“We need a good war to kick start the economy”

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.

Remembrance Day Poppies

Remembering WWI

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.

Simulating the output gap had World Wars not happened and la Belle Epoque continued.

Simulating the output gap had World Wars not happened and la Belle Epoque continued.

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:

  1. Cut your expenses: relatively impossible in a conflict
  2. 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
  3. Do not pay back: for instance Russia defaulted on its debts in 1917 as it turned Bolshevik
  4. 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).

German hyperinflation

Not very comfortable to sleep on if this is under your mattress

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.

Academics’ war
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.

Career dilemma: should you fit the job or the job fit you?

Career dilemma: should you fit the job or the job fit you?

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.

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2 thoughts on ““We need a good war to kick start the economy”

  1. Hello, I agree with most of your thoughts and especially the conclusion. But, there is a little bias in your statistics. Without falling in an excess of cliometrics, you start from GDP before WWI and calculate the time to recover the gap. As you mentioned, between the 2 dates there was WWII and 29 crisis, not a detail!
    I would be interested in knowing the time to recover if you consider as a start : 1928 GDP (and the average gross between 1918 and 1928) or 1939. It is true, because of WWI, there were at this time already very different situations (UK, F, US vs G for example) and of course, you will have huge differencies in GDP gross after WWII (Wirtschaftwunder), but I guess that for all these countries the output gap was not bridged in 1996 but years before!
    Wars (from an economical point of view) may not be good for the GDP but they do accelerate progress (even if it is only military oriented at the beginning) which is good at the end.

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    • Dear Guillaume, thank you for your suggestions.
      If you use the 1928 start and uses the growth of the 1918-1928 years (3.02% pa), then, assuming no 1929 crisis and no WWII, the gap would never have been plugged. This is because the loss of output in the crisis of 1929, the WWII and the economic slow-down from 1973 would not have been compensated by the 1946-1973 years.
      If you start in 1938, the gap will have been cleared in 1982, 44 years later.
      If you start in 1939, the gap would have cleared in 1981, 42 years later. This is explained by the the high GDP growth of 1939 as many countries re-armed ahead of WWII.

      So overall, the conclusion remains: wars lower output so much that many years are needed to come back to normal levels.

      As for wars accelerating progress, I am firmly in the camp that they do not but there is clearly no 100% answer.

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