Most of us hope that history will record World War II as the last global armed conflict on this planet, but it is generally conceded that this hope is still far too nebulous to justify discontinuing physical preparation for meeting an attack, and presumably the same policy of preparedness should apply in the economic field. Furthermore, even if we never have the same kind of an emergency again, a study of the experiences and the mistakes in handling the economy in wartime, when many of the normal economic problems are encountered in greatly exaggerated forms, should provide us with some information that will be helpful in application to the less severe manifestations of the same problems in normal life.
In undertaking a brief survey of the effects of large-scale war on the national economy, the first point that should be noted is that no nation has ever been in the position of having anywhere near enough productive capacity in reserve to meet the requirements of a major war. In all cases it has been necessary to divert a very substantial part of the civilian productive capacity to military production in addition to whatever new capacity could be brought into being. We can get a general idea of the magnitude of this diversion during World War II by analyzing the employment statistics, inasmuch as the available evidence indicates that the average productive efficiency in civilian industries during the war period was not substantially different from that of the immediate pre-war years.
There are some gains in productivity under wartime conditions because most producers are operating at full capacity and without the necessity of catering to all of the preferences of the consumers, but these are offset by the deterioration in the quality of the labor available to the civilian industries, the handicaps due to the lack of normal supplies of equipment and repair parts, and the very outstanding change in the attitude of the employees toward any pressure for efficiency. No accurate measurement of the relative productivities is available, but for an approximate value which will serve our present purposes, it should be satisfactory to assume a continuation of the pre-war level of productivity, in which case a comparison based on employment reflects the relative volumes of production.
In 1943, which was the peak year from the standpoint of the percentage of the total national product devoted to war purposes, the total labor force was approximately 60 million, and of this total the Commerce Department estimates that there were 28 million workers engaged on war activities, including war production.138 From the same source we get an estimate that the spending for war purposes in 1943 was approximately 45 percent of the total national product, which agrees with the labor statistics within the margin of accuracy that can be attributed to the two estimates. Subtracting the 28 million workers from the total of 60 million, we find that there were about 32 million workers engaged on the production of civilian goods. Hours of work were somewhat above normal. No exact figures are available, as we cannot distinguish between war work and non-war work in the data at hand, and it is likely that the reported average working hours are heavily weighted by overtime work in the war production industries, but an estimate of ten percent above normal would not be very far out of line. On this basis, the civilian labor force, for purposes of comparison with pre-war figures, was the equivalent of about 35 million full-time workers.
In 1940, before the war, there were 45 million workers employed. The decrease in civilian employment from 1940 to 1943 was 22 percent. We therefore arrive at the conclusion that the production of civilian goods dropped more than 20 percent because of the diversion of effort to war production, in spite of all of the expedients that were employed to expand the labor force. But this does not tell the whole story. In addition to the 45 million workers employed in 1940, there were another 8 million who should have been employed, a relic of the Great Depression that still haunted the economy. If the war had broken out in a time of prosperity (as the next one, if there is a next one, may very well do) the drop in civilian workers would have been from 53 million to an equivalent of 35 million workers, or 34 percent. We thus face the possibility that in the event of another major war we may have to cut the production of civilian goods as much as one third.
The significance of these figures is that there must be a reduction of the standard of living during a major war. A part of the production necessary to feed the war machine can be provided by discontinuing new capital additions and postponing maintenance and replacement of existing facilities. All this was done in World War II. Construction of new houses and manufacture of automobiles, home appliances, and the like, were kept to a bare minimum, while those items in these categories that were already in existence were visibly going down hill throughout the war years. But such expedients are not adequate to offset a 20 percent reduction in the civilian work force, to say nothing of a 35 percent reduction, if that becomes necessary. There must be a general lowering of civilian consumption. The nation’s citizens have to go without the products that would have been produced by the efforts of the 10 to 18 million workers that are diverted to war production.
All this is entirely independent of the methods that are employed in financing the war effort. Today’s wars can be fought only with the ammunition that is available today; no financial juggling can enable us to make any use today of the war material that will not be produced until tomorrow. If our nation, or any other, enters into a major war, then during the war period the citizens of that nation, as a whole, must reduce their standard of living. As the popular saying goes, “It cannot be guns and butter; it must be guns or butter.”
