IX. The post-war reconstruction

(1945 – 1960)

IX.1 The new beginning

Basic framework (1)

Economic

• War damages

• Great Depression experience

Political

• Superpower position of the USA and the USSR, Britain definitely lost its dominance

• Europe: strong influence of socialist movement

Basic framework (2)

Theoretical• Keynesian teaching• Planning– War experience– Technology (linear programming, computers)– Soviet experience

=>General acceptance of interventionist policies

IX.2 Bretton-Woods System

An urgent priority

• Inefficient gold standard – one of possible explanations of Great Depression (see LVI)

• After the collapse of gold standard – floating of major currencies– Lack of any international coordination– Competitive devaluations, – Protectionism→ beggar-thy-neighbor policies → prolonged recession

• WWII – exceptional situation, no international coordination, neither in forex, neither in trade

• Since 1944 - Allied forces started to create a new international monetary system– John Maynard Keynes and Harry Dexter White

Institutions and intentions

• July 1944 - Bretton Woods conference (New Hampshire, USA), result: Articles of Agreement

• 3 essential institutions– International Monetary Fund– World Bank– Organization to promote cooperation in international

trading arrangements

• Basic intentions:– Promote stability of the monetary system– Provide financing for the reconstruction after the war

and to the developing countries– Support the free trade

IX.2.1 IMF: Goals and Tools• Disastrous pre-WWII experience• After WWII, main economic policy goals: full

employment, price stability, external balance with free trade

• B-W system based on a believe that gold exchange standard serves best these goals

• Need for flexibility in case of disequilibria– Countries’ contributions to the pool of financial

resources to provide funding (lending) to countries in need

– There could have been a devaluation, in case of “fundamental disequilibrium”

Articles of Agreement – summary (1)

• New Permanent Institution, IMF, as consulting body, executor of the Articles, lender to countries in case of BoP problems

• Gold exchange standard– Each country establishes a gold price for its currency

(“par value”), keep it within 1 per cent range in the short run

– Currency convertibility for the current account, capital controls for financial account

– Changes of par values (de/revaluations) only with the Fund’s approval and in case of “fundamental disequilibrium”• Unfortunately, never precisely defined

Articles of Agreement – summary (2)

• Temporary imbalances were to be financed from domestic forex reserves (difference from pure gold standard, where those reserves were just monetary gold), in case of more substantial deficits, Fund was prepared to lend to individual countries– Each country contributes to the Fund a certain quota

according its size in the world economy• Symmetry in treating all the currencies, including USD

– Theoretically: possibility to de/revaluate USD– Independent domestic monetary policies (provided they did

not undermine other IMF’s rules)• It was assumed that after transitional period,

currencies will become fully convertible, including the liberalization on financial account

IX.2.2 International Bank for Reconstruction and Development

(“World Bank”)

• Helping to finance investment projects for reconstruction and development– Long-term loan and technical assistance

• Guaranteeing and participating in loans by private investors– Borrower need not be a government, but government must guarantee the

loan, that must finance “productive purposes”, be used for original purposes and the borrower must be able to repay

– Borrower must prove that in the prevailing market conditions, he would be unable to obtain the loan from private sources

• Individual countries’ subscription of capital → shares on total capital stock– 2% paid in gold and USD, 18% in countries’ individual currencies,

remaining 80% subject to call when Bank is required to meet its obligations

IX.2.3 Missing leg – international trade

• At Bretton-Woods, a third institution recommended– Not created at the conference– Preparatory discussions scheduled to start

in 1946– In 1949 – Havana conference: GATT• Some progress• The full-fledged organization – WTO, only in 1994

IX.3 The immediate post-war reality

Difficult years: 1945-1947

• The economic situation of European countries worse than expected

• War damages, lack of resources of any type, adverse weather (namely winter 1946-7)

• Gold and USD reserves depleted• Strong BoP deficits, reflecting huge need for imports

and lack of ability to export– “dollar shortage”

• War financing from USA (like Lend and Lease) or war relief international help (UNRRA) either terminated or insufficient

• Political threats from communism and too many very interventionists politicians in western Europe (F, D, etc.)

Basic principlesNote: What follows is an easy ex-post description, in the post-war

aftermath very few had such a clear view• Liberalization of prices, accompanied by anti-inflationary

policies– In the post-war reality: balanced budgets and removal of excess

money, created by war economics– Extremely difficult given the pressing reconstruction needs

• Balancing budgets→ BoP improvement → chance to import raw materials and

intermediate inputs, even under “dollar shortage” → reduction in public investment → lower growth, unless offset by private investment

• Need for strong trust in market economy– No fear of excessive taxation and nationalization

→ vicious political circle, call for actions that has not been previewed early 1945 and that did not enjoy full support in post-war political reality in Europe

IX.3.1 Marshall Plan• Official title: European Recovery Program

(ERP)• June 5, 1947, US Secretary of State, George

Marshall, speech at Harvard University– Offered aid to any nation, did not specify any

number, any other detail– In reality: directed towards Europe (originally

including USSR), under the condition that recipient countries will be able to organize the rebuilding plan themselves

• Plan rejected by USSR and other countries under its influence

Logistics• US side

– Economic Cooperation Administration (ECA)– US envoy in capital of each country that participated

• European side– Participating countries: A, B, DK, F, D, GB, GR, ICL, IRL, I, L, NL, N, P, S,

CH, TR– Coordinating agency: Organization for European Economic

Cooperation (OEEC)– Acceptance of market economy principles and free trade

• Drawing the money– Each country allocated the funds (money)– OEEC (with local governments) allocated the money to particular

projects, ECA arranged for transfer of goods, US supplier was paid in USD by ERP

– European recipient, including private firms, had to repay back (in local currencies, with delay, in installments, etc.)

