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Influence of WW2 in the implementation of Keynesian Demand Management

 

The Keynesian Demand Management -KDM- Theory

Governments’ response to the Great Depression started with the “laissez-faire” paradigm, austerity policies and the belief that free markets would automatically adjust for the optimal outcome.

UK-US unemployment Great Depression  With unemployment rates in USA and UK reaching 20%, British economist John M Keynes challenged the mainstream classical approach and advocated government intervention to solve the economic crisis.

Keynes criticized that, partly due to sticky factors, the classical model “cannot solve the economic problems of the modern world” as only “comes into its own” at the full employment level of output; thus representing only a “special case” (Keynes 1936: 378).

Keynes argued that aggregate demand determined the overall level of economic activity and that, in a recession scenario, austerity would only lead to prolonged periods of high unemployment and depression.

State should intervene in the economy with countercyclical measures to mitigate the effects of economic fluctuations.

In recession, government should try to increase aggregate demand using monetary measures (lowering interest rates) and fiscal measures (increasing public expenditure and lowering taxes) which would fasten recovery, increase consumption and create growth and employment.

On the other hand, during economic expansion, government should decrease expenditure and increase interest rates and taxes, thus limiting inflation during full capacity and saving for the next downward spiral.

Furthermore, government expenditure has a multiplier effect on the economy, as government increases in spending increase total spending by a multiple of that increase.

On welfare state, Keynes considered that taxes and social benefits would be automatic economic stabilizers. Countercyclical spending could be used for socioeconomic goals (infrastructure, housing, transport, schools, hospitals, etc.). For Keynes, therefore, demand management, full employment and welfare state were interlinked and would promote economic productivity and steady growth.

He also defended financial regulation to avoid the speculation bubble which led to the 1929 crack.

Formulating and Testing KDM

KDM was theorised before the war and as a response to the Great Depression.

Keynes’ most notorious book The General Theory of Employment, Interest and Money was published in 1936, fully into the appeasement era. The “Keynesian multiplier” was first developed by Richard F. Kahn in 1931.

The IS/LM model –the relation of aggregate demand and employment to the amount of money in circulation, the government budget, and the state of business expectations- was born at the Econometric Conference held in Oxford in 1936 by Roy Harrod, John R. Hicks, and James Meade.

KDM was not only fully theorised prior to the war, but was partially tested too: mainly in the US, during Roosevelt’s presidency, especially after 1937.

While not fully Keynesian, the New Deal did have some KDM components, such as the unemployment relief programs and deficit spending to stimulate aggregate demand or the stabilisation of the banking system and the Glass-Steagall regulations.

As Galbraith puts it, Keynes influence over Roosevelt was that “you didn’t worry about accumulating debt, or, more precisely, you worried about it but did it anyway. That was the substance of Keynes as it was manifested in the Public Works Administration, and in the Works Progress Administration (WPA), which was directed at the unemployed”. (Galbraith 2002:3).

In fact, government intervention on the economy was tested long before Keynes. The Bolshevik government in Russia was the first example of state planning over the economy. The USSR never suffered the consequences of the Depression, highly due to its unlinked situation in the global market.

While combining government intervention and mitigating economic cycles, a clear difference between state socialism and Keynesianism is that the former wholly replaces the private sector. In fact, it is precisely the total public ownership of the means of production that characterise a “real socialist” state.

Keynes did not want to limit the private sector, and “crowding out” would be only temporary during economic downfalls.

Another pre-war example of state intervention was NSDAP’s two 4-year plans. While they did respect the private sector, capital accumulation and wage labour, and were actually studied by some of Keynes’ pupils, they cannot be considered part of the KDM, as consumption increments were mainly done by the state, becoming the principal demand agent, and as fiscal expansion wasn’t based on increasing population’s purchasing power, which, in fact, remained stagnated during the Nazi years via real wage decrements in order to increase profitability of the private sector.

Role of War in implementing KDM

While KDM was theorised as a response to the depression and was already partially tested before WW2, it is quite true it was only fully applied and internationally accepted and developed after 1945.

In Britain in particular, KDM was only implemented after the war. The conflict had a huge influence on the social acceptance of Keynesian theories.