A corollary to this principle is that if any economic group succeeds in maintaining or improving its standard of living during wartime, some other group or the public at large must carry an extra burden. The labor union which demands that its “take-home pay” keep pace with the cost of living is in effect demanding that its members be exempted from the necessity of contributing to the war effort, and that their share of the cost be assessed against someone else. Similarly, the owner of equity capital who is permitted to earn abnormally high profits during the war period because of an inflationary price rise is thereby allowed to transfer his share of the war burden to other segments of the economy. The most serious indictment that can be made of the management of the U.S. economy during World War II is that it allowed some portions of the population to escape the war burden entirely, while others had to carry a double load.
To many of the favored individuals, particularly those engaged on urgent war production, where the pay scales were set high to facilitate the recruitment of labor, and where “cost plus” and other extremely liberal forms of compensation were the order of the day for the employers, the war period was a time of unparalleled prosperity, and there is a widespread tendency on the part of superficial observers to regard this era as one of general prosperity. “Why should it take a major war to lift us out of a depression and into prosperity?” we are often asked by those who share this viewpoint. But surely no one who attempts to look at the situation in its entirety can believe for a minute that the nation as a whole makes economic gains during a major war. Everyone knows full well that war is an extremely expensive undertaking. While we are thus engaged, we do not save, we do not prosper. The conflict not only swallows up all of our surplus production over and above living requirements, but also takes a heavy toll of our accumulated wealth. Even though the United States did not suffer the deliberate destruction by bombing and shelling that was the lot of those nations unfortunate enough to be located in the actual theaters of war, our material wealth decreased drastically.
The so-called “war prosperity” was simply an illusion created by government credit operations, and the discriminatory policies that deal out individual prosperity to some merely increase the cost that has to be met by others. Approximately one third of the “income” received in the later years of the war was nothing but hot air. It had no tangible basis, and it could not be used except when and as it was made good by levying upon the taxpayers for real values to replace the false. The “disposable” personal income in 1943, according to official financial statistics, was 134 billion dollars. But the increase in the national debt during the same period was 58 billion dollars,139 exclusive of the increase in outstanding currency, which is part of the debt, but not included in the statistics. Inasmuch as the income recipients are also the debtors, their true income (aside from the currency transactions and any debt increase in local governmental units) was the difference between these two figures, or 76 billion dollars, not the 134 billion that the individual members of the public thought that they received.
Anyone can understand that the money which he personally borrows from the bank is not part of his income. That which the government borrows on his behalf has no different status. The additional 58 billion dollars of so-called “income” created through credit transactions was purely an illusion, and the addition of this amount to the national income statistics did not increase the ability of the people of the nation to buy goods either in 1943 or at any other time. The only thing that this fictitious, credit-created income did, or can, accomplish is to raise prices.
There is an unfortunate tendency, among economists and laymen alike, to look upon government bonds outstanding in the hands of the public as an asset to the national economy, an accumulation of savings which constitutes a fund of purchasing power available for buying the products of industry. This fallacy was very much in evidence in the forecasts of the economic trends that could be expected after the close of World War II. The National Association of Manufacturers,140 for instance, commented with satisfaction on the large amount of “unused” buying power in the form of government bonds that would be available for the purchase of goods after the war. Alvin Hansen took the same attitude with regard to government obligations in general. “The widespread ownership of the public debt, this vast reserve of liquid assets,” he said, “constitutes a powerful line of defense against any serious recession.”141 But government bonds were not, and are not, “unused buying power,” nor are they a “reserve of liquid assets.” On the contrary they are very much used buying power and they are not assets. In the postwar case cited by Hansen, the buying power which they represent had been used for airplanes, tanks, guns, ships, and all of the other paraphernalia needed to carry on modern warfare, and it could not be used again. All that was left was the promise of the government that in due course it would tax one segment of the public to return this money to another group.
It is nothing short of absurd to treat evidences of national debt as assets. The only assets we have, outside of the land itself, are the goods currently produced and the tangible wealth that has been accumulated out of past production. Government bonds are not wealth; they are merely claims against future production, and the more bonds we have outstanding the more claims there are against the same production. In order to satisfy those claims the workers of the future will have to give up some of the products of their labors and turn them over to the bondholders. There is no magic by which the debt can be settled in any other way. It can, of course, be repudiated, either totally, by a flat refusal to pay, or partially, by causing or permitting inflation of the price level. But if the debt is to be paid, the only way in which the bondholders can realize any value from the bonds, it can only be paid at the expense of the taxpayers and consumers. Regardless of what financial sleight-of-hand tricks are attempted, the day of reckoning can be postponed only so long as the creditors can be persuaded to hold pieces of paper instead of tangible assets. When the showdown comes and they insist on exercising their claims, the goods that they receive must come out of the products that would otherwise be shared by workers and suppliers of capital services. If this diversion is not done through taxes it will be done by inflation. It cannot be avoided.
