World War II and

Its Consequences

“Tomorrow Belongs to Me”

http://www.youtube.com/watch?v=bs5bnVoZK4Q&feature=related

http://www.youtube.com/watch?v=BSoLN77fBn8

UK France Germany Italy Neth. USA

1913 100 100 100 100 100 100

1919 101 75 72 111 112 116

1929 112 134 121 131 177 163

1933 109 123 108 127 164 115

1939 134 139 183 162 195 165

The Great DepressionReal GDP 1913=100

If real growth rate 2% or 3%, then potential GDP was 112 or 119 in 1919

Policy Legacy

• Problems generated by World War I were not successfully resolved.

• Weak system hit by hard multiple shocks.

• 1930s a “lost decade”

• Failure of “laissez-faire,” “gold standard” and “balanced budgets”

• Distrust of free market policies

• Distrust of globalization

Reaction• Socialism and Government Intervention arises in

all countries---UK, France, Germany, Italy, US etc.

• Government control or regulation of industries----prices, entry and production—the end of laissez-faire.

• Deficit spending. Fiscal policy to stimulate the economy. End of balanced budgets.

• Off the Gold Standard. • End of Globalization. World Trade shrinks. End

of Immigration. Capital Controls—ends international capital movements.

The German Phoenix• Hyperinflation• Value of all nominal liabilities and assets wiped

out---savings account to mortgages.• New currency in November 1923: Rentenmark • Germany goes back on gold on a new parity

where $1 = RM 4.2• Strengthened by Dawes loan of US$800 million

to finance Reparations.• Economy Recovery and Growth 1924-1929, • But many impoverished by the war and

hyperinflation, over 1 million war dead and many injured

Germany’s Depression Experience in Perspective

Index of German Real GDP

1913 100

1919 72

1929 121

1933 108

1939 183

The Depression in Germany• Per capita income is

even a bigger drop—over 30%

• Only the U.S. has a depression as severe as Germany but the U.S. had a very prosperous decade of the 1920s and it was a victor not the vanquished in World War I

• Germany has lower p.c income than U.S.

The Depression in Germany

• 1928-1929: U.S. Capital leaves Germany accelerating recession, yet Germany continues to pay reparations.

• 1929: Recession means tax receipts fall, causing a budget deficit

• 1929-1931: To make payments and control the deficit, the government begins a deflationary policy---raises taxes and cuts expenditures.

• To keep capital, especially short-term capital in Germany, Reichsbank has a high discount rate: 7.5% in 1929, though lowered it is higher than U.S., U.K. or France.

• Germany falls deeper into recession.• Election of 1930, Nazis increase seats in Reichstag from

12 to 107.

The Depression in Germany

• 1931 Banking and Currency Crisis. Dilemma: Interest rate changes can’t solve both Germany abandons gold standard and imposes capital controls, but still wants to return to gold. Continues its deflationary policies.

• International Conference 1932 in Lausanne effectively ends reparations for all countries in World War I---relieves Germany of the burden of payment.

• Unemployment reaches 30%• New government tries some limited expansionary

policies—tax credits and government expenditure—little effect.

• 1932 Election, Nazis get 37% of vote and 230 seats.

The Nazi Seizure of

Power

• Second elections of 1932, Nazis share drops to 33% of the vote and 196 seats.

• The conservative government in the Reichstag is a minority government---Hitler is invited into a coalition. The old elites believe that he will be their “drummer boy”

• January 1933, Hitler appointed Chancellor. Old general van Hindenberg remains president, but eventually Hitler assumes the presidency and become in this dual role the Führer.

• Nazis promise a new political and economic regime.

• They obliterate all democratic institutions, the courts, the universities---all are leveled and subservient

The Nazi (National Socialist) Economy

• They abandon globalization entirely. They reinforce capital controls and impose controls on imports and exports. They negotiate when possible trade agreements with countries that prevent the use of any gold or foreign reserves---force other countries—Hungary, Romania, Yugoslavia to run trade deficits=transfer of resources. They head towards autarky within their sphere of influence.

