As we commemorated two days ago the 11th of November 1918, I thought it was topical to come back to this assertion and check whether it had solid backing. You may have learnt at school that prosperity followed the World Wars. But first, one thought for the millions who minded their own businesses and had to be called up front or struggled at the back.
Mind the (output) gap
When a war bursts, it changes significantly the way an economy performs: staff is diverted to the front or at the back, industries are forced to produce for the military, etc. It ensures that an economy’s performance will differ from what its potential is, either positively or negatively. We can link it to the concept of output gap, the difference between actual GDP or actual output and potential GDP.
During a conflict, an output gap is created and needs several years to close, even after reconstruction efforts have started in earnest. For instance, analysing the World Wars, I took the data from 12 advanced at the time countries in Europe (Austria, Belgium, Denmark, Finland, France, Germany, Italy, the Netherlands, Norway, Sweden, Switzerland and the United Kingdom) and computed their average GDP growth from 1900 to 1913 (la Belle Epoque): 2.13% annually. Next, I calculated the output gap, had growth been maintained at that pace through both World Wars periods. The results are astonishing.
So when you are told that war is good for the economy, chances are you wait an awful long time to enjoy the benefits… And remember that this is just GDP: externalities such as the value of human lives lost during both conflicts are not reflected directly in GDP. It may have taken more than 51 years to close this theoretical gap.
I ain’t got no money
Another way a conflict imposes big losses is on the savers. To fund the conflict, governments borrow money. Obviously, this money has to be paid back one day. To pay back debts, you have several avenues such as:
- Cut your expenses: relatively impossible in a conflict
- Increase your income: income tax was invented in the UK to fund wars against Napoleon, it was also introduced in the US during the Civil War and in France after WWI. Wars help create new tax – I do not know about you but I do not like like to encourage the creativity of the tax authorities
- Do not pay back: for instance Russia defaulted on its debts in 1917 as it turned Bolshevik
- Print money which as a consequence generates inflation, which crushes savers’ wealth.
Why is that? Foreign lenders will want to be reimbursed in a money that keeps its purchasing power, a hard currency. If the post-war government cannot find the income domestically (i.e. higher taxes), it will create some money to purchase the hard foreign currency which in turn is handed over to the foreign creditor. If this is done in too large proportions, it will trigger a rise in domestic inflation. When this is out of control, it is hyperinflation, such as in Germany in 1922-1925 where cumulative inflation reached 2,500 trillion percent. A trillion is 1,000 billion (see here my explanation on how big a billion is).
Why is this important? Look at the following principle: savings are needed to fund investments. If you agree with it, then as the savers class is slowly eradicated, fewer savings are available to fund investments and growth suffocates.
If it is not great to be the country at war, maybe a better position would be supplier to warring countries or having limited exposure to a conflict? Vernon Ruttan, a US economist, developed in Is War Necessary for Economic Growth? the theory that large scale and long term government expenditures, such as during a war, were necessary for new industries to emerge and productivity leaps to happen. Think how aviation developed during WWI and WWII or how women entered decisively into the workforce.
However, in a 2006 paper, The Impact of the Second World War on U.S. Productivity Growth, Alexander Field from Santa Clara University, suggests the opposite view: “whatever positive shocks may have been associated with progress in the mass production of airframes, ships, penicillin, or munitions/fertilizer were largely counterbalanced by the negative shocks associated with the disruptions to the economy resulting from rapid mobilization and demobilization”. The paper also expands on the fact that the best brains, who did not lose their jobs in the Great Depression, were affected to military production, which slowed down commercially viable research to focus on weaponry. So even for the US, WWII penalised growth.
Peace and wealth
To conclude, it seems to me that some current real-life examples are appropriate. The Institute for Economics and Global Peace, a think tank, published its 2015 Positive peace report where it indicated the countries with very high levels of peace. Unsurprisingly, wealthy countries are in the top 10. And did you notice that most of them have a history of neutrality and relatively small size of their military industry?
I am glad to report that the economy grows the fastest when there is peace and not war.