A little reflection on the financial predicaments in which so many foreign governments now find themselves should be sufficient to demonstrate how ridiculous that viewpoint which regards government bonds as “liquid assets” actually is. These governments are not lacking in printing presses, and if they could create assets simply by putting those presses to work, there would soon be no problems. But all the printing that they can do, whether it be printing bonds or printing money, does not change the economic situation of these nations in the least. Their real income is still measured by their production-nothing else-and their problems result from the fact that this production does not keep pace with their aspirations.
The spending enthusiasts assure us that government debt is of no consequence; that we merely “owe it to ourselves,” but this is loose and dangerous reasoning. It is true that where the debt is held domestically the net balance from the standpoint of the nation as a whole is zero. But this means that we now have nothing, whereas before the “deficit spending” was undertaken we had something real. What has happened is that under cover of this specious doctrine the government has spent our real assets and has replaced them with pieces of paper.
Government borrowing differs greatly from dealings between individuals. When we borrow from each other the total amount of available money purchasing power is not altered in any way; that is, there is no reservoir transaction. All that has taken place is a transfer from one individual to another. No one has increased or decreased his assets by this process. The lender has parted with his money, but he now has some evidence of the loan to take its place, and the net assets shown on his balance sheet remain unchanged in amount. The borrower now has the money, but his books must indicate the debt as a liability.
The borrowing done by the government is not a balanced transaction of this kind. It is a one-sided arrangement in which the participation of the government conceals the true situation on the debit side of the ledger. The net position of the lender appears to be the same as in the case of private credit dealings. His cash on hand has decreased, but he has bonds to take the place of the money. However, as a taxpayer, he now owes a proportionate share, not only of the bonds that he holds but also all other bonds that the government has issued. Any family that has laid away $1000 in bonds believes that they have saved $1000 which will be available for buying goods when they wish to spend the money. But while these savings were being accomplished, the government, on behalf of its citizens, built up a debt of $2000 per capita. A family of four which has saved only $1000 has in reality gone $7000 into the red. The debt will probably be passed on to their heirs, but in the long run someone will have to pay it in one way or another.
The “savings” made during a period of heavy government borrowing are fictitious and they cannot be used unless someone gives up real values to make them good. Either these real values must be taken from the public through the process of taxation, or those who work and earn must share their earnings with the owners of the fictitious values through the process of money inflation. Government borrowing provides the ideal vehicle for those who wish to spend the taxpayers’ money without the victims realizing what is going on.
Another absurd idea that is widely accepted is that the shortages of goods such as those which are caused by the curtailment of production during a major war constitute a favorable economic factor when the war is over and productive facilities are again available for civilian goods. Much stress was laid on the “deferred demand” for goods that was built up during World War II, and in the strange upside down economic thinking of modern times this was looked upon as a favorable factor, one of the “major ingredients of prosperity,” as the National Association of Manufacturers140 characterized it. But the truth is that the deferred demand was simply a measure of the deterioration that had taken place in the material wealth of the nation. There was a deferred demand for automobiles only because our cars had worn out and we were too busy with war production to replace them. If this is an “ingredient of prosperity” then the atomic bombs are capable of administering prosperity in colossal doses. But such contentions are preposterous. We cannot dodge the fact that accumulated wealth always suffers a serious loss during a major war, and the “deferred demand” is a reflection of that loss, not an asset.
While real wealth decreases during the conflict, the government conceals the true situation by creating a fictitious wealth that the individual citizens are unable, for the time being, to distinguish from the real thing. Instead of the automobile which is now worn out and ready for the junk pile, Joe Doakes now possesses war bonds which to him represent the same amount of value, and with which he expects to be able to buy a new car when the proper time arrives. But the value that he attributes to the bonds is only an illusion, a bit of financial trickery, and in reality Doakes will have to pay for his car in taxes or by an inflationary decrease in his purchasing power. Not only was enough of this false wealth created to mask the loss in real wealth during the war, but it was manufactured in quantities sufficient to make high wage scales and extraordinary profits possible while the true economic position of the nation as a whole was growing steadily worse. The extent to which superficial observers were deceived by the financial sleight-of-hand performance is well illustrated in this statement by Stuart Chase:
After Pearl Harbor money came rolling in by the tens of billions, enough of it not only to pay for the war but to keep the standard of living at par. Both guns and butter were financed.142
Perhaps such illusions can be maintained permanently in the minds of some individuals. Chase published these words in 1964, apparently unimpressed by the fact that his dollar was worth less than half of its 1941 value, or by the further fact that nearly 200 billion dollars of the money that “came rolling in” during the war was still hanging over the heads of the taxpayers in the form of outstanding government bonds. Whether all members of the general public realize it or not, the taxpayers ultimately have to pay all of the costs of a war. The holders of government bonds are not satisfied to hoard their bonds as the miser does his gold pieces; they all expect to exchange them for goods sooner or later. Then Joe Doakes must be taxed, either directly through the tax collector, or indirectly through inflation. Financial juggling may postpone the day of reckoning, but that day always arrives.
