ABSTRACT: The orthodox view of the U.S. reconversion after World War II relies on unacceptable GDP figures for the wartime economy and misinterprets the low level of unemployment during the war. For the postwar transition, the emphasis on consumer demand financed by drawing down liquid assets accumulated during the war is inconsistent with the facts. The success of the transition depended on the reestablishment of “regime certainty,” which in turn depended on diminishing the influence of the more zealous New Dealers. Wartime and postwar political developments created sufficient regime certainty for the postwar market system to generate genuine prosperity.

“At the end of 1946, less than a year and a half after VJ-day, more than 10 million demobilized veterans and other millions of wartime workers have found employment in the swiftest and most gigantic change-over that any nation has ever made from war to peace.”
Harry S Truman[1]

The complex and often fitful transition from central planning to the market in China and the Warsaw Pact countries has been a hot topic during the past decade. Notably, the United States made a similar transition after World War II. Indeed, the reconversion from a wartime command economy to a market-oriented postwar economy, a transition accomplished with astonishing speed and little apparent difficulty, constitutes one of the most remarkable events in U.S. economic history. Nevertheless, economists and economic historians have devoted little attention to that episode, and their explanations of it are, on close inspection, extremely problematic. With few exceptions, scholars have not yet recognized the problems inherent in dealing with that great event.[2] In this article, I consider some major issues of measurement and explanation related to the reconversion of the U.S. economy between 1945 and 1947, a transition that laid the groundwork for the prosperity of the following half century.

The Orthodox Story

To illustrate briefly the long-established view of the reconversion, I quote from the economic-history textbook by Gary M. Walton and Hugh Rockoff:

It was widely expected that the Great Depression would return once the war was over. After all, it seemed as if enormous levels of government spending during the war were the only thing that had gotten the country out of the depression. Many, perhaps most, economists agreed with this analysis. . . . The expected depression did not materialize. During the war, people had accumulated large stores of financial assets, especially money and government bonds. . . . Once the war was over, these savings were released and created a surge in demand that contributed to a postwar rise in prices and to the reintegration of workers from the armed forces and from defense industries into the peacetime labor force. Government policy also played a role in smoothing the transition. The so-called “G.I. Bill of Rights” . . . delayed the reentry of many former servicemen into the labor force and provided them with improved skills.[3]

As this statement illustrates, the orthodox account maintains, first, that the economy did not revert to depression after the war boom and, second, that the expected postwar bust failed to materialize primarily because consumers employed the financial assets accumulated as “forced savings” during the war to give vent to their “pent-up demand” for goods, primarily durables, whose supply had been restricted or prohibited during the war. Government policy played a lesser role in “smoothing the transition,” mainly by temporarily removing men from the labor force.[4]

Spurious Prosperity, Spurious Depression

Notwithstanding the orthodox story, the economy seemingly did plunge into depression in 1946—at least, that is the conclusion one must reach if one takes seriously the official GDP data on which economists and historians normally base their accounts of macroeconomic fluctuations. As Figure 1 shows, the economy began to contract in 1945, when real GDP fell by 4 percent from its wartime peak in 1944. Then, in 1946, the bottom fell out: real GDP dropped by 20.6 percent, by far the largest annual fall ever in U.S. economic history, exceeding even that of the worst year (1932) of the Great Contraction.[5] Real GDP continued to fall slightly, by 1.5 percent, in 1947 before finally beginning to recover in 1948.

Before one dismisses the apparent postwar economic collapse as a misleading statistical peculiarity, one ought to recognize that the same system of economic accounts that gives rise to that oddity also generates the evidence of the “wartime prosperity” (Figure 1), evidence that economists and historians alike have long credited. According to the official national product accounts, real GDP grew at astonishingly high rates—about 20 percent annually—in 1941, 1942, and 1943, and at the still remarkable rate of 8.4 percent in 1944. If we dismiss as spurious the GDP data that indicate a postwar depression, are we warranted as well in dismissing the GDP data that indicate a wartime boom?[6]

A glance at Figure 2 suggests that something may be askew in the data series indicative of wartime prosperity and postwar slump. Figure 2 shows the annual percentage growth rates of the private portion of real GDP, that is, GDP minus government purchases of newly produced final goods and services. Comparing those growth rates with the growth rates of total GDP in Figure 1, one sees that the differences were slight for the years 1930 to 1940. In 1941, however, a large gap opened. The gap became enormous in 1942 and 1943, when private output fell sharply—by 10.6 percent and 3.7 percent, respectively—even though total output increased by 20 percent each year. After converging in 1944, the growth rates of total and private GDP diverged in the opposite direction in 1945 and 1946. In the latter year, while total GDP fell by 20.6 percent, private GDP leaped upward by an astonishing 29.5 percent, a growth rate never approached before or since. From 1948 to 1950, the two growth rates again tracked closely, as they had before the war. Figure 3 allows one to see at once how, and how greatly, the private economy and the total economy (that is, that including government purchases) deviated in their officially calculated growth performance from 1941 to 1947.

Despite the widespread and longstanding acceptance of official GDP data indicative of wartime prosperity from 1941 to 1945, those data have no sound scientific basis.[7] Although the estimates have defects of various sorts, the fundamental problem is that meaningful national-product accounting requires market prices, and the command economy of the war years rendered all prices suspect and many of them, especially the prices paid by the government for goods and services, manifestly arbitrary.[8] To suppose that this problem can be solved by employing the market prices generated at another time or place is to lose sight of what a national-product estimate is supposed to tell us—namely, the aggregate valuation placed on final outputs, each output being valued at its existing margin of production by the people composing an economy that approximates a competitive equilibrium and operates with the resources, tastes, technologies, and institutions specific to its own time and place. Other difficulties such as the index-number problem and the gross inaccuracy of wartime price indexes only compound the fundamental problem.[9]

Simply by sniffing the data for the years 1941 to 1946, one ought to have smelled a rat. Consider that between 1940 and 1944, real GDP increased at an average annual rate of 13 percent—a growth spurt wholly out of line with any experienced before or since. Moreover, that extraordinary growth took place notwithstanding the movement of some 16 million men (equivalent to 28.6 percent of the total labor force of 1940) into the armed forces at some time during the war and the replacement of those prime workers mainly by teenagers, women with little or no previous experience in the labor market, and elderly men.[10] Is it plausible that an economy subject to such severe and abruptly imposed human-resource constraints could generate a growth spurt far greater than any other in its entire history? Further, is it plausible that when the great majority of the servicemen returned to the civilian labor force—some 9 million of them in the year following V-J Day—while millions of their relatively unproductive wartime replacements left the labor force, the economy’s real output would fall by 22 percent from 1945 to 1947?[11] The utter implausibility of such developments suggests that scholars have placed far too much weight on the metaphor of a wartime production “miracle.”

