The Keynesian Rope of Sand: Why World War II Did NOT End the Great Depression

By Tom DiLorenzo


Tuesday, July 10, 2012

So-called Keynesian economics is based on numerous myths and superstitions about the economic world. For example, John Maynard Keynes himself blamed the lack of private business investment spending during the Great Depression on "animal spirits" that supposedly spooked investors. The two biggest myths, however, upon which the whole edifice of the Keynesian "Government Can Spend Us into Prosperity" philosophy is based are: 1) the myth that government spending under President Franklin D. Roosevelt ended the Great Depression; and 2) If the Depression was not totally ended by New Deal spending, then government spending on World War II certainly must have done the trick. Exactly the opposite is true: New Deal and World War II spending made the U.S. economy worse off by siphoning off billions of dollars from the pockets and bank accounts of private consumers and investors. Government bureaucracy ballooned while the private sector starved. Only when the war was over, government spending was cut dramatically, and FDR was dead, did the private economy in the U.S. recover from the Great Depression.

Despite a doubling of federal government expenditures from 1933 to 1940, the creation of dozens of new federal government bureaucracies, and the direct employment of some ten million people in "public works" jobs, the official unemployment rate in 1939 was still 17.2 percent, nearly six times higher than it was in 1929 (2.9 percent) on the eve of the Depression. Per capita GDP was lower in 1939 ($847) than in 1929 ($857), as were personal consumption expenditures -- $67.6 billion vs. $78.9 billion (U.S. Dept. of Commerce, Historical Statistics of the United States).

One reason for the abject failure of the New Deal "stimulus spending" to reduce unemployment is that the diversion of billions of dollars out of private-sector pockets to finance government make-work jobs created additional unemployment in the private sector. More temporary, make-work government jobs were created at the expense of destroying a much larger number of private-sector jobs since bureaucracy and red tape typically accounts for several times the amount of money that is spent on salaries alone. It is not unusual to read today that it costs several hundred thousand dollars to "create" a single $30,000/year government job.

World War II did end unemployment in America, but only because more than 11.5 million men were drafted into the military whereas the total number of Americans unemployed as of 1940, on the eve of the war, was 5.3 million. In addition, millions more volunteered for the military to "beat the draft" because they knew that draftees were most likely to serve on the front lines than volunteers were.

The average American consumer was worse off during World War II because of the massive diversion of economic resources from the consumer economy to the war economy and the dramatic increase in taxes. By 1945 the top income tax bracket was 94 percent on an annual income of $200,000. The lowest income tax bracket was 23 percent on an annual income of $2000. There was nothing to buy, and even basic food and clothing items were rationed by the government. So despite an explosion of total federal government spending during the war years, the average American at home was still living in a depression economy worse than 1939/1940.

At the end of the war every Keynesian economist predicted an even worse economic depression because of the demobilization of the military and the accompanying radical reductions in government spending. The reductions in government spending were indeed dramatic: According to the Commerce Department's Historical Statistics of the United States, federal government expenditures fell from $98.4 billion in 1945 to $33 billion in 1948, about a two-thirds reduction. Far from creating a depression, prying all of that money from the hands of politicians and bureaucrats and returning it to its owners – working Americans – created the largest increase in private sector economic growth in all of American history in 1946. According to statistics found in the 1995 Annual Report of the U.S. Council of Economic Advisors, based on Commerce Department data, real inflation-adjusted private sector GDP increased by 29.5 percent in that year. In no other year has the U.S. economy ever grown even half that fast. Private investment skyrocketed and stock prices soared, in complete and total contradiction of what every Keynesian economist in the world had been predicting. Yet thanks to the power of government propaganda, and the state's academic mouthpieces (Paul Krugman comes to mind), the myth persists that government spending during World War II is "proof" that government can spend us into prosperity.

Thomas DiLorenzo is professor of economics at Loyola University Maryland and a member of the senior faculty of the Ludwig von Mises Institute. Among his books are How Capitalism Saved America; Hamilton's Curse; and his forthcoming Organized Crime: The Unvarnished Truth About Government.
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