Clear-thinking observers realize that huge individual holdings of readily negotiable government bonds constitute a serious menace to the national economy, not a source of economic strength. Even before the end of World War II the analysts of the Department of Commerce were beginning to worry about the financial future. Here is their 1944 estimate of the situation:
While the government encountered no major difficulties in raising money needed for the largest military program in history, it left the people with a tremendous fund of liquid assets. Part of this fund is sufficiently volatile to be a distinct inflationary threat at the moment. It may constitute a problem of major magnitude in the immediate postwar period.143
Now let us turn back to the principles developed in the earlier chapters, and see just why large bond and currency holdings are dangerous, why they “constitute a problem of major magnitude.” On analysis of the market relations, it was found that the essential requirement for economic stability is a purchasing power equilibrium: a condition in which the purchasing power reaching the markets is the same as that created by current production. It was further determined that the factor which destroys this balance and causes economic disturbances is the presence of money and credit reservoirs which absorb and release money purchasing power in varying quantities, so that the equilibrium between production and the markets that would otherwise exist is upset first in one direction and then in the other. Naturally, the farther these reservoirs depart from their normal levels the greater the potential for causing trouble. And the outstanding feature of the immediate post-war situation was that the money and credit reservoirs were filled to a level never before approached.
Except when it serves to counterbalance an actual deflationary shortage of money purchasing power, money released from the reservoirs can do no good. It cannot be used for additional purchases. There is no way of producing additional goods for sale without at the same time and by the same act producing more purchasing power. No matter how much we may expand production, the act of production creates all of the purchasing power that is needed to buy the goods that are produced. So the money released from the reservoirs can do nothing but raise prices. Instead of being a “reserve of liquid assets,” as seen by the general public and by Keynesians like Alvin Hansen, the government bonds in the hands of individuals at the end of the war constituted an enormous load of debt. The financial juggling that misled the public-and many of the “experts” as well-into believing that the nation had accumulated a big backlog of assets merely made the adjustment to reality more difficult than it otherwise would have been.
One of the most distressing features of the post-World War II situation is that the policies which brought it about-the policies that led to a severe inflation, that conferred great prosperity on favored individuals while their share of the war burden was shifted to others, that left us with a post-war legacy of debt and other financial problems-were adopted deliberately, and with a reasonably complete knowledge of the consequences that would ensue. H. G. Moulton gives us this report:
Shortly after the United States entered the war, a memorandum on methods of financing the war, subscribed to by a large number of professional economists, was submitted to the government. In brief, it was contended that stability of prices could be maintained if “proper” methods of financing were employed. It was held that if all the money required by the government were raised by taxes on income or from the sale of bonds to individuals who pay for them out of savings, there would be no increase in the supply of money as compared with the supply of goods, and hence no rise in the price level. On the other hand, to the extent that the Treasury borrowed the money required, either from the banks or from individuals who borrow in order to invest in government securities, the resulting increase in the supply of money would inevitably produce a general rise in prices.144
This statement is inaccurate in some respects. It attributes the inflationary price rise to an increase in the supply of money rather than to the true cause: an increase in the money purchasing power available for use in the markets, and it fails to recognize that cost inflation due to wage increases and higher business taxes would raise prices to some extent even if money inflation were avoided, but essentially it was a sound recommendation, and if it had been adopted the post-war inflation problems would have been much less serious. However, as Moulton says, “The policy pursued by the government was in fact quite the opposite.”