One way to gauge the trend of an economy’s capacity to produce is to connect the outputs achieved in peak years of the business cycle by a constant-rate-of-growth line. For example, by linking the outputs for the benchmark years 1929 and 1948, one can construct a capacity-trend line. Performing this exercise on the real GDP data shown in Figure 4, one finds not surprisingly that the economy during the 1930s performed well below its capacity-trend line. But one also finds—mirabile dictu—that from 1942 to 1945 the economy performed far above its capacity to produce.[12] Although one might speculate that various ad hoc events of the war years temporarily raised the economy’s capacity to produce, a far more compelling conclusion is simply that the apparent super-trend wartime boom in output was nothing but an artifact of an unjustifiable accounting system. No doubt Americans produced an abundance of munitions during the war: if one accepts the national-product estimates at face value, it transpires that nearly 40 percent of GNP consisted of war-related ouputs from 1942 to 1945.[13] But such national-product estimates should not be accepted at face value.

In brief, the war boom as typically comprehended did not occur; nor did the corresponding “crash of 1946” so evident in the standard GDP data. It is hardly surprising that contemporary Americans experienced 1946 as a gloriously prosperous year having nothing in common with 1932. Economists and historians, notwithstanding their reliance on faulty national-product data to describe the “wartime prosperity,” have properly disregarded such data when considering the postwar transition and correctly concluded that the much-feared postwar depression did not materialize. In light of the foregoing critique, let us now consider why the postwar transition took place so swiftly and smoothly.

Recovery of the Private Economy

Returning to Figure 4, note that a trend line connecting the values of (the logarithm of) private GDP for 1929 and 1948 shows that the private economy languished far below its capacity trend throughout the 1930s and the first half of the 1940s. Then, because of the spectacular 29.5 percent leap in 1946, the private economy reached the trend line and continued along it for the rest of the decade except during the brief, mild recession of 1949. Clearly the bulk of the postwar transition took place when the private economy made its magnificent recovery—a recovery that had been sixteen years in coming—during 1946.

Why the Postwar Consumption Boom?

Recall that the orthodox story of the postwar transition places heavy weight on the drawing down of accumulated liquid assets to finance consumers’ satisfaction of their so-called pent-up demands. In the words of Walton and Rockoff, quoted earlier in a longer passage, “During the war, people had accumulated large stores of financial assets, especially money and government bonds. . . . Once the war was over, these savings were released and created a surge in demand” (emphasis added). No doubt many people did urgently desire to purchase, among other things, new cars, household appliances, and houses, which had been unavailable or in tightly limited supply during the war.[14] But the idea that postwar consumers paid for such goods by drawing down their liquid-asset holdings runs up against several difficulties.

The most serious flaw in that part of the orthodox story is that, in fact, individuals did not reduce their holdings of liquid assets after the war. Let us define liquid assets as currency held by the public, demand and time deposits in commercial banks, deposits in mutual savings banks, and deposits in the postal savings system. In November 1945, liquid assets so defined reached an all-time high of $151.1 billion. By December 1946 they had risen to $161.6 billion, and by December 1947 to $168.5.[15] Every component of liquid assets so defined also increased during that two-year period. Of course, so long as the total amount of money was increasing, the public as a whole could not “draw down” its holdings: what one member of the public gave up, another acquired.

If people did not, indeed could not, reduce their holdings of liquid assets, perhaps they tried to do so, thereby driving up the velocity of monetary circulation. Not so. Neither the velocity of money defined as M1 nor the velocity of money defined as M2 rose in those years. For the four years 1945 to 1948, the velocity of M1 took the values 1.75, 1.52, 1.62, and 1.73; the velocity of M2 took the values 1.37, 1.16, 1.23, and 1.31.[16] Thus, people were actually holding the average dollar longer during the three postwar years than they had during the war years.[17]

Perhaps consumers were liquidating their bond holdings? No. At the end of 1945, individuals held $64.0 billion of the public debt; at the end of 1946, $64.1 billion; at the end of 1947, $65.7 billion. It is true that the amount of federal debt outstanding declined between 1945 and 1948, but the decline occurred almost entirely because of reductions in the holdings of commercial banks and corporations other than banks and insurance companies.[18]

How then did consumers finance their surge of spending during the postwar recovery of the private economy? The answer is, in nominal terms, by a combination of increased personal income and a reduced rate of savings; in real terms, simply by reducing the rate of personal savings. Between 1945 and 1946, when personal consumption spending increased by $23.7 billion, annual personal savings dropped by $14.4 billion, and personal taxes fell by $2.2 billion; increased (nominal) personal income financed the balance of the increased consumption. Between 1946 and 1947, when personal consumption spending increased by $17.3 billion, annual personal savings dropped by $5.2 billion, and personal taxes rose by $2.7 billion; increased (nominal) income financed the balance of the increased consumption. Between 1947 and 1948, when personal consumption spending increased by $12.9 billion, increased (nominal) personal income accounted for more than the entire increase, as personal taxes fell by just $0.2 billion and annual personal savings actually increased by $6.1 billion. Clearly, during the critical first two years after the war, the ability of consumers to spend more nominal dollars (+$41.0 billion) for consumer goods depended overwhelmingly on just two sources: increased personal income (+$20.5 billion) and reduced annual saving (-$19.7 billion).[19]

The potential for a reduction of the personal saving rate (personal saving relative to disposable personal income) was huge after V-J Day. During the war the personal saving rate had risen to extraordinary levels: 23.6 percent in 1942, 25.0 percent in 1943, 25.5 percent in 1944, and 19.7 percent in 1945. Those rates contrasted with prewar rates that had hovered around 5 percent during the more prosperous years (for example, 5.0 percent in 1929, 5.3 percent in 1937, 5.1 percent in 1940). After the war, the personal saving rate fell to 9.5 percent in 1946 and 4.3 percent in 1947 before rebounding to the 5 to 7 percent range characteristic of the next two decades.[20] After having saved at far higher rates than they would have chosen in the absence of the wartime restrictions, households quickly reduced their rate of saving when the war ended. Note, however, that they did not dissave. Even at the low point in 1947, the saving rate was 4.3 percent, not much below the prewar norm for relatively prosperous years.

