, we must guard against the acquisition of unwarranted influence, whether sought or not, by the military industrial complex. The potential for the disastrous rise of misplaced power exists and will persist.” Eisenhower was directing his warning at the military Keynesianism of the Democratic Party, which had just alarmed the public about an imaginary missile gap vis à vis the Soviets during John F. Kennedy’s presidential campaign. But then, it was Eisenhower who had ramped up the atomic arsenal that was a key element of the Cold War.
The policy of military Keynesianism was self defeating for two reasons. First, Republicans at the time emphasized the importance of budget deficits. Increasing taxes to pay for military Keynesianism would have neutralized some of the stimulative capacity of military expenditures. Consequently, military Keynesianism effectively increased pressure to rein in nondefense spending, especially those programs intended to help people toward the bottom of the income scale – the same people who were supposed to benefit from economic growth.
A second contradiction of military Keynesianism seems to be far more dangerous. The early English aristocrats were probably correct in their fear that a standing army might tempt the government to launch wars. Similarly, access to a huge arsenal of weapons of mass destruction creates an irresistible drive to brandish them, or even worse, to deploy them.
Military Keynesianism never went so far as to say that business benefits from war, just that military spending is an important component of maintaining a sufficient level of employment. Proponents of military spending my even argue that striving for military dominance is necessary to maintaining peace. Of course, striving for military dominance can unleash arms races, which require even more defense spending, or even worse, run the risk of triggering wars in which rivals attempt to prevent others from acquiring dominance.
Military Keynesianism poses another danger: military spending drains resources from productive sectors of the economy, potentially weakening both the domestic economy and military power, which ultimately depends upon the strength of the domestic economy. William Nordhaus of Yale University forcefully made this point with an (unintentional?) allusion to Curzon’s chessboard:
At best, an excessive military budget is simply economic waste. At worst, it causes problems rather than solving them by tempting leaders to use an existing military capability. During the Clinton administration, Madeleine Albright is reported to have asked Colin Powell, then Chairman of the Joint Chiefs of Staff, what’s the point of having this superb military if we can’t use it? Colin Powell is said to have replied, wisely if not presciently, that American soldiers are not toy soldiers to be moved around on some global game. [Nordhaus 2005]
Powell’s thinking echoed a widespread suspicion that the urge to use untested modern weapons in battle was one of the major causes of the Vietnam War. In that way, military Keynesianism may bear some responsibility.
In short, military Keynesianism was a clever tactic for putting Keynesian like economics in effect. However, the unintended consequences more than wiped out any positive benefits. Nonetheless, military Keynesianism remains a major part of fiscal policy despite its serious negative consequences.
In 2013, a hypocritical form of military Keynesianism swept across Washington, when a foolish program was about to take a meat ax to all government spending. In 2007, the same political forces that normally insist that all government spending necessarily has a negative effect on the vitality of the economy turned on a dime, welcoming lavish bailouts, especially for the nearly fatally wounded financial sector. Admittedly, many of these hypocrites denounced the bailouts, but would have gone bananas if the government had let the financial system fail. By 2011, in line with the virulent anti government ideology that was sweeping across the country, Congress passed a ridiculous law that imposed devastating, future cuts in domestic programs, as well as cuts in military spending. These cuts were to be imposed unless a bitterly divided Congress could agree on a program to reduce the budget by the beginning of 2013. This sequestration should have pleased those who held to the popular anti government dogma, which insisted government spending does not create jobs; at best, it only transfers employment from the private sector to the public sector.
As the deadline approached, the Anti Keynesians developed a modified version of military Keynesianism, claiming that military spending (but military spending alone) creates jobs. This revisionist Keynesianism set off a hysterical cry about the large number of jobs that would be lost if Congress went along with the cuts to military spending that it had legislated. To save the economy, non defense spending must be cut to stay within the bounds of the sequestration, while ruthlessly directing tax cuts to programs intended to help the less well off.
Because the combination of defense spending, massive tax cuts, and the bailout had led to large budget deficits, the proponents of this perverted military Keynesianism insisted that programs for productive government expenditures had to be cut in the name of fiscal responsibility to make way for (wasteful) military spending.
Whether the weapons acquisition pushed by the military Keynesians actually played a major role in instigating the Vietnam War remains a matter of speculation, but the long term negative economic effects of Vietnam seem indisputable, as will be discussed in the next section.
Another commonly held explanation for the war concerned the relationship between China and Japan. Although anti Japanese feelings must have been strong in China, given Japan’s recent, brutal invasion of the country, physically, China and Japan seemed to be natural trading partners. Japan had a modern manufacturing economy and a very poor resource base. China, with far more extensive resources and a relatively primitive productive sector with modest resource requirements at the time, would seem to be a very likely trading partner. By “clearing” Vietnam of dangerous influences, the United States could offer Southeast Asia to Japan as an alternative trading partner to China – an important consideration given the high priority for “containing” communism at the time.