• Unions are destroyed. Wage bargaining is conducted by a government agent. They introduce compulsory labor service in 1935. They use tax incentives and propaganda to convince women to leave the labor force—jobs for men to cut unemployment. Unemployment falls to 12% in 1935 from 30% in 1933

The Nazi (National Socialist) Economy

• The banks are nationalized and Nazi oversight is imposed, investment is directed.

• Government spending rises---the balanced budget is abandoned. Deficit spending is financed by the sales of bonds. Companies are financed by banks—loans at low rates to favored businesses--and the capital market is reserved for government bonds.

• Heavy government spending on housing, roads—the autobanen, automobiles, and the military---which only becomes dominant after 1936

• What was Hitler’s favorite car?

The Volkswagen• The Volkswagen was a

centerpiece of Nazism's claims to benefit ordinary Germans.

• Hitler proposed to build a cheap car that almost anyone could afford. He gave it the name "KdF Wagen," "Kraft durch Freude" (Strength through Joy Car), which we know as the Volkswagen.

• The builder was a subsidiary of the Deutsche Arbeitsfront (German Labor Front).

• Hitler laid the foundation stone for the Volkswagen factory in Wolfsburg in 1938.

• BUT, the price was far too high for the average German, much less the working class even with time payment schemes

Military Build-Up• How was the huge build-up achieved?• Economy had not grown that much• From the income side of GNP:

Y=Wages+Profits+Rents. Wages fall from 64% to 57% of total national income between 1932 and 1938.

• From the product side of GNP: Y=C+I+G Consumption fell from 83% to 59%, with the sum of investment and government spending rising from 18% to 41%.

Persecution of Jews, Opponents and Minorities

• Very costly—driven by ideology

• Huge flight of human capital to U.K. and U.S.

• Distributional effects---some Germans gain jobs, houses or property for cheap---attaches them to the regime.

Mobilizing for War• By 1940, military accounted for 36% of GDP and

rising• Problem in Germany is it is resource

constrained, it lacks many basic raw materials—oil and other goods that were imported.

• Hitler was aware that he would have to defeat the British and the French quickly---the British could rapidly build up, especially if backed by the U.S. The result was a policy of Blitzkrieg---lightening war.

1933-39 1940 1941 1942 1943 1944

U.S. 1.5 1.5 4.5 20 38 42

U.K. 2.5 3.5 6.5 9 11 11

U.S.S.R. 8 5 8.5 12 14 16

Germany 12 6 6 8.5 14 17

Japan 2 1 2 3 4.5 6

Combat Munitions Produced

(in 1944 U.S. munitions prices, billions $)

War Devastation• Costs in human life and resources far exceeds World

War I.• World War I ends in an armistice---World War II ends

with unconditional surrender of the Axis.• But even in countries conquered by Nazis the whole

governmental structure had been leveled and their economies directed at supplying the Nazis.

• Occupied France delivered 37% of its GDP to Germany in 1941 and 1942, and over 50% in 1943----plus 10% of its labor force was sent to work in Germany. Total cost of four years occupation is equal to over 60% of consumption.

• All of continental Europe is prostrate at the end of the war.

The Result of World War II

UK France Germany Italy Neth. USA

1913 100 100 100 100 100 100

1939 134 139 183 162 195 165

1945 155 71 145 92 100 313

Eastern Europe: The Iron Curtain• Stalin desires a postwar buffer area against

Germany.• At Allied Potsdam Conference (1945): Soviet

Union assigned parts of Poland, Finland, Germany and the Balkans for occupation.

• Winston Churchill: Sinews of Peace” speech at Westminster College in Fulton, Missouri: – “From Stettin the Baltic to Trieste in the Adriatic an

"iron curtain" has descended across the Continent. Behind that line lie all the capitals of the ancient states of Central and Eastern Europe. Warsaw, Berlin, Prague, Vienna, Budapest, Belgrade, Bucharest and Sofia; all these famous cities and the populations around them lie in what I must call the Soviet sphere, and all are subject, in one form or another, not only to Soviet influence but to a very high and in some cases increasing measure of control from Moscow.”