Why the Postwar Investment Boom?

The postwar resurgence of the private economy rested on an investment boom as well as a consumer spending surge. In current dollars, gross private domestic investment leaped from $10.6 billion in 1945 to $30.6 billion in 1946, $34.0 billion in 1947, and $46.0 billion in 1948. Relative to GNP, that surge pushed the private investment rate from 5.0 percent in 1945 (it had been even lower during the previous two years) to 14.7 percent in 1946 and 1947 and 17.9 percent in 1948.[21] As a standard for comparison, one may note that the investment rate had been nearly 16 percent during the latter half of the 1920s, before hitting the skids during the depression.[22]

Firms could finance their increased investment spending in part because, unlike individuals, they did unload some of the government securities they had acquired during the war. Between 1945 and 1946, holdings of public debt by corporations (exclusive of banks and insurance companies) fell by $6.9 billion; they fell by another $1.2 billion in 1947 before rising by $0.7 billion in 1948.[23]

Moreover, thanks to a reduced tax liability—the Revenue Act of 1945 lowered the top corporate income-tax rate and repealed the excess-profits tax—corporations enjoyed rising after-tax profits from 1946 through 1948.[24] During the years 1941 through 1944, after-tax corporate profits had held steady in the range of $10 to 11 billion annually. After-tax profits dropped to $9.0 billion in 1945, as the government cancelled procurement contracts and many firms incurred extraordinary expenses to reconvert their production facilities. Then, after-tax profits rose to $15.5 billion in 1946, $20.2 billion in 1947, and $22.7 billion in 1948. Those postwar profits compared nicely with the $8.6 billion of 1929 even after adjustment for inflation (which had diminished the value of the 1948 dollar by 37 percent relative to the 1929 dollar).[25] With greater after-tax profits to draw on, businesses increased their retained earnings.[26] Gross business savings increased from $15.1 billion in 1945 and $14.5 billion in 1946 to $20.2 billion in 1947 and $28.0 billion in 1948.[27] The additional retained earnings provided an important source of financing for the higher business investment after the war.

Corporations also returned to the capital markets in a big way. Stock and bond offerings, which only once had exceeded $3.2 billion in the years 1935 to 1944 (the exception being $4.6 billion in 1936), jumped to $6.0 billion in 1945, $6.9 billion in 1946, $6.6 billion in 1947, and $7.1 billion in 1948.[28] Public confidence in future corporate earnings also manifested itself in higher stock prices. The Standard & Poor’s index of 500 stocks, having fallen steadily from 1939 to 1942 before regaining the lost ground in 1943 and 1944, shot up by 21.6 percent in 1945, then by 12.6 percent in 1947 before falling back to the 1946 level for the remainder of the decade.[29] A price index of all common stocks, having reached a trough in 1942 before beginning a slow ascent, rose (fourth quarter to fourth quarter) by 31.1 percent in 1945. That index rose another 10 percent in the first half of 1946 before peaking and then retreating later in the year to a plateau where it remained, still nearly twice its wartime low, for the balance of the 1940s.[30] Purchasers of corporate bonds expressed their vote of confidence by keeping bond prices so high that the effective (nominal) yield remained in the narrow range of 3.0 to 3.5 percent between 1945 and 1949.[31]

In sum, the corporate investment boom of the postwar transition years received its financing from a combination of the proceeds of sales of previously acquired government bonds, increased current retained earnings (attributable in part to reduced corporate-tax liabilities), and the proceeds of corporate securities offerings. Higher postwar stock-market values and low effective yields on corporate bonds validated the optimism that underlay the investment boom. According to President Truman’s economic report of January 1948, “the extraordinary rate of business income in general allowed investment to proceed at record levels. Even greater expansion was prevented mainly by lack of material rather than by lack of intention to invest or lack of financial resources.”[32]

Real Private-Sector Recovery Officially Underestimated

The data depicted in Figures 1 to 4 and all the “real” data to which I have previously referred embody adjustments for changes in the price level based on the implicit deflators computed by the Commerce Department. Like the more familiar price indexes, the Consumer Price Index and the Producer Price Index, those deflators rest ultimately on price data collected by government agents. All scholars who have seriously considered the matter agree that during the war the more-or-less comprehensive price controls then being enforced gave rise to substantial understatement of the actual inflation, especially for the private portion of the national product.[33] In the words of Milton Friedman and Anna J. Schwartz:

prices, in any economically meaningful sense, rose by decidedly more than the “price index” during the period of price control. The jump in the price index on the elimination of price control in 1946 did not involve any corresponding jump in “prices”; rather, it reflected largely the unveiling of price increases that had occurred earlier. Allowance for the defects in the price index as a measure of price change would undoubtedly yield a decidedly higher rate of price rise during the war and a decidedly lower rate after the war.[34]

One upshot of correcting for the biases of the official price indexes during and immediately after the war is that the estimated real growth of private product during the war is thereby diminished and the estimated real growth of private product after the war is thereby increased—the miracle of 1946 was even greater than the official data (depicted in Figures 2, 3, and 4) indicate. According to the official implicit deflator for private product, the price level increased by 21.8 percent between 1945 and 1947.[35] Friedman and Schwartz’s estimated deflator for NNP, which probably overstates the inflation for private product alone, increased by just 9 percent during the two-year period.[36] Richard K. Vedder and Lowell E. Gallaway’s estimated deflator for GNP, which probably overstates the inflation for private product alone, increased by just 10.6 percent during that two-year period.[37] If one assumes that the private-sector price level actually rose by 10 percent between 1945 and 1947, which may well overstate the true increase, then real private product increased during those two years by a mind-boggling 44.5 percent, rather than the 33.8 percent implied by the data underlying Figures 2, 3, and 4 (taken from the Council of Economic Advisers’ 1995 report). No wonder nobody was complaining about a slump even though the official GDP data depicted a Great Contraction in 1946. In reality—that is, when output is evaluated at prices validated by free consumer choice—1946 was the most fabulously expansive year in U.S. economic history.

