Post-WWII European Exceptionalism: The Economic Dimension
J. Bradford DeLong
(delong@econ.berkeley.edu)
University of California at Berkeley and NBER
September 1997; revised December 1997
I. Introduction
In western Europe from 1945 to 1973 the "mixed economy"--that
social democratic halfway house scorned from the left (as failing to solve
the structural contradictions of capitalism) and the right (as opening the
door to left-wing totalitarianism)-- worked amazingly, remarkably, unbelievably
well. It delivered economic growth at a pace that the world had never before
seen. It produced an after-tax and -transfer distribution of income that
was remarkably egalitarian. It allowed western Europe to pass remarkably
smoothly through the final stage of the structural transformation to industrial
society.
What role did government management of the economy play in creating this
western European exceptionalism? Why were the lessons learned from the Great
Depression and from World War II so appropriate for managing the post-WWII
economy? And why was western European exceptionalism so temporary? Why did
these lessons turn out to be so inappropriate for the post-1973 period?
The short answer is that post-World War II Keynesianism was so successful
because it tapped into a virtuous circle. Trade expansion drove growth,
growth drove social peace, social peace allowed inflation to stay low even
as output expanded rapidly, rapidly expanding output led to high investment,
which further increased growth and created the preconditions for further
expansions of international trade.
Add all these factors up, and find an extra 1.5 to 2.0 percent per year
of productivity growth coming from nothing but the fact that things had
started off on the right foot.
Why, then, did the period of western European exceptionalism end? I am of
the view that it ended because it was assassinated by an odd combination
of oil barons, union leaders, and monetarists. Without the tripling of world
oil prices in 1973 and again in 1979, the pressure to do something to reduce
inflation would have been much weaker. Without strong pressure to do something
to reduce inflation, the alliance between social democratic welfare-state
politicians and union leaders would not have broken down as the first pressured
the second to sacrifice the real wages of union members in support of the
fight against inflation. (Of course, had union leaders been smarter, they
would have recognized that the sacrifice asked of them was small compared
to the consequences of refusal--the shift of political power to the right,
the rise of monetarism, and the disinflation policies of the 1980s which
had much, much more destructive consequences for workers' jobs and wages.)
Once it was plain that the old consensus politicians could not fight inflation
through corporatist dialogue, the new non-consensus politicians won votes
by promising that they would fight inflation through monetary restraint--and
their monetarist economic advisors assured them that any excess unemployment
created by fighting inflation would be transitory and temporary. In the
U.S. the monetarists were right. In Europe monetarists were wrong.
II. The Post-WWII Western European Miracle
A. The Magnitude of the Miracle
That post-World War II economic growth in Western Europe was a miracle
nobody can dispute. The magnitude of the "miracle" is evident
in the graphs of macroeconomic aggregates. In West Germany, France, Italy,
and even Great Britain the level of economic product--GDP--per capita exceeds
the best performance of the interwar period by the early 1950s. By 1960
all are above not just the best interwar performance, but are well above
the levels that would have been predicted by simply extrapolating the pre-1914
trend into the indefinite future.
In West Germany just after reunification, for example, GDP per capita (measured
in 1990 dollars) from the late 1970s through the early 1990s was and remained
some 40 percent higher than even pre-1914 trends would have predicted,
and some seventy percent higher than would have been predicted from the
interwar growth trend. In France GDP per capita settled into a new trend
some 70 percent higher than the pre-1914 trend--and fully 100 percent higher
than the interwar trend.
Italy was even more extreme, with GDP per capita levels settling into a
new trend at double what would have been predicted from simple extrapolation
from before 1914 or from the relatively stagnant interwar period. Even
Britain--Britain which experienced the smallest relative acceleration in
growth after World War II of the four--has today a GDP per capita level
some 20 to 30 percent above the pre-1914 trend, and some 30 to 40 percent
above the interwar trend.
The net result has been to give the average Italian in the early 1990s
a measured material standard of living of some $16,500 dollars of
1990 purchasing power: more than five times the measured material standard
of living on the eve of the Great Depression. For (West) Germany the coefficient
of multiplication is 4.5; for France it is 3.5; and for Britain the coefficient
of multiplication is roughly 3.
All these estimates of economic growth, however, are subject to the biases
that afflict all national statistical agencies, which are not perfect at
the difficult task of capturing the impact on the material standard of
living of the invention of new goods and new types of goods. Walk around
Westwood, and see the people wearing polarized sunglasses, listening through
earphones to portable CD players, wearing shoes with well-cushioned yet
lightweight soles, drinking the products of espresso machines--when did
the increment to material welfare from the ability to make shoes with better
soles, the ability to replace older with polarized sunglasses, or the invention
of the espresso machine or the walkman make it into national income accountants'
calculations of aggregate economic activity?
Odds are that each of these improvements did not. National income accountants
have limited budgets, and very difficult tasks.
So the best guess I can come up with is to copy the belief of Boskin et
al. (1996) belief that unmeasured improvements in productivity stemming
from new goods and new types of goods average perhaps one percent per year
today, extrapolate that estimate to cover all of this century, hypothesize
that unmeasured improvements contributed perhaps half as much in the second
half of the nineteenth century--and that before then they contributed little,
for the wave of pre-1850 innovations were largely in producer, not consumer,
goods.
If correct, then the coefficient of multiplication since 1930 in Italy
is not a factor of 5 but a factor of 10; in (West) Germany not a factor
of 4.5 but a factor of 9; in France not a factor of 3.5 but a factor of
7; for Britain not a factor of 3 but a factor of 6. That is, I think, the
proper measure of the post-World War II western European miracle.