While it is impossible to know what would have happen if…, it seems clear the war was an accelerator on the implementation of KDM in the UK, mainly due to the state control over the economy, the population social demands, and the geopolitical and financial regulation framework outcome of the war.

a. The state control over economy.

The war permitted full control over the economy, and a centralised organisation of production and distribution. All economic sectors (transport, rationing, energy, health services, housing, etc.,) came under state supervision, and all activity was derived into the primary goal: the war effort.

The war provided the technological framework which would permit a more prolonged control over the economy.

While state control during the war facilitated the objective conditions to allow a permanent intervention, it must be said it can not be a determinant factor. After all, “war economy” had already taken place during the Great War, when the state had crowded out the private sector and monopolised production and distribution. After 1918, it was back to business as usual.

Now, it was different. From the government spheres, interventionist voices were defending a permanent control over the economy, the creation of a welfare state and full employment goals.

Already during the war years, the British government drew the main framework of what would become the foundations of KDM: the Beveridge Report, which recommended an economic policy aimed at full employment, a centralised health, minimum level of subsistence, and protection system and a series of universal benefits and tax rates.

Keynesian full employment goal was institutionalized with the publication of the British White Paper on Employment Policy in 1944, which Keynes himself helped to draft, -which would influence future employment legislation such as Australian Full Employment Paper in 1945 or US Employment Act of 1946-, and which stated that “the government accepts as one of their primary aims and responsibilities the maintenance of high and stable level of employment after the war” .

b. The popular demands

Both the Beveridge report and the White Paper enjoyed high support from the public, and when the Tory-led coalition government pressed to hold the recommendations until the war ended, “the population was infuriated” (Barnett, 2001: 31). Churchill warned the public of the financial dangers of immediate emancipation aspirations and “urged to slow the process” (Barnett, 2001:31-32).

But by 1945, after the collective experience of a chaotic 15-year cycle of recession and war, the population had assumed social demands for market control and a welfare state. Social pressure was, probably, the main force in the implementation of KDM in the UK.

The war effort was justified on the premise better times would come. The “people’s war involved a radical attempt to reconstitute the social fabric of society in the interests of the lower classes. [They] were not fighting for the preservation of the pre-war situation – they wanted something better”. (Kilian, 2012: 1).

In fact, the idea of the war conceived as a potentially revolutionary instrument was not new: “The redeeming feature of war is that it puts a nation to the test. As exposure to the atmosphere reduces all mummies to instant dissolution, so war passes supreme judgment upon social systems that have outlived their vitality” (Marx, 1990: Vol. 14, p.516).

Collective efforts such as military industrial work force or mass evacuation of children, had great influence in increasing national consciousness of self-determination, social emancipation and people’s will to maintain public control of socioeconomic affairs.

In the armed forces, revolutionary demands were also on the rise, as showed on The Cairo Forces Parliament, a meeting of British soldiers in February 1944 which debated the structure of society they wanted in a post-war world and voted for the nationalisation of banks, land, mines and transport. It wasn’t unique. At Mhow and Deolaili similar demands were expressed by sections of the military.

c. Geopolitical Outcome of the War

The post war resulting bipolar scenario with geostrategic and ideological antagonisms, favoured a more relaxed version of capitalism and the consolidation of the welfare state, in trying to eliminate population’s sympathy to USSR and make market economy more attractive.

The resistance during the war, very strong Communist Parties in France or Italy, and the geographical proximity of Moscow, created the conditions to convert Europe into a Keynesian welfare state laboratory.

Capitalism needed its own attractive version and cession to social needs in order to maintain its core values: private property, wage labour and capital accumulation.

d. Financial Stability

Another consequence of the war was the quasi unanimous international support in financial regulation and to limit the exposure to banking speculation.

The first path was the Bretton Woods agreement in 1944, whose British delegation was led by Keynes, and which limited financial speculation, stabilized exchange rates and provided the framework of financial regulation for a generation, with the creation of institutions such as the IMF or the WB.

1945 elections and the implementation of KDM

The divisive and polarised UK general elections on 1945 were decisive onto the implementation of KDM.