– Crucial: repayments in local currency, deposited by governments in so-called counterpart funds – used for financing of further investment projects (Germany – KfW)

• Final repayment: only Germany and only about 1 BUSD (1971)

Basic numbersPeriod: 1948-1951

Total amount: 12,741 MUSD

Appraisal (1)

• Was it “the most unselfish act in the history” or “an act of American imperialism”?– None of those extreme descriptions

• Removal of vicious circle above– Relaxation of external (dollar) constraint– Conditioned the aid on agreeing to decontrol prices

and stabilize exchange rates and budgets– Helped to reduce inflationary pressures

• It contributed to European reconstruction– Was not a panacea, but provided immediate results

Appraisal (2)

• It helped to oppose communism in Europe– Proved to people that market economy can work– Pushed the political equilibrium towards coalition

that respected parliamentary democracy, market economy and rule of law

• Was very beneficial to US exporters and to US economy as such

• Important link to International Monetary System (see next subsection)

• It provided first lessons in European cooperation

IX.3.2 The “Fixed Rate” Dollar Standard

• The immediate post-war reality – asymmetry of international monetary system– Both Europe and Japan – strong demand for dollars– Dollar, being the only convertible currency, quickly became a

dominant, both as a reserve and intervention currency (instead of gold), inflow through Marshall plan

• Shift in the logic of the original B-W system:– US dollar fixed at 35 USD per oz. of gold, FED committed to

keep and trade gold at this price (no foreign exchange intervention by the US)

– ExR rates of other member countries fixed to USD (by implication fixed ExR among all other currencies)

– International reserves of member countries held in USD, USD as a reserve currency, countries (not US) expected to intervene to keep the rates fixed

Consequences (1)

For Europe:• Countries (except US) limited in their monetary

policies (long-term money supply must more or less follow US inflation)

• Adjustment to disequilibria via intervention with international reserves (mainly USD) → need for keeping reasonable level of reserves– To keep reserves → limits of convertibility and of

capital flows• Europe: convertibility only in 1958 and on current account

only (regulation of capital flows)– Limit current account imbalances by adjustment in

fiscal policies

Consequences (2)

US• USD as reserve currency, main task – keeping

the USD price of gold (35 USD per oz.)– No way to de/revaluate USD

• Practice free trade with no BoP or exchange rate target– Accept BoP deficits, if needed

• No capital controls, keep the US capital market open

• Compared to the rest of the world, US monetary policy independent, but provides a nominal anchor for all

Asymmetry – US as a center country

• US never had to intervene– If N countries, N-1 fix their currencies → Nth

currency fixed by definition– Corollary: US did not have to be afraid that in case of

BoP deficit, it will have to sacrifice international reserves to keep fixed ExR

• US was able to use monetary policy actively even when exchange rates are internationally fixed– Advantage: it can “selfishly” use it as a stabilization

tool (e.g. in a Keynesian sense)– Disadvantage: US kept responsibility for world price

level

IX.4 Post-war policies

IX.4.1 Lessons from 1945-1948

• The reform solution, hinted above (IX.3), was made feasible by– Marshall plan– Adjustment of B-W International Monetary Standard (IX.3.2)– Necessary, but not sufficient conditions for fast recovery

• Immediate needs– Investment, namely in sectors: food, coal, steel, transportation– Free trade and larger market (not limited by national

boundaries)• Need to keep international reserves (USD) enough to cover

eventual deficits – link to adjusted B-W system

– Social stability, keeping the political extremism out of parliamentary life and execution (governments)

Four main lessons1. Understanding that Germany must be included into

European economic mainstream2. The core is reform solution above, namely

– Monetary reform (to remove monetary overhang)– Decontrol of prices, abolition of rationing– Fiscal austerity

3. Real wages under control, profits back into investment

4. Keeping the real exchange rate competitive

Looks very simply, but quite difficult to understand (and form a policy) and even more difficult to politically defend

IX.4.2 Policy actions• Systemic reforms, mainly price decontrols

– Most important example – German monetary reform in 1948

– Ludwig Erhard, economist, politician, statesman, 1948-1963 Minister of Economy, later, 1963-1966, German Chancellor, his reform immediately successful

– Other countries – similar actions, albeit with different speed and different success

• European devaluations in 1949– Large range (from 8% in Italy up to 53% in Austria),

increase in competitiveness of European exports

Both steps: drastic measures, but triggered the growth. However, many other accompanying policies in different countries

IX.4.2.1 Coordinated capitalism

• Neocorporatist structures: negotiating bodies of labor (workers), management and governments (Tripartite), main goal:– keep the real wage growths under control– reassure workers that profits will be plugged back into

necessary investments• Institutionalization - different countries various ways:

workers in supervisory boards (D,A), PBO (NL), “Cooperative Body for Increasing Exports and Production” (S), production committees (N), etc.