Does this seem too large a coefficient of multiplication? It probably is
if you are one of relatively poor for whom the inventions of the past sixty
years are a smaller part of your consumption bundle, or if you are one
of the very rich for whom the principal benefit of wealth is ordering people
around: "seeing 'em jump." But for those from the lower middle
class on up to the merely rich, it is hard to imagine anyone who does not
view their material welfare as vastly, vastly greater than that of their
counterparts of sixty years ago. Consider modern audiovisual and recording
technologies, antibiotics, information processing, telecommunications,
air travel, not to mention what the Bank of England's Mervyn King once
called America's three contributions to civilization--hot showers, central
heating, and breakfast meetings.
Is there any individual in 1830, or even in 1930, with whom you could trade
material necessaries, conveniences, and luxuries, and count yourself better
off for the exchange?
B.Was the Miracle Inevitable?
From today's perspective it is easy to ignore claims that the western
European growth miracle is something in need of special explanation. Isn't
the "convergence" of western European economies to the approximate
level of national product per capita and the approximate long-run growth
path of the United States a "natural" process? Wasn't it bound
to happen as technology diffuses across national boundaries, as universal
secondary education makes its presence felt, and as governments allow market
forces to direct investment and to weed out uncompetitive firms (see Mankiw,
Romer, and Weil, 1992; Barro and Sala-i-Martin, 1995)?
But there is nothing "natural" about such "convergence"
to North American norms--or, to put it another way, if "convergence"
is "natural" to economists it is "unnatural" to political
economists. There are many forces and factors that could have blocked the
western European growth miracle--and that did block its analogue in many
times and places. The only other places and times that this "natural"
process has been operating with similar strength is in North America during
its 1860-1950 century of industrialization, and in East Asia in the past
two generations. In the world since 1870--in the world since 1945--the
dominant trend is toward divergence, not convergence (see DeLong,
1988; Pritchett, 1997).
Let me expand on this point by sketching out three alternative futures
for western Europe as of 1945--alternatives that might have been
the future, or that informed observers in 1945 thought might well become
the future, but that were vastly different than western Europe's actual
experience of relatively stable democracy, growing welfare states with
diminishing income inequality, and rapid economic growth.
1. Stalin's Dream
The first we might as well call Stalin's dream--the future that
Josef Stalin expected to see in western Europe in the generation after
the end of World War II. For Stalin and his acolytes, all the experience
of the interwar period reinforced the interpretation that Lenin (1916),
drawing from Hobson (1913), had arrived at in trying to understand the
failure of Marx's (1848) predictions of increasing immizeration to come
true in the pre-World War I period. The pre-World War I economies had managed
to avoid the problems of overproduction, insufficient consumption, and
consequent financial crises, deep depressions, and worker immiserization
through imperialism: maintaining employment at home by force-flooding the
rest of the world with exports. But by 1910 there were no new markets to
conquer: imperialist expansion had reached its limits.
Hence, Stalin and his acolytes believed, World War I: the imperialist capitalist
powers resort to armed force so that the victors, at least, can restore
the conditions for imperial expansion and further prosperity. But because
the spoils of empire from defeated Germany, Austria-Hungary, and Turkey
were small, the post-World War I prosperity in the victors was short-lived
and anemic. Moreover, the bourgeoisie in the losing nations became
anxious for a rematch. Hence World War II. World War I had brought their
brand of state socialism to Russia and its dependencies. World War II would
bring their brand of state socialism to the Balkans and to the Elbe.
So to Stalin and his acolytes, the obvious thing to do in the aftermath
of 1945 was to cement state-socialist control over the nations it had one,
and to wait for World War III. The centrally-planned direction of investment
through the replacement of the anarchy of the market by the logic of socialist
development would enable industry in eastern Europe to leap far ahead of
western Europe (see Sweezy, 1942): Krushchev addressing Eisenhower was
confident that he and his "will be there at your funeral." Overproduction
and underconsumption would soon push western Europe, Britain, and the United
States into a new Great Depression. The U.S. would greedily eye the British
and French empires as potential markets to ensure full employment across
the Atlantic. Sooner or later--in 1960 or so--World War III would break
out with the U.S. on the one side and Britain and France on the other.
And in the aftermath of capitalist imperialism's third suicide attempt,
state socialism would advance to the Atlantic, or perhaps further.
2. The Argentine Trajectory
A second live possibility--one feared greatly by staff economists like
Charles Kindleberger (1987) in the U.S. Department of State--was that post-World
War II western European governments would fail: they would either fail
to maintain the high level of aggregate demand urged by Keynes (1936),
or they would fail to allow the market system to do its job in its place.
Call the second of these possible failures the Argentine trajectory.
Had post-World War II western European political economy taken a different
turn, governments might have been slow to dismantle wartime allocation
controls. The late 1940s and early 1950s might have seen the creation in
western Europe of allocative bureaucracies to ration scarce foreign exchange,
and the imposition of price controls on exportables in order to protect
the living standards of urban working classes.
In response to the social and economic upheavals of the Depression, Argentina
in fact adopted such policies: demand stimulation, large-scale income redistribution
to politically powerful organized urban workers, and the use of tight controls
to manage imports, exports, and the trade balance.