It is quite understandable that a government which rests on a shaky base and is doubtful as to the degree of support it would receive from the people of the nation in case the true costs of war were openly revealed should resort to all manner of expedients to conceal the facts and to avoid facing unpleasant realities, even though it is evident that this will merely compound the problems in the long run. Perhaps there are those who are similarly uneasy about the willingness of the American public to stand behind an all-out military effort if they are told the truth about what it will cost, but the record certainly does not justify such doubts. Past experience indicates that they are willing to pay the bill if they concur in the objective.
It is true that, as J. M. Clark put it, there is a tendency toward “an uncompromising determination on the part of powerful groups that “whoever has to endure a shrunken real income, it won't be us,”145 But such intransigent attitudes are primarily results of the policies that were adopted in fear of them. The worker who sees the extravagant manner in which the war spending is carried on, the apparently boundless profits of war-connected business enterprises and the general air of “war prosperity” can hardly be criticized if he, too, wants his take-home pay maintained at a high level. But if the government is willing to face realities, and, instead of creating a false front by financial manipulation, carries out a sound and realistic economic policy that does not conceal the true conditions-one that makes it clear to all that wartime is a time of sacrifice, and will require sacrifices of everyone-there is good reason to believe that most members of the general public, including the industrial workers, would take up their respective burdens without demur.
The first requirement of a realistic wartime economic policy is sound finance. As pointed out earlier in the discussion, the general standard of living must drop when a major portion of a nation’s productive facilities is diverted from the production of civilian goods to war production, and the straightforward way of handling this decrease that must take place in any event is by taxation. However, taxes are always unpopular, and since governments are prone to take the path of least resistance, the general tendency is to call upon other expedients as far as possible and to keep taxes unrealistically low. But this attempt to avoid facing the facts is the very thing that creates most of the wartime and post-war economic problems. The only sound policy is to set the taxes high enough to at least take care of that portion of the cost of the war that has to be met from income.
The other major source from which the sinews of war can be obtained is the utilization of tangible wealth already in existence, either directly, or indirectly by not replacing items worn out in service, thus freeing labor for war production. There are some valid arguments for handling this portion of the cost of the war by means of loans rather than taxes, but in order to keep on a sound economic basis any such borrowing should be done from individuals, not from the banking system. The objective of these policies of heavy taxation and non-inflationary borrowing is to reduce the consumers’ disposable income by the same amount that the government is spending, thus avoiding money inflation. Some cost inflation may, and probably will occur, as there will undoubtedly be some upward readjustment of wages to divert labor into war production, but this should not introduce any serious problems.
Prevention of money inflation will automatically eliminate the “easy profit” situation in civilian business. Profits will remain at normal levels, but they will remain normal only for those who keep their enterprises operating efficiently. They will not come without effort, as is the case when money inflation is under way. There will no doubt continue to be a great deal of waste and inefficiency in the direct war production industries, as it is hard to keep an eye on efficiency when the urgency of the needs is paramount. But, on the whole, this kind of a sound financial program will not only apportion the war burden more equitably, but will also contribute materially toward lightening that burden, since it will eliminate much of the inefficiency that inevitably results when there is no penalty for inefficient operation.
A sound and realistic program of financing the war effort will have the important additional advantage of avoiding public pressure for “price control” measures. If the price level stays constant in wartime, it is clear to the individual consumer that his inability to obtain all of the goods necessary to maintain his pre-war standard of living is due to the heavy taxation necessitated by the military requirements. He can see that he is merely carrying a share of the war burden. But when his take-home pay, the balance after payroll taxes and other deductions, is as large as ever, perhaps even larger than before the war, and he has been led to believe that the cost of the war is being met by the expansion of the nation’s productive facilities-that the management of the war effort by the administration in power is so efficient that the economy can produce both guns and butter-then the inability of maintain his pre-war standard of living is, in his estimation, chargeable to inflated prices. This price rise is not anything that he associates with the conduct of the war. To him it is caused by the activities of speculators, profiteers, and the other popular whipping boys of the economic scene, and he wants something done about it. The usual government answer is some action toward “price control,” often only a gesture; sometimes a sincere and well-intentioned effort.
But however praiseworthy the motives of the “controllers” may be, attempts to hold down the cost of living by price control are futile, and to a large degree aggravate the situation that they are intended to correct. As brought out in the previous discussion, price is an effect-mathematically it is the quotient obtained when we divide the purchasing power entering the markets by the volume of goods-and direct control of the general price level is therefore mathematically impossible. Any attempt at such a control necessarily suffers the fate of all of man’s attempts to accomplish the impossible.