Labor-Market Shifts

Although the arbitrariness of prices and the suppression of voluntary resource allocation in a command economy preclude meaningful straightforward comparisons of wartime and peacetime national products, we can gain some understanding of the postwar transition by examining the changing size, composition, and employment of the labor force in the 1940s. No doubt, many scholars and lay persons alike have viewed the wartime economic conditions as prosperous because of the “full employment” that prevailed. But that aspect of the so-called wartime prosperity also tends to mislead us, because for the most part it reflected nothing more than the buildup of a huge armed force, mainly by conscription.[38] After V-J Day, however, the armed forces rapidly demobilized, shrinking from 12.12 million uniformed personnel in mid-1945 to 1.58 million in mid-1947. Simultaneously, civilian employment by the armed forces fell from 2.63 million persons to 0.86 million, and military-related employment in industry dropped from 11.0 million persons to 0.79 million. Therefore, total military-related employment fell in just two years from 25.75 million (39.2 percent of the total labor force) to 3.23 million (5.3 percent of the total labor force).[39]

Between 1945 and 1947 the civilian labor force increased from 53.9 million persons to 60.2 million. Nonetheless, civilian unemployment increased only from 1.0 million persons (1.9 percent of the civilian labor force) to 2.4 million (3.9 percent).[40] During the same period, civilian nonmilitary-related employment increased from 39.1 million persons to 55.4 million, an increase of 16.3 million (41.7 percent increase) in just two years.[41] After the war the ratio of nonmilitary-related employment to civilian labor force reached a level indicative of private-sector prosperity for the first time since 1929.[42] Whereas the American economy had eliminated unemployment during the war by reallocating labor resources to the production of military goods and services, it retained a low level of unemployment during the postwar transition because servicemen and munitions workers moved into nonmilitary-related employment and because many people left the labor force. (The total labor force, which comprises the armed forces and the civilian labor force, fell by about 5.7 million.) It was no miracle to herd 12 million men into the armed forces and to attract millions of men and women to work in munitions plants during the war. The real miracle was to reallocate a third of the total labor force to serving private consumers and investors in just two years. That event, whose reality is unambiguous, is unique in U.S. economic history.

Vedder and Gallaway, who are among the few to have grappled seriously with the problems of measurement and explanation at issue here, maintain that the smooth labor-market adjustment during the postwar transition occurred because the aggregate productivity-adjusted real wage fell.[43] To demonstrate the robustness of that explanation, they calculate their wage index under a variety of assumptions about wages, price-level changes, and labor productivity. Unfortunately, every variant, including the indirect variant (labor’s share of income or product), requires that one treat wartime national product and postwar national product as directly comparable. As I have already argued, national-product estimates for a command economy are essentially arbitrary. Therefore, the change of Vedder and Gallaway’s calculated wage index between 1945 and 1946 cannot bear the interpretative weight placed on it. Moreover, Vedder and Gallaway’s analysis rests on a model that assumes “labor supply is highly elastic . . . [and] moves over time slowly and predictably with demographic and other trends”—assumptions that contrast starkly with the sharp changes of labor-supply conditions from 1945 to 1947.[44] The model simply does not apply to the experience of the period 1941 to 1947, as Vedder and Gallaway themselves come close to admitting at several points.[45]

All we can say with confidence is that, given the economic conditions that existed during the transition and the expectations held at that time by consumers, investors, and enterprise managers, firms appraised the value of labor services highly enough that in the aggregate they were willing to employ nearly all workers seeking employment at the prevailing money wages. Whether the real wage as perceived at that time by actors in the labor market was higher or lower than what they perceived it to have been during the war had no relevance. Decisions to offer or accept employment are forward-looking, not retrospective.[46] The wartime economy with its byzantine, constantly changing structure of prohibitions, priorities, scheduling, physical allocations, conservation and limitation orders, quotas, set-asides, subsidies, price controls, commodity rationing, credit rationing, interest-rate pegging, conscripted and draft-exempted labor, and massive direct government investment in industrial facilities was—or soon would be—a bygone. After the war, private decision makers looked to a future in which they would again have room to maneuver.

Postwar Expectations

Although scholars sometimes refer to the expectation of a postwar depression as if they take it to have been widely entertained at the end of the war, in fact that expectation prevailed most notably among the Keynesian theorists and econometricians newly ensconced in agencies such as the War Production Board, the Bureau of the Budget, and the Federal Reserve Board.[47] Other economists, including W. S. Woytinsky and Rufus S. Tucker, turned out to have had a more prescient view of the postwar economy. Michael Sapir, himself a government forecaster, remarked later that “economists of an older vintage tended to do better because they relied more on history.”[48] (History did not provide a perfect guide, however. People who, like the average business economist in Joseph Livingston’s survey, continued for years to expect a postwar deflation, probably did so because of what they knew had happened after previous wars, especially after World War I.)[49]

For determining the actual course of events, the expectations of economists, right or wrong, mattered far less than the expectations of consumers and investors, especially the latter. Unless private investment recovered, no postwar prosperity could last long—after all, it was the failure of private investment to recover fully that had kept the economy from getting out of the Great Depression in the 1930s. Fortunately, as Sapir noted, “business men’s expectations about the economic climate were much more optimistic than those of the Washington economists whose views commanded most attention; and actual developments may constantly have exceeded even those expectations, thus leading to further upward revisions of investment plans.”[50]