Díaz-Alejandro (1970) provides what has become the standard analysis
of Argentina's post-World War II economic stagnation: At the end of World
War II Juan Perón gained mass political support. Taxes were increased,
agricultural marketing boards created, unions supported, urban real wages
boosted, international trade regulated. Perón sought to generate
rapid growth and to twist terms of trade against rural agriculture and
redistribute wealth to urban workers who did not receive their fair share.
The redistribution to urban workers and to firms that had to pay their
newly increased wages required a redistribution away from exporters, agricultural
oligarchs, foreigners, and entrepreneurs.
The Perónist program produced almost half a decade of very rapid
growth. But then agricultural production fell because of the low prices
offered by government marketing agencies to subsidize urban workers. The
rural sector found itself short of fertilizer and tractors. Squeezed between
declining production and rising domestic consumption, Argentinian exports
fell. By the first half of the 1950s the real value of Argentine exports
was only 60 percent of the depressed levels of the late 1930s, and only
40 percent of 1920's levels.
The consequent foreign exchange shortage presented Juan Perón with
only unattractive options. First, he could attempt to balance foreign payments
by devaluing to bring imports and exports back into balance in the long
run and in the short run by borrowing from abroad. But effective devaluation
entailed raising the real price of imported goods, and thus cutting the
living standards of the urban workers who made up his political base.
Moroever, devaluation improves the trade balance only in the long run of
two years or more. In the short run devaulation is effece only if it makes
international speculators willing to bet their money and provide short-term
cpaital inflows--and a resort to foreign funding wouldhave been treason.
Second, he could contract the economy, raising unemployment and reducing
consumption, and expand incentives to produce for export by decontrolling
agricultural prices. Once again, however, this would have cut the living
standards of his political base by creating mass unemployment.
The only live option was to control and ration imports. As Díaz-Alejandro
writes:
First priority was given to raw materials and intermediate goods imports
needed to maintain existing capacity in operation. Machinery and equipment
for new capacity could neither be imported nor produced domestically. A
sharp decrease in the rate of real capital formation in new machinery and
equipment followed. Hostility toward foreign capital, which could have
provided a way out of this difficulty, aggravated the crisis...
Subsequent governments did not reverse these policies: the political
forces that Perón had mobilized had to be appeased, and the economic
interests that lived off of the (few) import licenses or off of the exclusion
of foreign competition grew large and active. Thus post-World War II Argentina
saw a huge rise in the price of capital goods. Given low and fixed agriculture
prices, hence low exports, it was very expensive to sacrifice materials
imports needed to keep industry running in order to import capital goods.
Unable to invest, the Argentine economy stagnated.
In 1929 Argentina was a developed country: its share of the labor force
in industry is intermediate between Germany and Italy--about like France.
Its level of national product per capita is sometimes above, sometimes
below, but always in the same league as France and Germany (and far above
Italy) until the 1950s (see Diaz-Alejandro, 1970). Yet since World War
II Argentina has stagnated. Measured GDP per capita today is some
60 to 70 percent higher than in 1930 or in 1914 (and taking account of
unmeasured improvements in productivity perhaps gives a coefficient of
multiplication of 2.5): Argentinians today have access to enough modern
consumption technology to give them significantly higher material standards
of living than their counterparts of the Belle Epoque. But the gap
between what Argentina's level of material productivity is and what
it so clearly might have been is immense. And the consequences of slow
growth for Argentinian politics have filled the country with sorrow.
Might have Western Europe followed a similar trajectory? Yes. In Díaz-Alejandro's
estimation, four factors set the stage for Argentina's decline: a politically-active
and militant urban industrial working class, economic nationalism, sharp
divisions between traditional elites and poorer strata, and a government
that viewed the price system as a tool for redistributing wealth rather
than for determining the pattern of economic activity.
At the end of World War II western Europe was at least as vulnerable as
Argentina to this populist overregulation trap. The war had given Europe
more experience than Argentina with economic planning and rationing. Militant
urban working classes calling for wealth redistribution voted in such numbers
as to make Communists plausibly part of a permanent ruling political coalition
in France and Italy. Economic nationalism had been nurtured by a decade
and a half of Depression, autarky and war. European political parties had
been divided substantially along economic class lines for a generation.
Ex ante I at least cannot find strong structural factors that would
ensure that western Europe's post-World War II economic trajectory would
keep it in, and Argentina's carry it out, of the First World.
3. The Cross of Gold
"Thou shalt not press down upon the brow of labor this crown of
thorns. Thou shalt not crucify mankind upon a cross of gold." So American
presidential candidate William Jennings Bryan concluded his speech at the
1996 Democratic Party convention. The third alternative is the crucifixion
of the post-World War II European economy upon the cross of gold, in
a manner similar to what happened at the end of World War I.
Such a scenario seems to me at least to be easy to imagine. It requires
only (i) a much earlier end of American loans and grants to Europe, (ii)
the failure of international capital flows from the United States to fill
the gap, and (iii) the control over monetary and fiscal policies in western
Europe then of people with the same views as those who control monetary
and fiscal policies in western Europe now. Such governments respond to
rising prices or to trade deficits by deflation. They respond to trade
surpluses by accumulating gold reserves. The first priority is to maintain
sound finance: a balanced government budget and a firm commitment not to
reduce the gold value of the currency.
Suppose American aid to Europe had come to a sudden and firm end
at the end of 1946. Suppose that private international capital flows had
not started up to cover the gap between western European exports and
imports--after all, American long-term investors in Europe after World
War I had lost a fortune. Suppose that western European countries had applied
policies--mixtures of devaluation and deflation--in order to avoid running
out of foreign exchange reserves. What would have happened then?