The depression and then the war represented a sociological turning point in UK’s population, more pro-state and interventionist: “the classical paradigm was completely abandoned. It was now the belief that governments needed to play a role in regulating their economies and that laissez faire paradigm could not operate with only an invisible hand. A real hand needed to serve as a countervailing to control its cycles and any speculative abuses.”(de Regil, 2001: 3).

Win the PeaceWhile Churchill still enjoyed great approval ratings, Tory’s failure to commit -blaming public finances- to the total application of the Beberidge reforms, prompted a Labour landslide victory.

Labour’s electoral manifesto proposed to consolidate public control over economy, fully and urgently develop the Beveridge Report and to assume KDM and full employment. It even proposed “a 10-year national reconstruction plan (…) with democracy at the bottom and centralisation at the top” (Kynaston 2007: 130).

The sociological advance was assumed to be total, as Aneurin Bevan exclaimed during the campaign, “We have been the dreamers, we have been the sufferers, now we are the builders. We enter this campaign at this general election, not merely to get rid of the Tory majority. We want the complete political extinction of the Tory Party and 25 years of Labour Government (…) [to do] a new and modern industrial revolution for our heavy industry. It can only be done by modern, fine men of a new age.” (Kynaston 2007: 64).

The Atlee government followed a double strategy based on “the macro-management of the economy to ensure economic growth under conditions of full employment and a range of social policies dealing with the redistribution of the fruits of economic growth, the management of its human effects and the compensation of those who suffered from them.” (Pearson 2006: 30).

In this period, called the golden age of capitalism, the UK enjoyed steady growth and full employment. Other countries which also applied KDM had similar fortunes: “unemployment fell to 3% in the US in the early 1950s, 1.5% in Britain and 1% in Germany in 1960” (Harman, 1999: 548).

In a short period of time, the NHS was created, over a million social homes for “low-income families” (Jefferys, 1992: introduction) were built. By 1951, “about 20% of the British economy had been taken into public ownership” (Thorpe, 2001: 109).

Even after Labour lost office in 1951, both KDM and the welfare state were assumed by mainstream political and economic actors for a generation; until the 1970’s stagflation crisis, the subsequent abandonment of Keynesian demand management and the shift to structural adjustment and neoliberal supply-side economy management.

Conclusion

Without war, KDM would have probably been tested anyway. KDM was theorised and formulated as a response to the Great Depression and even partially tested before the war, both in US and after some other interventionist experiences in other countries.

The war, however, proved to be a clear accelerator in the implementation of KMD, mainly due to the state control over the economy, the population social demands, and the geopolitical and financial regulation framework outcome of the war.

In the UK, the war precipitated a chain of events, from the popular demands to avoid returning to the pre-war situation to avoid similar crisis and control the economy and consolidate a modern welfare state. The popular support to Labour, the party which assumed fully and urgently the Beveridge report and full employment goals, was fundamental in the implementation of KMD in Britain.

In few years, mainstream political parties and academics shared the utility of counter-cyclical management, which brought growth and full employment until the 1973 crisis and the resurrection of classical thought.

References

Barnett, C (2001) The Audit of War. London: Pan Books.

De Regil, A (2001) Keynesian Economics and the Welfare State. New York: Global Economic Development – The Jus Semper Global alliance: New York.

Galbraith, John Kenneth (2002). Commanding Heights, interview. New York: Public Broadcasting Services.

Harman, Chris. (1999) A People’s History of the World. London: Bookmarks.

Jefferys, K.(1992) The Attlee governments, 1945-1951. London: Longman.

Keynes, John Maynard (1936) The General Theory of Employment, Interest and Money. London: Macmillan.

Kilian, Mark (2012) Their war and ours: the people and the Second World War. London: Socialist Review.
Kynaston, D (2007). Austerity Britain 1945-1951. London: Bloomsbury Publishing Plc.
Marx, Karl and Engels, Frederick (1990) Collected Works. New York: International Publishers.

Pearson, C (2006) Beyond the welfare state. Cambridge: Polity Press.

Thorpe, Andrew. (2001) A History Of The British Labour Party. London: Palgrave.

 

 

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