Opinion: Can the Government spend its way out?

By Neville Bennett There is growing unease in the world about massive state spending programs designed to get economic growth going again. There are plenty of reasons to be skeptical. For example, I believe the American one is poorly targeted, and will take too long to have any effect.  Another way of approaching the topic is to ask if massive state spending has worked in the historical past. It is a good question. I have little doubt that a number of post-war downturns responded to an easing of fiscal and monetary policy, but I believe that depressions are different, and not very responsive. I am presently skeptical that Keynesian pump-priming can conquer. The historical record is not too useful because few attempts were made 1929-37 to use budget deficits to get the economy moving. Paradoxically the country that recovered fastest was Great Britain, and it had a balanced budget and low spending throughout the relevant period. There is a branch of economic history that considers counter-factual propositions: one example might be, would economic growth in the nineteenth century have continued without the invention of the steam railway? We are all counter-factualists now because we believe Keynesian policy would have got UK out of depression. But we are guessing. The fact is the UK took a big hit between 1929 and 1931, but it recovered really well without exceptional spending. I use 1937 as a cut off point because the depression was over. The economy then grew rapidly under the stimulus of re-armament. Contrary to most perceptions, the British economy recovered very quickly from a sharp fall in activity 1929-31, but the growth in industrial production 1932-37 is very rapid. It will be noted that Britain suffered less than other western states. I am confident that few people know that British industrial production grew by almost 50% between 1932 and 1937. Here is the data:

Index of industrial production
	1929	1932	1937
Britain	100	84	124
Germany	100	53	117
United States	100	53	103
France	100	72	82

My data may lead some people to say that perhaps industrial production grew in the 1930s, but surely the workers were poor. This is untrue. Workers got increased wages and enjoyed an appreciating standard of living because the cost of living fell. Wages could buy more. We call this improving real wages. This is the data:

Date	Nominal wages	Cost of living	Real wages
1929	98.6	94.9	104.0
1932	94.4	81.1	116.5
1937	103.1	91.0	113.5

The increase of real wages was at the heart of the economic recovery in the 1930s. The reason is readily sketched, the cost of living fell largely because the real cost of imports fell very rapidly, especially food while British exports, although declining a little in price, fell relatively less than imports. Economists call this "improving terms of trade". Wages fell from 1929 to 1932, but their fall was less than prices. The increase in real wages prompted more spending on consumption, even big ticket items like cars and houses. Indeed, a housing construction boom would be one of my chief points of explaining the economic recovery. That boom was in houses built, not like the latest catastrophe which was a boom in nominal value. I will return to housing later. The growing prosperity did not come from rising government expenditure. Government expenditure was less than income every year from 1929-37, except for 1933. Government believed in a balanced budget, and that taxes should go down. While the New Zealand authorities spent heavily on public works to employ out of work people, the British government did not because it thought public works would displace private investment. In any case, most governments in the "˜30s could not stimulate economies very much because their share of GDP was very small in comparison to today. Governments did not interfere very much. So what I am saying is that Government did not get Britain out of the depression ... normal business activity did it. Government helped with its low interest rate policy, low taxes, and vigorously creating trade opportunities. I do not under-estimate unemployment. There was a basic problem after the 1914-1918 war in surplus production in some fields. Demand for coal, for example, fell and production from older fields was uneconomic .The same was true for some textiles. Whole communities in Wales and the North were in dire straits in the 1920s, and the unemployment for the UK in 1929 was 10.4%. It was still at 10.8% in 1937, having hit a brief high of 22% in 1932. Unemployment was high in 1932 partly because demand was falling everywhere, especially in the US which was hard-hit and responded by cutting trade with the world (see my blog about the Smoot-Hawley tariff). New industries were a tremendous help in getting out of the depression. The motor industry took off, so did the use of electric power and masses of appliances. Artificial fibers brought a new textile industry (e.g. women's stockings). Film, mass newspapers and advertising were creating a faster lifestyle and new patterns of consumption. I could give statistics of increased employment in many industries - cars, cycles, artificial silk, aircraft, electric cables and wires etc. - but the point is that the production of cars, fridges, radios, stockings etc. increased sharply in the 1930s. The dynamic part of the economy moved to the midlands and the south, and this helped the huge housing boom in expanding towns and suburbs. About 300,000 houses a year were built in the "˜30s; as many as in the "˜50s when house-building was a national priority. Two features are important: building in the "˜20s was largely by local government (slum clearance) but the "˜30s was private houses typically in suburbs. The boom was fostered by falling prices of materials and labour. A new small working-class home fell from ₤350 to ₤300 1931-3. Many houses were for rent, as institutions were less likely than previously to lend money abroad. My conclusion is that a resilient economy was the reason for Britain's recovery in the depression. Government's role was minor, and it did not increase spending. It does not mean that governments should not now spend money to increase demand because circumstances are different. Moreover, as bad as 1929-31 was, it is still better than some features of 2007-9, especially the financial black hole. Another reason for caution is Japan did better than Britain until the Army shot Takehashi, their brilliant finance minister, who did spend. Perhaps I can write about Takehashi another time. ------------------ *Neville Bennett was a long-time Senior Lecturer in History at the University of Canterbury, where he taught since 1971. His focus is economic history and markets. He is also a columnist for the NBR where a version of this item first appeared.