Devaluations--no matter how large--would not have helped European countries
balance their international accounts. Devaluation makes exports cheaper,
but it also means that less foreign currency is earned for each commodity
exported. In the long term of more than two years, devaluation will swing
the current account toward surplus. In the short run of less than two years,
devaluation is more likely to increase than reduce a current account deficit.
In the short run deflation is the only way to close a gap between exports
and imports. The average current-account deficit for the big three western
European nations--Italy, Britain, and France--was 3.0 percent of national
product. Since imports [M] are a function of the level of national product
[Y]:
and the current account balance, NX, is equal to the difference between
exports and imports:
If exports are unchanged, the magnitude of the reduction in national product
depends on the size of the increase in imports needed to bring the current
account into balance, and on m', the marginal effect of a reduction in
national product on imports.
Thus an optimistic estimate of the reduction in national product
necessary to close such a gap would be roughly 9 percent, if the marginal
effect of a reduction in national product on imports were equal to one-third--twice
as much as the average propensity to import, and if exports are unaffected
by the policies undertaken to bring trade into balance.
But in fact things are worse, for exports are not unaffected by
the policies undertaken. More than half of European countries' exports
in the immediate aftermath of World War II were to other European countries.
Were Italy to reduce its current account deficit by reducing imports, it
would reduce imports from France--and so boosts France's current account
deficit. European countries' attempts to reduce their trade defiicts reduce
each other's export earnings as well.
Taking account of the size of intra-European trade and the fact that reductions
in national product are an order of magnitude larger than the reductions
in the trade deficit, requiring western Europe to balance its current account
from 1947 on would have imposed a Great Depression-sized interruption on
the course of western European recovery.
Thus I do not undertand eiher of Alan Milward's (1984) two arguments for
the relative insignificance of the Marshall Plan. The claim that the Marshall
Plan merely postponed a necessary adjustment to reality seems to miss the
point: expanding exports and other sources of financing to match imports
was infinitely easier in the early 1950s as a gradual process in the context
of the Korean War boom and the contribution of a U.S. army to western European
defense than it would have been as a sudden shock in 1947.
The claim that countries forced to restrict imports suddenly and substantially
could still have financed imports of essential capital goods begs the question
of how the reduction in other categories of imports was to be achieved:
Was it through overall reductions in demand that would cause mass unemployment?
Or was it through the installation of an apparatus of controls and licenses
that would soon have acquired a powerful native political constituency
and pushed western Europe onto the Argentine trajectory?
Whatever patterns of western European economics and politics would have
emerged from such a Great Depression-sized interruption of post-World War
II recovery, they would not have been the 1950s as they actually were even
if the post-World War II political settlement had survived such a second
Great Depression.
How realistic are these three alternative scenarios? The third is very
realistic: ex ante there were good reasons to think that it might
well happen. Post-World War II and pre-World War II history are littered
with examples of countries that faced substantial current account financing
difficulties, and found their economies in deep recession as a result.
The second in fact happened to Argentina.
The first is not so realistic. I think that it likely captures what Stalin
and his acolytes believed would happen. But the world does not work as
Lenin, or Hobson thought. Imperial markets were not essential to the manenance
of First World prosperity. The U.S. on the one hand and Britain and France
on the other did not come close to military blows over the future of empires,
and over Third World markets. The fulfillment of the first alternative
is a counterfactual of a different nature than the others: it requires
not just different events operating within the historical patterns and
structures of behavior, but different patterns and structures.
Nevertheless, post-World War II reconstruction did proceed amazingly well
in western Europe. The particular combination of institutions and policies
appeared remarkably well tuned to produce rapid economic growth in the
1950s and 1960s. And things could very easily have been otherwise. They
were otherwise in western Europe after World War I, in the southern cone
of Latin America after World War II, or in western Europe after the 1973
oil shock.
III. Components of the European Exceptionalism
So what were the components of the European miracle? What were the
sources of such rapid post-World War II western European growth?
A. Expanding International Trade
A first and important cause of rapid post-World War II growth was expanded
international trade.
Traditionally, western Europe had exported industrial goods to and imported
agricultural goods from Eastern Europe, the Far East, and the Americas.
After World War II there was little prospect of rapidly restoring this
international division of labor. Imports of food and consumer goods for
relief diverted hard currency from purchases of capital goods needed for
long-term reconstruction. Changes in net overseas assets reduced annual
earnings from abroad. The net effect of the inward shift in demand for
exports and the collapse of the net investment position was to give Europe
in 1947-8 only 40 percent of the capacity to import that it had possessed
in 1938.
From this base, the successful export performance of western Europe after
World War II is remarkable. By the end of the 1960s the "openness"
of the main western European economies--the sum of their exports plus their
imports, measured as a share of total national product--was easily twice
that of the interwar average. World War II marked a watershed between an
interwar period in which international trade was a relatively small and
stable share of national product, and a period in which trade underwent
a strong secular increase not only in its absolute volume, but relative
to GDP.
What if this expansion of world trade had not taken place? What if exports
and imports as shares of national product had remained at their (relatively
low) levels of the interwar period?
The puzzle always facing economists trying to understand economic growth
is whether trade causes faster growth or growth causes expanded trade.
The most recent attempt to cut this Gordian knot was undertaken by Jeffrey
Frankel and David Romer (1996). Their conclusion is that each dollar of
expanded imports or exports expands total national product by some thirty-four
cents: expanded exports allow an economy to shift labor into the export
sectors where it is more productive, and to raise consumer welfare and
producer productivity by giving them more power to purchase imports from
low-price consumer and capital goods producers in other countries. Expanded
trade puts more pressure on domestic monopolies to reduce their excess
profits and to become more efficient. Expanded trade allows economies to
more easily and productively soak up technological innovations made elsewhere
in the world.