In 1944 and 1945 the Fortune poll of business executives registered widely prevailing confidence about postwar economic conditions. In May 1944 a national sample of executives was asked: “In general, does it seem to you that after the war the prospects of your company will be better, or worse, or about the same as they were before?” Of the respondents, 51.2 percent said better, 8.5 percent worse, and 36.8 percent about the same.[51] In February 1945 a national sample of executives was asked: “How, in your judgment, will employment in your company after the war compare with wartime and with prewar employment?” Relative to their wartime employment, 33.9 percent expected greater employment and 26.7 percent less (39.4 percent did not answer the question); relative to prewar employment, 48.2 percent expected greater employment and 5.6 percent less (46.2 percent did not answer the question).[52]

Unlike the brash young Keynesian economists, businessmen in 1945 and 1946:

could not believe that a serious “slump” was around the corner just because the government had stepped out of the market so fast—after all, they had a large and growing volume of unfilled orders for peacetime products. . . . Expectations of price increases, tax reductions, and large volume sales apparently far outweighed in business minds the impact of reduced government spending.[53]

After two years of the postwar boom, businessmen remained confident. According to President Truman’s economic report for 1948, “business sentiment now appears to entertain the expectation of strong markets for as far ahead as it can see.”[54]

Sapir also noted that soon after V-J Day “a climate of expectations looking to much freer markets was implanted in business.”[55] He seemingly failed to appreciate, however, that those expectations arose not only from postwar developments suggesting that the government would move quickly to abandon or loosen war-related controls but also from a closely related factor, the altered character of the federal administration. During the war, businessmen and administrators friendly to business had largely taken over the management of the command economy, displacing especially the ardent New Dealers who had surrounded President Franklin D. Roosevelt from 1935 until the military buildup of 1940/41.[56] After the war, with FDR dead and the federal administration in less hostile hands, businessmen perceived a much diminished threat to their property rights.[57] Investors were then much more willing to hazard their private property than they had been before the war, as both survey data and financial-market data confirm.[58]

In 1946 the electorate gave the Republicans, who had campaigned for lower taxes and reduced government spending, a majority in both houses of Congress, thereby ensuring that even if the Truman administration were to move toward strengthening the New Deal, it would not get far. In pushing for lower taxes after the war, the Republicans hoped to starve to death at least some parts of the bloated federal bureaucracy that had grown up between 1933 and 1945. As Senator Robert A. Taft said in 1947, “the best reason to reduce taxes is to reduce our ideas of the number of dollars the government can properly spend in a year, and thereby reduce inflated ideas of the proper scope of bureaucratic authority.”[59] That message came as music to the ears of potential investors, reassuring them that the federal government no longer posed the potentially disastrous threat to their property rights that they had perceived it to pose when it was controlled by the zealous, business-hating leaders and advisers of the Second New Deal.[60] Passage of the Taft-Hartley Act in 1947 curtailed the ability of unions to interfere in the operation of business and allowed businessmen and investors to breathe even easier.

Toward a More Defensible Understanding of the Postwar Transition

Having analyzed the reconversion and the failure of the government forecasters to come even close to predicting its actual macroeconomic contours, Sapir wrote in the late 1940s, “Looking backward it seems incredible that we could have missed the signs so badly.”[61] Even more incredible is that economists and economic historians, with few exceptions, have continued for fifty years to misunderstand what happened during the war and reconversion, relying on theoretically groundless government-product data and error-ridden private-product data for the command economy and continuing to represent the “wartime prosperity” as having validated the basic Keynesian model but failing to notice that the events of the reconversion totally discredited such a model. Even Vedder and Gallaway, who have explicitly recognized the entrenched errors and tried to avoid them, have failed to break completely free of them.

A basic reason for the continuing deficiencies of economic scholarship on the war and reconversion is that analysts have continued to think in terms such as “the 1944-47 business cycle experience.”[62] As that expression reveals, scholars treat the events of the war and reconversion years as if they composed a segment, directly comparable with other segments, in a longer-running economic process. More specifically, economists and economic historians treat the macroeconomic events of the war-and-reconversion segment as if those events resulted from causal forces common to and reverberating through the longer-running economic process and thereby imparting to it certain dynamic properties (for example, a characteristic “cyclical” movement). They fail to comprehend that the drastic institutional discontinuities of the wartime command economy rendered it sui generis and hence not directly comparable with either the prewar or the postwar economy. If it is to be understood, it must be understood on its own terms.

Retrospectively describing the wartime economic expansion, War Production Board economists in 1945 seemed to appreciate the nature of the beast, observing that:

This expansion is unique, not only because of its magnitude and the relatively high level from which it started, but also because of its institutional basis. To a much greater extent than during the peacetime cyclical upswings—or even the expansion during World War I—this expansion has depended upon Government’s readiness to provide most of the fixed and much of the working capital needed in war production; upon the existence of what amounts to a guaranteed market for anything that could be produced; and in general, upon Government’s initiative, support, guidance and control.[63]

In short, as all contemporary sources attest, the American economy became essentially a command economy during 1941 and 1942; it operated as such during 1943, 1944, and 1945; and it made the transition back to a mainly market-oriented configuration between, roughly, mid-1945 and mid-1947.[64] Of course, in various respects the government never surrendered the powers it had assumed during the war.[65] The point here, however, is that by the latter half of 1947 the economy had reverted to operating as a market system about as far as it ever would, and at that time it was far less subject to government control than it had been during the war. Between 1940 and 1947 the U.S. economy passed through an institutional cycle (market-command-market) and a corresponding output cycle (butter-guns-butter). Because of that extreme cycling of its institutional structure and its output composition, the economy’s performance during those years simply cannot be compared in any unambiguous manner with that of either the pre-1941 economy or the post-1946 economy. Nor can we justifiably impose any macroeconomic model on a long period that includes the years 1941 to 1946 as a subperiod: any model appropriate for analyzing the subperiod is inappropriate for analyzing the other years, and vice versa. Command economies and market economies do not—to employ a positivist figure of speech—obey the same laws. In the face of this fundamental analytical difficulty, we must recognize that some questions simply cannot be answered; at least, they cannot be answered if posed in the usual way (for example, was real GDP greater in 1944 or 1948?).

