OPINION

JULY 30, 2011.

World War II Stimulus and the Postwar Boom

The government didn't increase personal consumption—it enforced thrift. And investment is what's needed now, not an election-year pop.

By RICHARD P. RUMELT


Despite two years of fiscal and monetary stimulus, the U.S. economy is sagging. This has renewed the argument over the usefulness of more stimulus, and many of its proponents make an analogy to World War II.


Last month, former Obama adviser Larry Summers put the case this way: "But for Hitler and the military buildup he caused, FDR would have left office in early 1941 a failure, with American unemployment above 15 percent and with the recovery promise of the New Deal shattered." And in 2008, Princeton's Paul Krugman referred to "the enormous public works project known as World War II."


This is received wisdom to many economists and historians, but it skates around key facts of the World War II economy. Chief among them: Government policy didn't stimulate personal consumption, as Keynesian policy makers aim to do today, but rather enforced thrift.


During World War II, there was no investment in civilian infrastructure and the government placed severe restrictions on consumption. That meant significant portions of the massive government spending went toward saving and private debt repayment. Thrift restored personal balance sheets, ultimately setting the stage for the postwar boom.


In 1939, before the U.S. entered the war, about 15% of the work force was unemployed. The war eliminated unemployment by moving 11% of workers into the military, where they were indentured at low pay with little ability to purchase consumer goods. Another 5% were directly employed by the government as military support personnel.


As the military swelled, the civilian work force declined to 53.9 million in 1945 from 55.2 million in 1939. A shrinking civilian work force and surging government demand created wage inflation of about 5% per year. Higher wages, plus about 20% more hours worked, generated a 65% increase in real (inflation adjusted) national disposable income between 1939 and 1945. But, remarkably, total consumer spending did not rise to match these higher incomes. During the 1941-45 war years, over 22% of disposable income was saved.

This high saving rate was driven by fiat. Thanks to wartime rationing, Americans were only allowed to purchase small amounts of sugar, butter, meat, gasoline, tires, shoes, bicycles, processed foods and other goods. Plus, there was virtually no production of new cars, radios, home appliances or housing. In fact, when inflation and increased working hours are taken into account, consumption per hour worked actually declined for the bulk of civilians during the war. Civilian living standards stayed at Depression-era levels.


Americans' wartime savings over 1941-45 were $142 billion, about $1.3 trillion in 2005 dollars. These funds went to pay down consumer credit, buy War Bonds, and bulk up savings accounts. During the war, outstanding consumer credit fell to $5.7 billion from $7.2 billion, a 44% reduction in constant dollars.


Despite higher incomes, household mortgage debt rose only slightly during the war, falling by 17% in real terms. As a consequence, the overhanging debt that had plagued households since the start of the Great Depression was dramatically reduced and household balance sheets markedly improved.


When hostilities ended in 1945, many expected that an expanded civilian work force, plus reduced federal deficits, would bring back the depression of the 1930s. There was indeed a brief recession in 1946, but as production was rededicated to consumers and rationing was lifted, people rushed to replace rusted-out automobiles and broken-down refrigerators. The returning soldiers got jobs, moved to newly constructed housing in the suburbs, and the postwar boom was on. And it was greatly accelerated by households' renewed capacity to take on debt.


Consider the ratio of household debt to disposable income over the decades from 1919 to 2010. Data (from the Federal Reserve Flow of Funds, the Bureau of Economic Analysis and other historical records) show that the debt ratio started a sharp upswing in 1920-22 with the 1920s housing boom and the introduction of consumer financing by auto makers and producers of home appliances, rising to 41% in 1929 from 16% in 1919.


As the economy dipped into recession in 1930, household incomes fell and people made dramatic reductions in spending for consumer goods in order to hold onto their cars and homes. Falling incomes forced the debt/income ratio to a peak of 61% in 1932. By 1940, the ratio had slowly worked its way down to 40%, about where it had been in 1929. Then, with the advent of the war and rationing, the ratio plummeted to 20% by 1944-45, a level not seen since 1924.


Today, households carry a much greater relative debt burden than they did in 1929, largely due to a 25-year mortgage binge. Between 1980 and 2007, disposable income grew at 5.9% per year while household indebtedness grew at 8.7% per year—a clearly unsustainable situation. As in 1939, this hangover of debt blocks new rounds of consumption and dulls the impact of fiscal and monetary stimuli.


If one wanted to replay the economics of World War II (without the war), it would mean high consumption taxes aimed at the middle class, and putting 30 million Americans to work at minimum wage or less. No serious politician could put forward such a plan.


The difficult truth is there is no easy cure for the present hangover. Myopic policies allowed credit to be pushed over its natural limit. Credit expansion shifts consumption from the future to the present, but the future has now arrived. Policies aimed at reigniting the credit-driven consumption boom of the last 25 years won't work.


Instead of looking for a pre-election year pop, it would be wiser to focus on transitioning from credit-driven economic growth to growth that is, once again, driven by new productive investments. The key policy aims should be removing the tangle of tax, policy, regulatory and human-capital impediments to domestic private investment.


Mr. Rumelt, a professor of business at the UCLA Anderson School of Management, is the author of "Good Strategy/Bad Strategy," just out from Crown Books.