Frankel and Romer's estimates allow us to assess how much post-World War
II western European growth was aided by the fact that a wide variety of
pressures--from the U.S. government seeking faster European unity to French
politicians eager to weld the German and French economies together so tightly
that neither could ever afford to begin a war again--pushed western European
economies into more open configurations with higher import and export shares
of national product. A little bit less than half a percentage point per
year in post-World War II pre-mid 1970s growth in national product in the
major economies of western Europe can be attributed to increased openness.
B. Market-Conforming Government
Renewed growth required, in addition to financial stability, free play
for market forces. On this issue the Marshall Plan--specifically, the conditions
attached to U.S. aid--left western Europeans with no choice. Each recipient
had to sign a bilateral pact with the United States. Countries had to agree
to balance government budgets, restore internal financial stability, and
stabilize exchange rates at realistic levels. Europe was still committed
to the mixed economy.
But the U.S. insisted that market forces be represented liberally in the
mix: this was the price that the U.S. charged for its aid. The demand that
European governments trust the market came from the highest levels of the
Marshall Plan administration. Dean Acheson (1960) describes the head administrator,
Economic Cooperation Administration chief Paul Hoffman, as an "economic
Savonarola." Acheson describes watching Hoffman "preach his doctrine
of salvation by exports" to British Foreign Secretary Ernest Bevin.
"I have heard it said," wrote Acheson, "that Paul Hoffman
missed his calling: that he should have been an evangelist. Both parts
of the statement miss the mark. He did not miss his calling, and he was
and is an evangelist."
Now this point should not be overstated. The price charged for Marshall
Plan aid was one that western Europeans might well have paid for its own
sake in any event. Support for the market was widespread, although just
how widespread was uncertain. At most U.S. and other pressures tipped the
balance.
Moreover, post-World War II Europe was very, very far from laissez faire.
Government ownership of utilities and heavy industry was substantial. Government
redistributions of income were large. The magnitude of the "safety
nets" and social insurance programs provided by the post-World War
II welfare states were far beyond anything that had been thought possible
before World War I. But these large welfare states were accompanied by
financial stability, and by substantial reliance on market processes for
allocation and exchange.
This bet on the market turned out to be a good one. It is hard to figure
out how much a marginal step away from market and toward centrally-planned
allocations would have harmed post-World War II western European growth.
Perhaps it is simply best to say that this factor was tied up with all
the others: without a market-heavy component of resource allocation under
the mixed economy, it is hard to believe that either expanded trade or
high investment would have been a significant aid to growth.
In 1942 Paul Sweezy (1942) could look forward into a future in which the
centrally-planned Communist-run economies of eastern Europe would grow
much, much faster than the inefficient, wasteful, depression-ridden market
economies still under the whip of the bourgeoisie.
He was wrong.
C. Keynesian Demand Management
The post-World War II era was the era of John Maynard Keynes. But what
does that mean? It means that Keynes's name was a powerful one to conjure
with, because anyone who rejected his intellectual legacy could be accused,
convicted, and immediately hanged as a fool who wished to bring the Great
Depression back.
But how much of a difference did Keynesian policies actually make? Let's
take a look at Keynesian policies--both those adopted for Keynesian reasons,
and those adopted for non-Keynesian reasons but that Keynes would nevertheless
have applauded.
1. Supreme Allied Commander, Europe
As far as western Europe is concerned, the first "Keynesian"
policy was the U.S. government's desire to spend a fortune--and to require
that western European governments spend a fortune as well--on the military
establishment of NATO. For this we should thank Josef Stalin and Kim Il
Sung: the attack on South Korea was an essential step in shifting the American
congress from a post-World War II demobilization mindset to a Cold War
mobilization mindset. Without Stalin's letting Kim Il Sung off the leash
and his attacking South Korea, there was no prospect that congress would
have ever approved the blueprint for the Cold War military that Dean Acheson
(1969) and company had drawn up in NSC-68.
By the mid 1950s, however NATO was in place, just waiting there in case
Stalin's successors were to attempt in Germany what Stalin, Mao, and Kim
Il Sung had attempted in South Korea: the reunification by force of a country
that had been divided in the armistice that ended World War II.
In the mid-1950s Stalin's successors were largely unknown: we today know
vastly more about them than anyone west of the iron curtain knew then.
The only solid thing known about them then was that they had flourished
under Stalin. They had shot one of their own number--Lavrenti Beria--in
the power struggle that followed Stalin's death.
Stalin their master had exhibited a taste for snatching up territory when
he thought it could be taken cheaply--starting with the suppression of
the Mensheviks in Georgia, and including the attack on eastern Poland in
the opening days of World War II, the annexation of Latvia, Lithuania,
and Estonia as well as Moldova in advance of Hitler's attack on Russia.
That western Germany could probably not be snatched up cheaply was not
wholly reassuring. Stalin also exhibited a remarkable amount of
bad judgment: allowing Kim Il Sung to launch the Korean War, the unsuccessful
attack on Finland in 1939, his belief in the early 1930s that social democrats
were the foe of the German Communist Party most worth fighting, and (the
mother of all miscalculations) his decision to deal with Hitler by becoming
his ally in the hope that he could then watch Nazi Germany and the western
democracies exhaust themselves in trench warfare.