Some prices can be controlled individually, to be sure, but whatever reductions are accomplished in the prices of these items are promptly counterbalanced by increases in the prices of uncontrolled items. The general level of prices is determined by the relation of the purchasing power entering the markets to the volume of goods produced for civilian use, and since the goods volume is essentially fixed in wartime, the only kind of an effective control that can be exercised over the general price level is one which operates through curtailment of the available purchasing power. Even if it were possible to establish prices for all goods, and administer such a complex control system, whatever results might be accomplished would not be due to the price control itself, but to the fact that the excess purchasing power above that required to buy the available goods at the established prices would be, in effect, frozen, as it would have no value for current buying.
Furthermore, price control is not merely a futile waste of time and effort; it actually operates in such a manner as to intensify the problem which brought it into being. The relative market prices of individual items are determined by supply and demand considerations, and if one of these prices shows a tendency to rise preferentially, this means that the demand for this item at the existing price is greater than the supply. If the price is permitted to rise, the higher price results in a decrease in the demand and generally increases the supply of the item, thus reestablishing equilibrium. Holding down the price by means of some kind of an arbitrary control accentuates the demand, which is already too high, and restricts the supply, which is already too low. “Surely no one needs a course in systematic economics,” says Frank Knight, “to teach him that high prices stimulate production and reduce consumption, and vice versa. The obvious consequence is that any enforced price above the free-market level will create a “surplus” and one below it a “shortage,” entailing waste and generating problems more complex that any the measure is supposed to solve.”146
This is another place where the economists have allowed themselves to be governed by emotional reactions rather than by logical consideration of the facts. Samuelson, for example, calls attention to an instance in which the price of sugar was “controlled” at 7 cents per pound, where the market conditions were such that the price might otherwise have gone as high as 20 cents per pound. “This high price,” he tells us, “would have represented a rather heavy “tax' on the poor who could least afford it, and it would only have added fuel to an inflationary spiral in the cost of living, with all sorts of inflationary reactions on workers’ wage demands, and so forth.”147
In analyzing this statement, let us first bear in mind that a high price for sugar does not deprive anyone of the sugar which he actually needs. As all the textbooks tell us, and as we know without being told, the most urgent wants are satisfied preferentially. An increase in the cost of any item therefore results in a reduction in the consumption of the least essential item in the family budget. A rise in the price of sugar thus has no more significance than an increase in the price of that least essential item. Higher prices for any component of a consumer’s purchases reduce the standard of living that he is able to maintain. To the extent that sugar enters into non-essentials, such as candy, the consumption of sugar will be reduced irrespective of where the price rise takes place, but to the extent that sugar is regarded as essential to the diet, the reduction will take place in the consumption of other goods. In view of the severe general inflation that was taking place at the same time, the excessive concern about the possible rise in the price of sugar, a very minor item in the consumer’s expenditures, is rather ridiculous. It is clearly an emotional reaction rather than a sober economic judgment. Whatever “tax” the sugar price increase may have imposed on the poor was simply a part of an immensely greater “tax” due to the general inflation of the price level by reason of government financial policy.
Furthermore, Samuelson, in common with many of his colleagues, apparently takes it for granted that an increase in the price of one commodity will exert an influence that will tend to cause other prices to rise-it will “add fuel to an inflationary spiral,” as he puts it-whereas the fact is that any increase in the price of one commodity reduces the purchasing power available for buying other goods and hence must cause a decrease in some other price or prices. Unless the total available purchasing power is increased in some manner, the average price cannot rise. Of course, under inflationary conditions, the available money purchasing power is being increased, and all prices are moving in the upward direction, but each separate increase absorbs a part of the excess purchasing power; it does not contribute toward further increases. The snowball effect visualized by Samuelson is non-existent. An increase in the price of sugar is an effect, not a cause. When the government draws large quantities of money from the reservoirs and pours it into the purchasing power stream going to the markets, the average price must go up no matter how effectively the prices of sugar and other special items are controlled.
Any rise in the price of an individual item that exceeds the inflationary rise in the general price level is due to a lack of equilibrium between the supply and demand for that item. If the price is arbitrarily fixed at a point below the equilibrium level, this is a bargain price for the consumer, and it increases the already excessive demand, while the already inadequate supply is further reduced, since producers are, in effect, penalized for producing controlled, rather than uncontrolled items.