Still, we can make reasonable conjectures and bring pertinent evidence to bear as we strive to understand how the reconversion proceeded so quickly and successfully as gauged by, say, the low unemployment rate that prevailed throughout the transition. Some causes I have already suggested, including the impetus to private investment that arose from postwar reductions of taxes on corporate earnings. The government deserves additional credit for the speed with which it released men from the armed forces, cancelled and settled extant munitions contracts, sold many government production facilities to private parties, transformed its budget deficit into a surplus, removed wartime controls, and assisted military personnel in making the transition to civilian life immediately after their mustering out.[66]

Under provisions of the G.I. Bill, which historians have often credited with helping to keep transitional unemployment low by paying veterans to attend college, the government did support some 800,000 veterans who enrolled as students in September 1946.[67] Even if all of those enrolling veterans had instead been unemployed, however, they would have raised the unemployment rate by only 1.4 percentage points. Moreover, the law did more than simply remove veterans from the labor market. Historians have generally failed to appreciate that the G.I. Bill’s provisions for veterans’ unemployment benefits—$20 per week for as many as 52 weeks—amounted to an unemployment subsidy for veterans who were in the labor force, and therefore caused measured unemployment to be greater than it otherwise would have been. In August 1945, about 900,000 veterans were counted as unemployed, constituting about 44 percent of the total number of persons unemployed.[68]

Too often, however, even the government’s helpful transition measures have been seen either as ad hoc measures or as the fruits of foresighted government planning during the war. It is important to recognize that those measures were precisely the sort one ought to have expected to be taken by the men who controlled the administration, the Congress, and the war-specific economic agencies during the transition. As I have emphasized earlier and documented elsewhere, the upper reaches of the wartime command economy came under the control of men sympathetic to business even before the United States became a declared belligerent.[69] By the manner in which they exercised their power, those men—thousands of whom were themselves businessmen on leave from their firms—transformed the climate in which investors and businessmen formed their expectations about postwar political and economic conditions. Therefore, even though the wartime administrators imposed extraordinarily pervasive and forceful controls on the economy, investors and businessmen confidently regarded those controls as temporary.

The speed with which the controls were removed—most of them in 1945 and most of the rest in 1946—validated that confidence and encouraged investors and businessmen to act, for the first time since the early 1930s, as if their property rights in their capital and the income it generated would remain reasonably secure. Without that outlook, which elsewhere I have called “regime certainty,” the other measures tending to make the transition a success would have availed relatively little. Restoring the regime certainty of investors and business people was a necessary condition for the transition to a prosperous postwar economy; nothing could substitute for it, and without it the economy probably would have fallen back into depression before long if not immediately.[70]

One interesting, empirically verifiable implication of the foregoing interpretation can be tested against the results of surveys of wage expectation. In November 1943 the American Institute of Public Opinion (AIPO) asked a national random sample of employed persons: “Do you think the wages now being paid in industries producing war materials will continue to be as high when these same industries produce peacetime goods?” Of the respondents, 9 percent said yes and 95 percent said no (6 percent had no opinion).[71] In May 1944, AIPO asked a national random sample of employers and employees who worked in war plants and planned to continue working after the war: “Do you think you will get the same rate of pay as you are now getting, or will you probably have to take less?” Of the respondents, 45 percent said same, 39 percent said less, and 6 percent said more (10 percent had no opinion).[72] In June 1945, AIPO asked a national random sample: “After the war, are you expecting the general level of wages to be higher, lower, or about the same as it is now?” Of the respondents, 5 percent said higher, 63 percent lower, and 27 percent about the same (5 percent had no opinions).[73] Clearly, the central tendency of wage expectations was that wages would be lower after the war.[74]

That expectation probably inclined workers to accept more readily the lower wage rates offered to them after the war. Had they tended to expect the same or even higher wages, they would have been more likely to hold out for higher wage offers than they received after the war and therefore they would have been more likely to be unemployed. It is not difficult to imagine that, had the federal government been under the sway of politicians more closely allied with organized labor, as it had been between 1935 and 1941, workers would have anticipated and therefore held out for higher wages.

The CIO wanted an immediate 20 or 30 percent wage increase at the end of the war to make up for the elimination of overtime pay, and many old New Dealers like Commerce Secretary Henry Wallace and Robert Nathan of the Office of War Mobilization and Reconversion considered such an increase essential to maintain living standards and avoid the long-feared postwar downturn.[75]

Clearly, in the labor market as in the investment domain, the character of the postwar regime helped to establish conditions consistent with a smooth transition to a high-employment civilian economy.

Indeed, the labor-market developments exemplify just one of the many areas in which the perceived temporariness of the wartime controls contributed to postwar behavior consistent with a smooth transition. In many other ways as well, the transition would have been far more painful had the government been dominated by the same “long-haired boys” who had occupied its upper reaches during the Second New Deal. Those men shared “the conviction that government must exercise an increased level of authority over the structure and behavior of private capitalist institutions”; even in the late 1930s, at the high tide of their policies, they believed “the New Deal had not gone far enough.”[76] Such devotees of government planning and control would have fought to retain many of the wartime controls, as indeed those who remained in the government actually did in 1945 and 1946.[77 ]As Michael J. Lacey has written, however, “Truman and his Fair Dealers were generally reconciled to the existing structure of the economy. Feats of wartime production had restored the public image of business leadership, and a general willingness to concede economic leadership to the corporate sector reemerged.”[78]

To sum up, the success of the transition hinged on the expeditious abandonment of the government’s command-and-control apparatus and the return to resource allocation via the price system. It required sufficient confidence in the future security of private property rights that investors would once again place high volumes of resources at risk in long-term projects. Such a transition could go forward successfully only under a regime far more dedicated to the market system than the dominant faction of the latter half of the 1930s had been. Ironically, the war had brought into power a coalition much more congenial to the market, and many of the most zealous New Deal planners had been pushed onto the periphery or completely out of the government. Though the postwar regime was by no means devoted to laissez faire and the economy remained subject to a host of government restrictions, participants in the postwar market economy had enough confidence in the security of their property rights and enough room to maneuver that they could succeed in reinvigorating the private economy for the first time since the 1920s.