Perhaps Stalin's successors would exhibit a similar appetite for conquest
on the cheap, and a similar weak grasp of geopolitical realities.
So by the mid-1950s a full U.S. army--corps, divisions, airwings, and an
enormous logistical tail--was sitting in western Germany as a deterrent.The
U.S. spent lavishly to project its Cold War military power. Net military
transactions amounted to three-quarters of a percent of U.S. national product
in the mid 1950s, and total unilateral transfers to Europe to 1 percent
of America's national product: approximately 3 percent of western European
GDP at that time.
Typical Keynesian analyses would combine this flow of unilateral transfers
with the expanded western European welfare state to conclude that there
simply was no room for anything like a Great Depression in post-World War
II western Europe. The flow of social welfare spending, of American unilateral
transfers, and of European defense spending were amplified by the Keynesian
multiplier to provide a strong base of aggregate demand already reasonably
close to the ceiling of potential output.
In truth the impact of Keynesian doctrines was felt more in what they prevented
than in what they did: they prevented the balance-the-budget at all costs
policies that had proved so harmful during the Great Depression (see Hall,
1989). But to prevent by ideological force even the possibility of something
like Chancellor Bruening's resort to deflation in the early 1930s was an
important achievement.
2. Elastic Supplies of Labor
Keynesian policies, however, were effective only so long as labor markets
were accomodating. So long as increased pressure of demand applied by governments
in response to slowdowns produced additional output and employment rather
than higher wages and hence higher prices, the macroeconomy was stable.
Investment was maintained at high levels, and rapid growth persisted. Should
things change--and should Keynesian policies be blamed for higher inflation
rather than praised for maintaining high employment--then the policy consensus
that supported western European exceptionalism might quickly unravel.
The key to Europe's rapid growth, from this perspective, was its relatively
inflation-resistant labor markets. So long as they accomodated demand pressure
by supplying more labor input rather than demanding higher wages, the other
pieces of the puzzle fell into place. What then accounted for the accomodating
nature of postwar labor markets?
One explanation is that they were not really so accomodating as all that.
Inflation in the first half of the 1950s in France, Italy, Britain, and
West Germany averaged some 4.3% per year--higher than inflation is today
in any of the four countries, and a level of inflation that would cause
today's central banks to worry that policy was too loose, raise interest
rates, and push unemployment back up.
Why didn't central banks in the 1950s worry about inflation that averaged
nearly five percent?
One reason was the so-called Balassa Effect: a rapidly-growing industrializing
economy has a rapidly-rising equilibrium real exchange rate as well, because
the process of industrialization is the process of becoming better at producing
the industrial manufactures that make up the bulk of international trade.
Thus a fixed exchange rate in the 1950s was compatible with a relatively
high inflation rate--an inflation rate several percent per year higher
than the United States. And as long as central banks focused not on internal
balance but on maintaining a fixed exchange rate against the dollar, it
did not strike them that the moderate inflation of the 1950s was anything
to worry about.
The conventional explanation, following Kindleberger (1967), is elastic
supplies of underemployed labor from rural sectors within the advanced
countries and from Europe's southern and eastern fringe. Elastic supplies
of labor disciplined potentially militant labor unions. A problem with
this argument is that the competition of underemployed Italians or Greeks
or Eastern European refugees was hardly felt in the United Kingdom, yet
labor market behavior was transformed in the U.K. as in other countries
after World War II.
But their are other explanations.
Charles Maier's (1987) very convincing explanation is "History."
Memory of high unemployment and strife between the wars served to moderate
labor-market conflict. Conservatives could recall that attempts to roll
back interwar welfare states had led to polarization, destabilizing representative
institutions and setting the stage for fascism. Left-wingers could recall
the other side of the same story. Both could reflect on the stagnation
of the interwar period and blame it on political deadlock.
Certainly any comparison of the magnitude and duration of strikes between
pre-Nazi and post-World War II Germany cannot help but leave the viewer
convinced that industrial relations were completely and fundamentally different
before and after.
Yet another element in the post-World War II supposed success of Keynesianism--policies
to boost production and maintain full employment by managing aggregate
demand--was the fact that Keynesian policies came as a surprise. It
remains possible that the first generation of Keynesian policies are vastly
more effective because they represent a change. Perhaps in subsequent generations
they are likley to generate not faster growth and higher employment but
stagflation--the combination of higher unemployment and higher inflation--as
individuals and businesses learn to foil the effects of a government-induced
boost to the economy by indexing their wages to inflation before the fact.
3. Virtuous Circles
Yet another potential explanation is the Bretton Woods System. Bretton
Woods linked the dollar to gold at $35 an ounce and other currencies to
the dollar. So long as American policy makers' commitment to the Bretton
Woods parity remained firm, limits were placed on the extent of inflationary
policies. So long as European policy makers were loath to devalue against
the dollar, limits were placed on their policies as well. Price expectations
were stabilized. Inflation, where it surfaced, was more likely to be regarded
as transitory. Consequently, increased pressure of demand was less likely
to translate into higher prices instead of higher output, higher employment,
and greater macroeconomic stability.
A final potential explanation is the Marshall Plan. Putting the point in
this way serves to underscore that the Marshall Plan was but one of several
factors contributing to observed outcomes. In principle, the Marshall Plan
could have mattered directly. Marshall Planners sought a labor movement
interested in raising productivity rather than in redistributing income
from rich to poor. With labor peace a potential precondition for substantial
Marshall Plan aid, labor organizations agreed to push for productivity
improvements first and defer redistributions to later. Moreover, money
was channeled to non-Communist labor organizations. European labor movements
split over the question of whether Marshall aid should be welcomed-which
left the Communists on the wrong side, opposed to economic recovery.