As an example of what this leads to, the price of men’s standard white shirts was controlled during World War II, whereas non-standard shirts, such as sport shirts, were partially or wholly exempt from control. The result could easily have been foreseen by anyone who took the trouble to analyze the situation. The manufacturers made little or no profit on the production of standard shirts, and therefore held the production to a minimum. During much of the war period they were almost impossible to obtain in the ordinary course of business, and those who wanted shirts had to buy fancy sport shirts, which were available in practically unlimited quantities at much higher prices. The net result was that the consumer, for whose benefit the controls were ostensibly imposed, not only paid a very high price for his shirts, but had to accept something that he did not want. This is not an unusual case; it is the normal way in which price control operates. The controls produce shortages, and the consumers are then forced to pay high prices for unsatisfactory substitutes.
Samuelson makes a comment which reveals some of the thinking that lies behind the seemingly inexplicable advocacy of price control by so many of the economists: the very group who ought to be most aware of its futility. Following his discussion of the sugar illustration and related items, he tells us, “the breakdown of the price mechanism during war gives us a new understanding of its remarkable efficiency in normal times.”148 It is not entirely clear whether it is the abnormal rise in the price of sugar and other scarce commodities that he calls a “breakdown,” or whether it is the general rise in the price level, but in either case he is accusing the price mechanism of breaking down when, in fact, it is doing exactly what it is supposed to do, and what should be done in the best interests of the economy.
When the government is pumping large amounts of credit money into the markets, as it did in World War II, prices must rise enough to absorb the additional money purchasing power. The function of the price mechanism is to cause the necessary price increase to take place and to allocate it among the various goods in accordance with the individual supply and demand situations. The mechanism simply responds automatically to the actions which are taken with respect to the purchasing power flow; it is not a device for holding down the cost of living. In order to prevent a rise in the general price level, if this seems desirable, measures must be taken to draw off the excess money purchasing power and either liquidate it or immobilize it for the time being.
If Samuelson’s diagnosis of a “breakdown” refers to the greater-than-average rise in the prices of certain commodities such as sugar, he is equally wrong in his conclusions, as the price mechanism is doing its job here; it is reducing the demand for these scarce items and increasing the supply. The price rise will force some consumers to reduce their use of these commodities, of course, but when productive facilities are diverted from civilian use to war purposes, the consumers must reduce their standard of living in one way or another. Someone must use less of the scarce items. The truth is that the price system does its job in wartime with the same “remarkable efficiency” as in times of peace It does what has to be done when the results are unwelcome, as well as when they are more to our liking. Samuelson and his colleagues are blaming the price system for results that are due to government financial policies.
Under some circumstances control over the prices of certain individual items is justified as a means of preventing the producers or owners of commodities in short supply from taking undue advantage of the supply situation. Control over the prices of automobile tires during World War II, for example, was entirely in order. But it should be realized that the consumers were not benefitted in any way by the fixing of tire prices. Whatever they saved in the cost of tires simply added to the amount of money purchasing power available for the purchase of the limited amount of other goods allocated to civilian use, and thus raised the prices of these other goods. Price control for the purpose of preventing excessive windfall gains is sound practice, but price control for the purpose of holding down the cost of living is futile.
The contention will no doubt be raised that the savings to the consumer by reason of controlled prices of sugar, tires, etc., will not necessarily be plowed back into the markets. But savings deposited in a bank are loaned to other individuals and spent. Most types of investment involve purchases in some market. Thus savings applied in either of these ways remain in the active purchasing power stream. It is true that the amount which is saved may be applied to the purchase of government bonds, in which case it is removed from the stream flowing to the markets. However, it should be remembered that the only excuse for price control is the existence of a period of economic stress, in which the general standard of living has to be reduced. Under the circumstances it is not likely that any more than a relatively small fraction of the decrease in outlay for the controlled commodities will be applied toward purchase of government securities. We cannot expect the “poor,” to whom Samuelson refers, to buy war bonds with what they save on the cost of sugar. Even in the short run situation, therefore, price control has little effect in reducing the purchasing power flow.
In the long run, any “saving” that is made by purchase of government bonds, hoarding of money, or other input into the money and credit reservoirs, is entirely illusory, so far as the consuming public is concerned. Such “savings” never enable consumers as a whole to buy any additional goods. The so-called saving by accumulation of government credit instruments merely postpones the price rise for a time. The only thing that these savings can do, when and if they are used, is to raise prices.