• Economic incentives to reach Tripartite agreement: tax breaks, social security, unemployment insurance and benefits– Trade-off between wage restrain (workers) and social security

provisions (managers, governments)

Regional cooperation (1)

• Unilateral opening of European economies unfeasible – danger of quick loss of forex reserves

• Access to large (“multi-country”) market• Concentration of resources (human, material,

financial) to sectors with highest priority – again beyond the possibility of a single country

→ all this led to the creation of several crucial regional institutions

Regional cooperation (2)

• Marshall Plan coordination: OEEC– Later, till today, OECD– The “first school” of European bureaucrats

• European Payments Union (EPU)– Funded by Marshall Plan, countries had to accept

liberal policies– Multilateral cancellation of bilateral imbalances– Credits to finance temporary deficits– Mechanisms, forcing the countries to accept

corrective policies– Proved as successful in dealing with Europe’s

reserve crisis in late 1949, via support to BoP of D and NL

Regional cooperation (3)

• European Coal and Steel Community (ECSC)– 1951: F, D, I, NL, B, L (not UK!)– Coordinated the development of coal and

steel industries– The first truly supra-national European

institution, with bodies that resemble today’s EU

– In 1969 merged into EC

Complementing the market

• Apart of many common policies above, there was the crucial coordination question: will market be able to quickly direct the necessary resources into most demanding sectors without the support of the Government?

• Mostly the answer was no and various countries provided solutions in different ways

Nationalizations and state ownership

Nationalizations:• 1945 - UK (also Czechoslovakia), in 1955 A• Confiscations and from pre-war period (F)• By definition (D)Concentration of production/financial conglomerates either

in state hands or under the control of few private groups• France: control of banking system and most important

firms to direct credit to particular sectors• Italy: state-owned holding companies (IRI, ENI) –

preferential credits, if they invest into heavy industries• Spain: copied the Italian example some years later• Sweden: Wallenberg family

Indicative planning (1)

• In the situation immediately after the war, it could have complemented markets– Setting targets, that markets were not quick to achieve– Directing the resources to four most important sectors above

• Later, after 1952, it extended the coverage to many areas that could have been better without state intervention– To increase employment– To ensure conditions for long-term growth– To improve export performance of the country– To develop the infrastructure– To protect domestic industries and help to create strong national

companies– To support certain structure of energy resource utilization (e.g.

nuclear vs. coal)• It had some positive impact in the first years of post-war

reconstruction

Indicative planning (2)

Complements or distorts the markets?• Competition vs. national monopolies• Free trade suffers• Bureaucracy• Price distortions• Financing, budget deficits• Short-term gains vs. long-term lossesThe main problem• Selective, targeted policies: tax relieves,

“cheap” credits, export subsidies, direct subsidies, structured tariffs, etc.

National diversities• Institutional differences – different planning agencies:

– F: Commisariat Général du Plan– NL: Central Planning Bureau– Japan: Economic Planning Agency (EPA) and Ministry for

International Trade and Industry (MITI)• Differences in social, political and cultural aspects:

– D: ordoliberalism– Scandinavian countries: strong feeling of social solidarity from

pre-war years– NL: scientific and mathematical methods of planning– Japan: strong discipline, respect of the authorities– All countries: strong feeling that hard work, saving and

investment is needed → between 1945-1952: common feeling and common approach among different groups of societies

IX.4.2.2 Personalities

• F: Robert Schuman, Jean Monet

• D: Konrad Adenauer, Ludwig Erhard

• B: Paul-Henri Spaak

• I: Alcide de Gasperi

• NL: Jan Tinbergen

IX.5 Conclusions

Note: Full evaluation of the period 1945-1969 will be provided in one of the later Lectures

• 1945-1952: very difficult, extraordinary period, that need extraordinary measures

• Core of the solution: market oriented reforms: monetary reform and price liberalization

• Period of strong state intervention– Probably justified in this short period– Seeds of future problems

• Most countries: extremely fast restart of the economic machine– See data from LI

Literature to Ch. IXOn Bretton-Woods:• Krugman, Obstfeld, Chapter 18, pp. 499-500• Solomon, R., The International Monetary System 1945-

1976. Harper&Row 1977 (excellent survey, based on personal experience, also useful as to Marshall Plan)

General:• Eichengreen, B., The European Economy Since 1945.

Princeton University Press, 2007, Chapters 1-4On different national approaches after WWII:• Gardner, Stephen H., Comparative Economic Systems.

The Dryden Press, 1988Marshall Plan:• Behrman, Greg, The Marshall Plan, Aurum Press Ltd.,

2008