All these explanations rely, at some level or other, on virtuous circles.
One way to think about the post-World War II settlement, and the contrast
with the interwar period, is as a coordination problem. Labor, management
and government in Europe could, in effect, choose to try to maximize their
current share of national income-as after World War I. Inflation, strikes,
financial disarray, cyclical instability and productivity problems can
all be seen as corollaries of this equilibrium.
Alternatively, the parties could trade current compensation for faster
long-term growth and higher living standards, even in present-value terms.
Workers would moderate their wage demands, management its demands for profits.
Government agreed to use demand management to maintain employment in return
for wage restraint on the part of unions. Higher investment and faster
productivity growth could ensue, eventually rendering everyone better off.
Such a "social contract" is advantageous only if it is generally
accepted. If workers continued to aggressively press for higher wages,
management had little incentive to plow back profits in return for the
promise of higher future profits. If management failed to plow back profits,
workers had little incentive to moderate current wage demands in return
for higher future productivity and compensation. If labor relations were
conflictual rather than harmonious, productivity would be the casualty.
Once western Europe had shifted onto this "social contract" equilibrium
path--once workers and management began to behave in a mannger consistent
with the superior equilibrium--they had no obvious reason to stop.
D. High Investment
Europe's rapid growth in the 1950's and 1960's was associated with
exceptionally high investment rates. The investment share of GNP was nearly
twice as high as it had been in the last decade before World War II. Accompanying
high rates of investment was rapid growth of productivity. Even in Britain,
the laggard, productivity growth rose sharply between 1924-37 and 1951-73,
from 1 to 2.4 percent per annum.
This high investment share did not, however, reflect unusual investment
behavior during expansion phases of the business cycle. Rather, it reflected
the tendency of investment to collapse during cyclical contractions and
the absence of significant cyclical downturns between 1950 and 1971. High
investment was a consequence of successful Keynesian demand management.
Thus successful performance at managing the business cycle translated into
success at maintaining long-run economic growth. How much success? It depends
on how much you believe that high investment is an important source of
rapid growth in the sophistication and productivity of technologies that
an economy can successfully apply. I believe in the estimates found in
DeLong and Summers (1991): they suggest that a five percentage point reduction
in investment as a share of GDP--a reduction in the average share that
might well have followed from a much more variable cyclical performance--would
have produced an 0.8 percentage point per year in the rate of economic
growth.
IV. The End of the Miracle
Everything went right in western Europe--growth, distribution, price
stability, employment stability--up until 1973. Since things have gone
wrong. If western Europe is "exceptional" today, it is exceptional
in its high and stubborn structural unemployment, and in the strange monomania
with which its central bankers manage economies.
A. False Monetarist Gods
In the late 1960s and early 1970s western European inflation creeped
up from roughly three percent per year to roughly six percent per year,
in part because inflation in the United States had creeped up. It is not
clear why six percent per year inflation would have represented a crisis:
it was little more than the rate of inflation that European governments
had tolerated in the early 1950s, after all.
What changed Europe's political economy and did provoke a crisis was the
explosion in inflation that followed the tripling of world oil prices by
OPEC in the fall of 1973. Governments reacted to a fall in aggregate supply
by trying to boost aggregate demand--and found themselves with inflation
rates in the range of twelve to twenty percent in the mid-1970s and again
at the end of the 1970s, when the Fundamentalist Iranian Revolution again
disrupted world energy markets.
In the wake of these oil shocks and the rise in expectations of future
inflation that the unhingeing of the price level's nominal anchors had
created, governments had a choice of three strategies. The first was drift:
hope that something would turn up to improve the situation. This may have
been the best strategy ex ante, but ex post nothing turned
up to improve the situation. The second strategy was to attempt "corporatism":
ask labor unions to moderate wage increases, and accept falling real wages
for a while as part of the price for restoring overall price stability
and maintaining the high-growth, high-investment, high-employment configuration
in western Europe.
The third strategy was to hit the economy on the head with a brick: turn
over macroeconomic management to central bankers, give central bankers
the independence to make their own decisions, and tell them to make fighting
inflation their first, last, and only priority.
The "corporatist" strategy failed. Some union leaders could not
hold their members to the corporatist bargains that union leaders had agreed
to. Some union leaders found themselves outflanked in union politics by
challengers who denounced those who had comfortably gotten into bed with
the politicians. Some union leaders did not think that high inflation was
their problem or that their country's social democrats were their party.
In this they were wrong. Consensus politicians generally got one or at
most two chances to bring inflation under control by corporatist agreement.
After their one or two chances had expired, voters angry at inflation would
vote the other guys in--and the other guys would go the central-banker
route. Few union leaders in the 1970s understood how damaging the high-unemployment
central bank-launched disinflations of the 1980s were going to be to their
constituents and their organizations.
By 1985 there were many ex-union leaders and many ex-union members who
wished that they had been more willing to cooperate with consensus social
democratic politicians in the 1970s.
As inflation remained high in the late 1970s, left-wing economists hastened
to assure voters that inflation was just a redistribution and not a very
painful one. In the United States Alan Blinder (1986) compared inflation
to a head cold--and the provoking of a recession to "cure" inflation
the equivalent of submitting to a lobotomy to try to cure a head cold.