In general, wartime price control and rationing should be applied in conjunction, if they are used at all. If rationing of a commodity is required, control of the price of that commodity is practically essential, not because this does the consumer any good, as it does not, but to prevent some individuals from getting undeserved windfalls at the expense of producers of other goods. Conversely, if the supply situation is not serious enough to necessitate rationing there is no justification for price control. In fact, the necessity for rationing is all too often a result of scarcities caused by price controls
In the case of non-commodity items, such as rentals, the criterion should be whether or not the normal increase of supply in response to a higher demand is prevented by restrictions on new construction or other government actions, Where the control of prices is justified on this basis, however, the price should never be set below the amount which conforms to the general price level. For example, if the pre-war rental of a house was $300 per month, and the general price level increases 20 percent, the controlled rent should be raised to $360 per month.
Failure to keep pace with inflation is the most common mistake in the administration of rent control. It is, of course, due to the popular misconception that rent control helps to hold down the cost of living, and this futile attempt to evade the realities of wartime economics has some very unfortunate collateral effects. One is that the attempt to prevent the landlords from taking undue advantage of the housing shortage goes to the other extreme and does them a serious injustice. If their rentals are not allowed to share in the inflationary price rise, they are, in effect, being compelled to reduce their rents, as the true value of $300 in pre-war money is reduced to $250 by a 20 percent inflation. Furthermore, when the conflict finally comes to an end, the nation that has adopted rent control is faced with a dilemma. If the controls are lifted and rents suddenly increase to levels consistent with the inflated general average of prices, there will be an outcry from those who have to pay more. Consequently, there will be strong political pressure for maintaining the controls and keeping the rents down. But if the controls are continued, building of new homes for rental purposes will be unprofitable, and the housing shortage that developed during the war will continue.
This was not a very difficult problem in the United States, where the controls during World War II were limited, and where such a large part of the new housing construction is for sale rather than for rent, but it created some serious situations in other countries-France, for instance. In the words of a European observer quoted by Samuelson and Nordhaus, “Nothing is as efficient in destroying a city as rent control-except for bombing.”149 The best way of handling the price situation during a war is to prevent any inflation from occurring, but if some rise in the price level is permitted to take place, as a by-product of the wartime wage policies perhaps, any prices that are controlled should be periodically adjusted to conform to the new general price level.
There is a rather widespread impression that price control did have an effect in holding down the cost of living during the two world wars, but this conclusion is based on a distorted view of the effect that the controlled prices exert on the prices of uncontrolled items. As indicated in the statements quoted in the discussion of the wartime price of sugar, it is widely believed that an increase in some prices tends to cause increases in other prices, and that controls over some prices therefore hold down the general price level. Such a viewpoint is clearly implied in Moulton’s assertion that “the regulating agencies in due course performed a national service of first importance in pegging prices at substantially lower levels.”144 But his own statistics show that during the 13 month period to which he refers, the price level of uncontrolled commodities rose 25 percent.
Furthermore, the inability of the price indexes, upon which the inflation statistics are based, to reflect the kind of indirect cost increases that are so common in wartime, or under other abnormal conditions, is notorious. “This [the B.L.S. Index] does not include or make sufficient allowance for various intangibles, such as forced trading up because of shortages or deterioration of low-priced lines, general lowering of quality of the merchandise, and elimination of many of the conveniences and services connected with its distribution,” say the analysts of the Department of Commerce. The conclusion of these analysts in 1945, at the end of World War II, was that prices for such things as food and clothing, items that account for over half of the consumer budget, were not much different from what they would have been without controls.150
The statistical evidence definitely corroborates the conclusion which we necessarily reach from a consideration of the flow of purchasing power; that is, holding down the prices of specific items simply raises the prices of other goods, while at the same time it introduces economic forces that work directly against the primary objective of the control program. We get nothing tangible in return for putting up with “the absenteeism, the unpenalized inefficiencies, the padded personnel in plants, the upgrading for pricing and downgrading for quality and service, the queues, the bottlenecks, the misdirection of resources, the armies of controllers and regulators and inspectors, associated with suppressed inflation.”.148
The only way in which prices can be held at the equilibrium level (the level established by production costs) is to prevent any excess of money purchasing power from reaching the markets. If price control measures accomplished anything at all toward holding down the general price level during the wars, which is very doubtful, particularly in view of all of the waste and inefficiency that they fostered, this could only have taken place indirectly by inducing consumers to spend less and invest the saving in war bonds or other government securities. Whether or not any such effect was actually generated is hard to determine, but in any event there are obviously more efficient and effective methods of accomplishing this diversion of purchasing power from the markets. Price control for the purpose of holding down the cost of living is a futile and costly economic mistake at any time, whether in war or in peace.