One of the first things you learn in econ class is that there is no free lunch. If you want more than one thing, you have to do less of another. More guns, less butter. It is based on the assumption that the economy usually operates near its “production possibility limit”, beyond which it cannot go.
Mike Konzal and JW Mason of the liberal Roosevelt Institute challenged that idea in a Guest essay in the New York Times last week, using World War II as an example. We are taught that Americans had to tighten their belts to free up resources for war in World War II, “but in reality, on an aggregate level, there was no decline in domestic consumption during the war years,” he wrote. .
The lesson they take is that America doesn’t have to settle for unpleasant tradeoffs because the economy is far from the hypothetical production possibility limit that most people think. Don’t be too quick to apply the brakes when the economy starts to roar, he argues. “To pull off a roaring 2020, we must be prepared to manage a surge, not fight it.”
Wait, though. Could his World War II story be true? What about the stagnation in automobile production during the war years? What about rationing meat, gasoline, sugar, etc.? Backyard Victory Garden that was planted by people to provide extra food for soldiers?
I decided to go and take a look at the data. Certainly, this chart shows that personal consumption expenditure increased every year during the war years, but by one—in 1942.
It is true that there has been a huge increase in government consumption and investment. Business investment declined to make room for it, but consumer spending continued to rise – and then, of course, exploded after the war ended. This chart shows how various components of GDP have changed since the recession year of 1938, when the economy was operating well within its production potential limits.
To be sure, there is truth to the conventional wisdom that people tightened their belts during the war. Price Fischbach, professor of economics at the University of Arizona, wrote in a A 2019 essay for the Center for Economic Policy Research’s website VoxEU.org, “Military spending in the context of a quasi-command economy crowds out private consumption and investment and forces people into the military. In short, Americans win the war.” while his allies made even greater sacrifices.”
Fischbach writes that the official data “does not account for a decline in the quality of goods, the additional cost of obtaining rationed goods and the complete absence of other goods. Adjusted, the amount consumed per capita was lower throughout the war than in 1940 when the economy was still emerging out of the Great Depression.”
Fischbach writes that even on the home front, he worked long and hard. “Night shifts became more common and workplace injury rates increased.” Those effects don’t show up in the consumption data.
Still, Konkzal and Mason have a point. Americans can improve their game if need be. Payroll employment in the US in May was still down from 8 million in February 2020. This is clear evidence that the US economy is still operating below capacity—and it would be a mistake to fall back on growth with higher interest rates now.