Left-wing economiests were ignored by voters. Faced with a disease--inflation--that
the consensus social democratic politicians could not cure, voters and
politicians looked for another solution, and the monetarists were there
to offer one.
In country after country, consensus social democratic politicians were
replaced by those who would or themselves handed over power to manage the
macroeconomy to central bankers whose views could be described as "monetarist"--not
necessarily in the sense that they believed that chartist-like tracking
of M1 was the answer, but in the sense that they believed that if
the central bank focused on reducing inflation then the rest of the economy
would take care of itself.
And, indeed, the politicians and central bankers were assured by monetarist
economists that a shift toward an anti-inflation policy would lead at the
most to a few years of temporarily high unemployment. The monetarist belief
was that business cycles are fluctuations around (not shortfalls below)
a business cycle-free long run growth path. Fight inflation, the monetarists
told the central bankers, and in a few years you will have the best of
both worlds: low inflation and low unemployment. In the long run,
Friedman (1968) assured everyone, the average rate of unemployment would
be the "natural" rate of unemployment no matter what the rate
of inflation was--so there was ultimately no cost to handing control of
economic policy over to the inflation-fighters.
As far as the United States is concerned, it appears that the monetarists
told the truth.
As far as Europe is concerned, it appears that the monetarists lied. Unemployment
in Europe began to rise in the mid-1970s, and is now more than four times
what it was at the start of that decade. There has been no sign of any
"natural" rate toward which unemployment tends to return.
B. The Exclusion of the Unemployed
And as unemployment in Europe rose and remained high in the 1980s,
it became more and more clear that no one--or, rather, no one powerful
in the political nation--really cared.
There is a sense in which the European Union today has high unemployment
because, in Daniel Cohen's words, "the war on unemployment is in the
hands of governments which represent first and foremost the point of view
of the people who have jobs and fear losing them." As a result, unemployment
has been feared less than the remedies that would have been necessary to
contain it.
One possible road that western Europe might have taken in response to the
stubborn persistence of unemployment would have been to try to construct
in Europe the conditions that made the monetarist promise--that unemployment
produced by fighting inflation would be temporary--true in the United States.
European governments could have attempted to increase the amount of "churning"
in the labor market by increasing speed with which those who seek jobs
find them: forcing those who have jobs o compete with those who do not.
The distributional consequences of following this "American strategy"
are unpleasant. One consequence is great insecurity on the part of the
employed, and a shift in power in labor-management relations back toward
management. A further consequence is the steady downward pressure on wages
from the potential competition of the unemployed, downward pressure that
has led to a vast widening of income inequality in th United States.
A second road to cure European unemployment would have been to try to boost
public employment, and to spend large sums of money on reentry programs
for the jobless--training subsidies, job search assistance, and much higher
subsidies to employers for hiring the unemployed. But these costly reentry
programs must be paid for by higher taxation. The fear has been either
that higher taxation will slow economic growth, or that programs for the
unemployed will crowd out other social benefits.
The European Union has remained stuck in the middle. It has rejected the
first strategy. It has not tried the second. The U.S. provides a somewhat
positive example of the first strategy. There is no successful example
of the second: it is not clear that it is even possible.
V. Conclusion
Had European political economy taken a different turn, post-World War
II European recovery might have been hobbled by clumsy allocative bureaucracies
that rationed scarce foreign exchange and placed ceiling prices on exportables
to protect the consumption of urban working classes. Yet post-World War
II western Europe saw a rapid dismantling of controls over product and
factor markets, and the restoration of price and exchange rate stability.
To some degree this came about because underlying political-economic conditions
were favorable (and no one in Europe wanted a repeat of interwar experience).
To some degree it came about because the governments in power believed
that the "mixed economies" they were building should have a strong
pro-market orientation. To some degree it came about as a result of a Marshall
Plan that gave post-World War II European politicians a little bit of extra
room to maneuver, in order to carry out their intentions:. Without such
aid, they would likely have faced a harsh choice in the late 1940s between
contraction to balance their international payments and severe controls
on admissible imports.
For budgets to be balanced and inflation to be halted in post-World War
II western Europe, political compromise was required. Consumers had to
accept higher posted prices for foodstuffs and necessities. Workers had
to moderate their demands for higher wages. Owners had to moderate demands
for profits. Taxpayers had to shoulder additional liabilities. Recipients
of social services had to accept limits on safety nets. Rentiers had to
accept that the war had destroyed their wealth. There had to be broad agreement
on a "fair" distribution of income, or at least on a distribution
of the burdens that was not so unfair as to be intolerable. Such agreement
was easier to reach the larger the size of the pie available for division
among interest groups. Thus at first aid and then rapid economic growth
made virtuous circles very possible.
What about Europe today, which is far from exceptional? We cannot but believe
that the differences that separate the slowly-growing, unemployment-ridden
western Europe of today from the western Europe of the Great Keynesian
Boom must be small. Not much changed, and yet we wandered from there to
here. Perhaps we can change a little bit back, and go back from here to
there?
Perhaps. Perhaps not. In any event, poliices of continued fiscal contraction
in order to meet abstract requirements for future monetary union seem,
at least to those of us on this side of the Atlantic, completely beside
the point. They do not provide firms and workers with stronger incentives
to make and find jobs either through government subsidy or through market
opportunity. Since either tacking right or left appears unacceptably risky,
the decision of European governments has been to stay in the middle and
hope that monetary union will lead something positive to turn up. But it
appears more likely that, as Molly Ivins says, there is nothing in the
middle but yellow lines and dead armadillos.
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Created 9/15/1997
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