For comments on previous drafts, I am grateful to Lee J. Alston, Donald J. Boudreaux, Burton Folsom, Daniel B. Klein, Gary D. Libecap, Hugh Rockoff, Mark Thornton, two anonymous referees, seminar participants at Seattle University, and the audience at the 1998 annual meeting of the Economic and Business History Society. Thanks, too, to Susan Isaac.

1. Truman, Economic Report, 8 January 1947, p. 1.

2. Exceptions include Skousen, “Saving the Depression”; Vedder and Gallaway, “Great Depression of 1946” and Out of Work, pp.150-75; and Smiley, American Economy, pp. 197-206.

3. Walton and Rockoff, History, pp. 580-81. I have no intention to single out Walton and Rockoff for special censure; most textbooks of U.S. economic history contain similar passages. I myself once wrote: “The immediate postwar period was prosperous not because of shrewd fiscal management by the federal government but because consumers, starved by years of depression and wartime restrictions on the production of civilian durable goods and bloated with bank accounts and bonds accumulated during the war, produced an expansive market and encouraged a private investment boom” (Crisis, p. 227). On the contemporary forecasts, see Sapir, “Review,” pp. 273-351.

4. For a well-documented account of the origins and perpetuation of the orthodox story, see Vedder and Gallaway, Out of Work, pp. 161-64.

5. Basic data from U.S. Council of Economic Advisers, Annual Report 1995, p. 406.

6. Since World War II, the relative price of munitions has tended upward. Therefore, each time the GDP deflator has been updated and the real GDP figures recomputed for the 1940s, the magnitudes of both the war boom and the postwar bust become greater, as Vedder and Gallaway have illustrated in the references cited in note 2. That statistical phenomenon is interesting and for certain purposes important, but the main points I seek to make in this article are distinct, and they remain regardless of the deflator employed. My critique rests more on a comparative-institutions foundation than on a merely statistical basis.

7. My argument for this conclusion, which builds on earlier critiques, especially that of Simon Kuznets, appears most fully in Higgs, “Wartime Prosperity?” pp. 44-49.

8. As Ellen O’Brien has written, “the treatment of the government sector put in place in 1947 (which has remained standard practice in the US since that date) was initiated by estimators in order to assess the impact of the tremendous increase in war expenditures on the economy. While World War II may have focused attention on the role and finance of government spending, theoretical debates from the pre-war period continued through 1947 and were never fully resolved.” See O’Brien, “How the ‘G’,” p. 242.

9. The conclusion that the low unemployment rates during the war evidenced wartime prosperity is similarly flawed. The buildup of the armed forces, overwhelmingly by conscription, accounts fully (and then some) for the decline of unemployment. See Higgs, “Wartime Prosperity?” pp. 42-44.

10. U.S. Bureau of the Census, Historical Statistics, p. 1140; and Ballard, Shock, pp. 129-30.

11. “On VJ-day 2 million veterans were employed. Today more than 10 million of them have jobs.” About 900,000 were unemployed and “about 1 million veterans—aside from those in school—have not yet started to look for work.” U.S. Office of War Mobilization and Reconversion, Eighth Report, 1 October 1946, p. 60. On departures from the labor force, see Ballard, Shock, p. 131.

12. Although the deflator is different and therefore the “real” values are affected somewhat, the trend real (1972$) GNP data computed by Nathan S. Balke and Robert J. Gordon derive from this technique and tell the same story. For their data, see Balke and Gordon, “Appendix B,” pp. 782-83.

13. Calculated from current-dollar data in U.S. Council of Economic Advisers, Annual Report 1970, p. 177. For a detailed list of physical quantities of munitions produced during the war, see Krug, Production, pp. 29-32.

14. For graphic representations of how consumer spending for durables, nondurables, and services deviated from their prewar consumption functions during the war years, see Sapir, “Review,” pp. 304-05. Note, too, that during the first year of reconversion “the phenomenal and quite unexpected rise in nondurable expenditures . . . [was] most striking” (p. 308, emphasis added).

15. Friedman and Schwartz, Monetary History, pp. 717-18.

16. Ibid., p. 774.

17. Friedman and Schwartz speculate about “a continued fear of a major contraction and a continued belief that prices were destined to fall.” Hence, ”the public acted from 1946 to 1948 as if it expected deflation.... [T]his fear or expectation ... induced [the public] to hold larger real money balances than it otherwise would have been willing to” (ibid, pp. 583-84). For evidence of expectations of deflation in the late 1940s, see the Livingston survey data in Gordon, “Postwar Macroeconomics,” p. 112.

18. U.S. Council of Economic Advisers, Annual Report 1970, p. 255. Thus, consumer behavior accorded with the findings of the National Survey of Liquid Assets conducted for the Federal Reserve Board by the Bureau of Agricultural Economics early in 1946. According to Sapir (“Review,” pp. 312-13), that study tended “to support the idea that on the whole families did not intend and did not want to spend their liquid assets in 1946 on such things as automobiles, refrigerators, and consumer goods generally. Apparently people preferred if possible to buy out of income, or perhaps borrow on short-term (by means of installment credit).”

19. The source for all data analyzed in this paragraph is U.S. Council of Economic Advisers, Annual Report 1970, pp. 194-95.

20. Ibid., p. 194

21. Ibid., p. 177.

22. Swanson and Williamson, “Estimates,” p. 55.

23. U.S. Council of Economic Advisers, Annual Report 1970, p. 255.

24. Repeal of the excess-profits tax was no small matter. From 1941 through 1945, net payments of that tax cumulated to $40 billion. See U.S. Bureau of the Census, Historical Statistics, p. 1109.

25. Ibid., p. 260 (corporate profits and taxes) and p. 181 (implicit price deflator for private national product).

26. “Business corporations, while paying out a record amount in dividends, retained the remarkably high proportion of five-eighths of their profits after taxes in 1947.” Truman, Economic Report of the President, 14 January 1948, p. 24.

27. U.S. Council of Economic Advisers, Annual Report 1970, p. 198.

28. Ibid., p. 266. In addition, short-term funds could be borrowed at very low rates: 0.75 percent in 1945, 0.81 percent in 1946, and 1.03 percent in 1947 for 4 to 6 month prime commercial paper. Data source is Balke and Gordon, “Appendix B,” p. 783. Even if the true rate of inflation was much lower than reported, those nominal rates of interest implied substantially negative real rates of interest.