Western Europe: Tulip-Soup• Europe 1944-1945---devastated and even famine emerges.• Eastern Europe seized by the Soviet Union• Lack of food and basic raw materials.• Huge trade deficits and huge budget deficits• Danger that it will be financed by money creation

War Legacy—Economic Controls• To finance war effort, governments---both belligerents

and occupied countries--- increasingly used money finance.

• Consequence was inflation.• In reaction price controls were imposed, resulting in

shortages, leading to rationing. Wage controls imposed. Graph?

• Bread, butter, meat, sugar, coffee, gasoline and many other goods were strictly rationed.

• Controls remain in place after the war, governments fear consequences of lifting the controls---result food and goods become scarce. Black market grows

• Production stagnates. Workers decrease labor effort. • Farmers refuse to bring food and livestock to market

where they receive low prices.• In France, Parisians eat yellow bread from corn-meal.

Political Uncertainty

• Victorious allies put coalition governments in place, consisting of all of Nazis opponents from conservative Catholics to Communists.

• These groups cannot agree on policy---economic liberals want decontrol while the left wants a managed economy.

• Continued inflation and end of labor repression---leads to strikes and demands to raise wages. Industries shut down.

• Movement to nationalize industry everywhere—Social Democrats in Germany and Labor Party in the U.K.

• Effect is to reduce investment---people hesitate to make decisions.

How to Solve Economic Crisis?

1. Budgets must be balanced to reduce inflationary pressure

2. Inflation can then be reduced.3. Prices can then be de-controlled, leading

producers to bring their goods to market.4. Wage demands can be moderated to

relax squeeze on firms profits.5. Economy may then grow and incomes

rise

How to Solve Economic Crisis?

• BUT, these changes are not costly.

• Who will bear the cost of balanced the budget—labor or capital?

• Will capital be taxed or labor taxed?

• Result a “war of attrition” each side tries to outwait the other---hope the other will concede.

Solution: The Marshall Plan• Secretary of State George C.

Marshall’ address at the Harvard University Commencement Exercises, June 5, 1947

• Our policy is directed not against any country or doctrine but against hunger, poverty, desperation, and chaos. Its purpose should be the revival of a working economy in the world so as to permit the emergence of political and social conditions in which free institutions can exist.

• The truth of the matter is that Europe's requirements for the next three or four years of foreign food and other essential products -- principally from America -- are so much greater than her present ability to pay that she must have substantial additional help or face economic, social, and political deterioration of a very grave character.

Solution: The Marshall Plan

1947-1951

• U.S. transferred $13 billion to Europe.

• U.S. provided goods to the European governments who sold them on their domestic markets and used the proceeds for their budgetary expenses.

• Equal to 2.5% of countries national incomes

• But it worked to solve the conflicts that had presented a solution to the political-economic stalemate. Substantial addition to budgets.

• U.S. sets “conditionality” aimed at restoring the free market---keep out of Soviet grasp.– Balanced budgets– Stabilize exchange rates– Decontrol prices and discourage

nationalizations.

Solution: The Marshall Plan

• 1920s and 1930s, Europe had divisive labor-management conflicts.

• American authorities disbursing Marshall funds urged unions and governments to focus on raising productivity rather than current compensation and paying out dividends. Press for increased investment.

• In Britain the TUC cooperated with management to moderate wage demands. In the Netherlands and Germany unions allowed wages to lag behind productivity so that industry can gain profits and reinvest them.

The Marshall Plans Results

• Industrial output rose 37% between 1947 and 1951

• Agriculture recovers.

• Exports increase adding to reserves of dollars and gold.

• The European “miracle” begins. Europe begins to make up for the lost years 1914-1945.

The European Miracle1945-1960

UK France Germany Italy Neth. USA

1913 100 100 100 100 100 100

1939 134 139 183 162 195 165

1945 155 71 145 92 100 313

1960 213 239 347 311 381 382