It doesn’t get much attention, but one of the most interesting economic experiments in American history occurred right after World War II. Despite warnings of Armageddon from Keynesian economists, government spending was slashed as the United States demobilized from the war.
So how did this experiment is smaller government work? Well, here’s some of what Jeff Jacoby wrote on the subject.
Writing last year in the Cato Policy Report, economists Jason Taylor and Richard Vedder showed that the great post-World War II economic boom was ushered in by the swift rollback of what had been the largest economic “stimulus” in US history. At the time, leading Keynesians cautioned that the abrupt withdrawal of federal dollars would plunge the economy into a new depression. Their warnings were ignored. “Government canceled war contracts, and its spending fell from $84 billion in 1945 to under $30 billion in 1946,” Taylor and Vedder wrote. “By 1947, the government was . . . running a budget surplus of close to 6 percent of GDP. The military released around 10 million Americans back into civilian life. Most economic controls were lifted, and all were gone less than a year after V-J Day. In short, the economy underwent . . . the ‘shock of de-stimulus.'” Fearful predictions of massive unemployment — 14 percent, Business Week said — never materialized. Far from collapsing, “labor markets adjusted quickly and efficiently once they were finally unfettered.” Even with millions of demobilized soldiers re-entering the workforce, “unemployment rates . . . remained under 4.5 percent in the first three postwar years.” Workers who lost government-funded jobs quickly replaced them in the surging private sector. “In fact,” Taylor and Vedder add, “civilian employment grew, on net, by over 4 million between 1945 and 1947 when so many pundits were predicting economic Armageddon. Household consumption, business investment, and net exports all boomed as government spending receded.” America’s postwar experience indicates that vibrant growth is generated not by massive government interference in the economy, but by the reverse. The way to revive a gasping private sector is for government to get out of its way, not to choke it with trillions of dollars in new spending.
Not surprisingly, Reagan understood this issue, as he said in this video. Also, here’s one of my videos, which looks more broadly at the issue of whether government spending is a help or hindrance to economic growth.