29. U. S. Council of Economic Advisers, Annual Report 1970, p. 267.

30. Balke and Gordon, “Appendix B,” p. 805.

31. Ibid., p. 783.

32. Truman, Economic Report of the President 1948, p. 25.

33. Higgs, “Wartime Prosperity?” pp. 51-52.

34. Friedman and Schwartz, Monetary History, p. 558.

35. U.S. Council of Economic Advisers, Annual Report 1970, p. 1881.

36. Friedman and Schwartz, Monetary Trends, p. 125.

37. Vedder and Gallaway, Out of Work, p. 155.

38. Higgs, “Wartime Prosperity?” pp. 42-44. See also Vedder and Gallaway, Out of Work, p. 168 (“The wartime unemployment rates of under 2 percent were low, at least in part, because the normal rules of noncoercive labor-market participation did not apply”).

39. U. S. Department of Defense, National Defense Budget Estimates, pp. 124, 126, 128.

40. U.S. Bureau of the Census, Historical Statistics, p. 126.

41. U.S. Department of Defense, National Defense Budget Estimates, p. 126.

42. U.S. Bureau of the Census, Historical Statistics, p. 126.

43. Vedder and Gallaway, Out of Work, pp. 168-70.

44. Ibid., p. 16.

45. Ibid.: “these results ... are highly suspect because the underlying data are almost certainly replete with significant distortions” (p. 152); “enormous distortions [were] associated with the substitution for market-valued economic activity of command-economy activity not formally measured at true market prices” (pp. 156-57); and “we have only limited faith in the estimates of falling adjusted real wages” (p. 170).

46. As Ludwig von Mises wrote, “the anticipation of future prices of the products . . . determines the state of prices of the complementary factors of production. ... The fact that yesterday people valued and appraised commodities in a different way is irrelevant” (Human Action, pp. 336-37).

47. Sapir, “Review,” pp. 289, 340; and Jones, “Role,” pp. 129-30.

48. Sapir, “Review,” p. 317.

49. Seeking a comparative perspective, one might ask: why did the post-World War I depression of 1920/21 occur, given that the wartime controls had been largely abandoned and the political outlook for private enterprise seemed rosy? In my judgment, the answer lies largely in the mistaken policies of the Federal Reserve System, and in that regard I have nothing to add to the account of Friedman and Schwartz, Monetary History, chap. 5, esp. pp. 231-39. The brevity of the 1920/21 depression owed much to the contemporary downward flexibility of wages and prices.

50. Ibid., p. 297, See also Ballard, Shock, pp. 19-22.

51. Cantril, Public Opinion, p. 1121.

52. Ibid., p. 902.

53. Sapir, “Review,” pp. 320-21.

54. Truman, Economic Report of the President 1948, p. 43.

55. Sapir, “Review,” p. 314.

56. Higgs, Crisis, pp. 203-04, 211-15, and “Private Profit,” pp. 186-94; Hooks, Forging the Military-Industrial Complex, pp. 80-224; Riddell, “State”; Jeffries, “‘New’ New Deal” and “‘Third New Deal’?”; and Brinkley, End, pp. 175-200.

57. See Lacey, Truman Presidency, esp. pp. 5-6, 76, 136-37.

58. For an extensive presentation of evidence for this claim, see Higgs, “Regime Uncertainty.”

59. Taft as quoted in Isbell, “1948 Tax Cut,” p. 177.

60. Of the Second New Deal (that is, 1935 to 1940) bureaucrats, James Burnham wrote in his book, The Managerial Revolution (1941), “they are, sometimes openly, scornful of capitalists and capitalist ideas. . . . They believe that they can run things, and they like to run things.” Quoted in Hayek, Collected Works, p. 251.

61. Sapir, “Review,” p. 321.

62. Vedder and Gallaway, Out of Work, p. 158.

63. U.S. War Production Board, American Industry, p. 4.

64. Many contemporary sources are cited in Higgs, “Wartime Prosperity?” p. 54, fn. 40.

65. For enduring legacies, see Higgs, Crisis, pp. 225-34.

66. On all these reconversion policies, see Ballard, Shock.

67. U.S. Office of War Mobilization and Reconversion, Eighth Report, 1 October 1946, p. 62.

68. Ibid., pp. 59-60.

69. Higgs, “Private Profit” and “Regime Uncertainty.”

70. Higgs, “Private Profit” and “Regime Uncertainty.” Hugh Rockoff has written about “a new macroeconomic regime” that he argues undergirded postwar prosperity, but his discussion applies not so much to the immediate postwar years as to the much longer postwar era. Indeed, prior to the Federal Reserve-Treasury Accord of 1951, the monetary regime continued to feature the same Fed subordination to the Treasury that had begun at the outset of the war. See Rockoff, “United States,” pp. 115-18. In any event, the “regime certainty” at issue here, essentially a political and property-rights phenomenon, differs from the “new macroeconomic regime” hypothesized by Rockoff.

71. Cantril, Public Opinion, p. 1013.

72. Ibid., p. 900.

73. Ibid., p. 1014.

74. Workers might have expected lower postwar wages simply by anticipating the effect of a drastic reduction of war-related work, which paid relatively high wages. According to Claudia Goldin (citing a 1946 study of women workers by the Department of Labor), “the earnings premium for war-related over consumer-related manufacturing was between 25 percent and 45 percent in 1944/45, depending on the war production area” (“Role,” p. 743, fin. 1).

75. Lichtenstein, “Labor,” p. 135.

76. Brinkley, End, p. 56. The “long-haired boys” were also known as “the liberal crowd” and, by association with their patron saint, Felix Frankfurter, “the Harvard crowd.” George Peek called them the “boys with their hair ablaze” (ibid., p. 51).

77. For example, Chester Bowles, among other prominent New Dealers, fought to retain price controls. See Goodwin, “Attitudes,” pp. 90-99; and Lichtenstein, “Labor.” See also Byrd, “Role,” p. 130. As Brinkley has written, the hardcore New Dealers embraced government planning “with almost religious veneration” (End, p. 47).

78. Lacey, “Introduction,” p. 5.


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