At the present moment, when it’s clear that the imminent economic crisis resulting from the Covid-19 pandemic, will need a massive financial intervention by the UK government to avert a catastrophe, a lot of people are worried about how the cost of this will be met. And, what long-term effects that will have.
So, it may be very helpful to think about how these issues were coped with when we last had a financial seismic shock- in 1940, at the start of World War 2. This letter by Tom Griffiths, quoted by Australian Professor of Economics Steven Hail, does that superbly.
“A recent phone-in comment by LBC Radio’s economics correspondent set me thinking, as it led to the usual nonsense over equating Govt. spending with ‘debt’. There were phrases like “UK Govt is paying the salaries of 60% of Brits- even another month will bankrupt us” etc. I thought of a useful parallel which went on immensely longer, and yet the promised bankruptcy never arose.
Shortly after the declaration of war in 1939, Britain ramped itself up into practically the most single-focused economy ever seen in the modern world. Within 2 years, 6 million Brits were paid directly by HMG in the armed forces alone. That is, at least 25% of the adult population. On top of which, a huge percentage of the UK economy was switched to exclusively war materials output. Domestic car, bus and truck manufacturing stopped completely. As did train manufacture. Dockyards concentrated on war vessels or freighters which often had a very short life.
This continued until early 1946: in other words the UK Govt closed huge swathes of private industry, and more or less directly employed over half the UK population for 5 years uninterrupted. Practically nothing of the ‘traditional’ industries worked for anything other than Government money, apart from farms, food industry, shops and a token amount of clothing and domestic items manufacture. For 5 whole years.
According to enthusiasts of the simplistic “household budget” metaphor, this would have left us with a decimated economy, a crushing mountain of ‘debt’ equal to 5 years or more of GDP, and plunged us into a deep and savage depression.
Instead, the only visible debts were a combination of the real ones: the $6.5bn dollars owed to Canada and the USA for provision of food, oil and war materials, and the sum total of war bond redemption costs in £Sterling. The Dollar debts began repayment in 1950, and the total apparent visible debt was only about a third of what the ‘household’ model would have predicted, i.e. about 2-2.5x GDP
The whole 5-year complete takeover by Govt didn’t lead to much inflation, due to rationing and price controls.
As troops were demobilised in a planned way, because the infrastructure of the economy was still in place, although rather battered, output simply started again. Not quite as simple as turning on a tap, but not far off. The promised depression never occurred, probably helped by the stimulus of having to rebuild lots of things, and re-supply our old markets which had been turned off by the almost 100% cessation of international trade. So the answer to the pessimists is: we weathered a similar international hiatus which involved the Govt paying almost everyone, for a full 5 years once, and bounced back. That is (with this current lockdown scheduled to probably last 4 months) an almost exact parallel economic hit, but 15 times greater in magnitude.”
Professor Hail adds: “
We of course think about Keynes’ pamphlet ‘How to Pay for the War’ when thinking about the economics of resource mobilisation. Real resources had to be transferred from production for private markets to production for the Government and for war.
These days, things are very different . As then, the Government isn’t going to run out of pounds, but now, in the absence of significant foreign currency debt and/or a fixed exchange rate, it doesn’t face a purely financial constraint at all. It has a lot more fiscal space.
In the late 1940s, there were US dollar debts and there was a fixed exchange rate system, but as Tom’s message reminds us, the Government was far from bankrupted – indeed, the Welfare State was introduced – and post-war growth naturally reduced the debt/GDP ratio over time too.”