This column is a lead commentary in the VoxEU Debate "The Economics of the Second World War: Eighty Years On"
War requires extreme reallocation. Resources must be found and financed. Prices and costs may be overlooked, while markets are disrupted as civilian law gives way to commands from the military, and sometimes from warlords.
How did economics and economists of the 1930s and 1940s contribute to war preparations and the waging of war? Surveys such as Harrison (1998) provide context. Biographies can illuminate individual lives, for example Skidelsky (1983, 1992, 2000) on Keynes, Smethurst (2007) on Takahashi, and Weitz (1997) on Schacht. Bollard (2019) compares and contrasts the contributions of key economists in various belligerent countries.
Paying for the war
In principle, war might be funded in different ways—out of past savings, current taxes, borrowing (abroad or domestically), or through inflation. In 1939, John Maynard Keynes published How to Pay for the War (reprinted in Moggridge 1972: 367-439). He recognised that even in wartime there were choices. The efficiency of war mobilisation and the distribution of burdens on workers, lenders, and future generations would depend on the funding method chosen. The impulse of the UK government at the start of the WWII had been to control markets and ration supply. Keynes turned this on its head, proposing to ration demand by using taxes and compulsory savings.
One of the problems Keynes identified was that wartime spending would overwhelm the normal business cycle and cause over-heating. To this end he helped organise the first major UK National Accounts. He accepted that post-war stabilisation would become a major problem. It was unclear whether there would be a labour shortage or a shortage of demand after the war. He also thought about how to activate the stabilisation tools of fiscal and monetary policy after wartime disruption.
In the Far East, preparations for war had started much earlier. In 1905, Japan had defeated Russia, financed partly by Japan’s first international capital borrowings in Europe. This was followed by intense pressure to fund the Japanese Imperial Army’s expansionist plans. These pressures brought down successive governments in the interwar years.
Japan was cushioned from the worst of the Great Depression by a unique combination of fiscal policy and quantitative easing. But in 1931, the Japanese Army invaded Manchuria and laid out plans for further expansion to secure the key materials necessary for wartime production that Japan was lacking. While the army prepared for a wider invasion of China, civilian ministers led by Minister of Finance Korekiyo Takahashi tried to limit their demands for a larger share of the national budget. But the army and navy chiefs had seats in Cabinet and blocked budgets that did not meet their growing demands for military spending.
It was a critical time for civilian government, with revolving Cabinets, assassinations, and attempted coups. Takahashi struggled against military intransigence. He was criticised and threatened but refused to budge, and, in 1935, he was assassinated by army officers. This marked the end of civilian control in Japan.
In Japan, civilian control over paying for war broke down. It was likewise difficult to effect rational economic policies where military control broke down. This was the chaotic position faced by Chinese economist and Finance Minister H H Kung as the Japanese invaded his homeland. Simultaneously facing conflict with the Japanese, the Chinese Communist Party, and various regional warlords, the Chinese Kuomintang (nationalist) government desperately needed funding for its army.
Where Western macroeconomic principles would not work, Kung took a distinctly Eastern approach. He used connections with the gang leaders of Shanghai to extort salt and cigarette taxes from starving peasants, strong-armed the banks to lend to the Government, nationalised their assets, ran a racket with the country’s silver reserves, printed paper money, and took a slice of the opium trade. As the war continued, he extorted military and financial aid from the US by lobbying, threatening, and promising. This kept the Kuomintang Army going for a decade until its ultimate defeat.
Resources for the war
With its demands on arms production, army mobilisation, and labour force reallocation, war brought a major shock to peacetime allocation and access to resources in all belligerent countries. Supply of strategic resources from food to coal, iron, nonferrous metals, oil, and rubber was key to all the war efforts. Some large countries like the USSR and the US could access key resources from within their own economies. But others like the UK depended on food imports, and Japan on importing essential materials of war.
The Versailles Treaty of 1919 barred Germany from significant rearmament. Despite this, Germany began covertly rearming in the mid-1920s. Secret rearmament accelerated in the early Hitler years. Hjalmar Schacht, the governor of the Reichsbank and minister of the economy, worked on ways to evade trade restrictions and to access key resources through barter deals with ex-colonies and countries in southeast Europe. To pay for this undercover trade, Schacht devised creative financial instruments such as the so-called MEFO bills, issued to armaments suppliers and discountable by banks under direction from the Reichsbank.
Nazi Party chiefs led by Hermann Göring promoted a self-sufficiency programme that Schacht felt would cause serious economic distortion, promoting production without regard to prices or costs. National Socialist ideas of procurement from occupied Europe were equally basic: coal from France and grain and oil from the Soviet Union, extracted by force if necessary. Schacht came into conflict with the Nazi leaders who arrested him in 1944. He was rearrested in 1945 by the Allies and put on trial at Nuremberg, but the court acquitted him of war crimes.
The ally most impacted by WWII was the USSR. Although weakened by the collectivisation of the peasants, the Holodomor famine, and repeated purges, its economy was rearmed and mobilised under centralised control. Stalin was hostile to the idea of constraints and trade-offs and his rule by terror extended to economists: well-known academics like Kondratiev and Feldman had been eliminated. Those who wanted to survive had to be very cautious.
The intensity of Soviet war mobilisation left civilian consumption at or below a bare minimum. The consequences of this approach were addressed by mathematician and economist L V Kantorovich. He researched ways to improve the efficiency of Soviet resource allocation, inventing linear programming in 1941. In wartime he generalised this work in a report The Best Use of Economic Resources (later published as Kantorovich 1965), which pointed to the use of shadow prices to improve sectoral efficiency. Unfortunately, the Soviet ideologues saw such prices as a contravention of the fundamental precepts of Marxist-Leninist economics. As a result, Kantorovich’s work was suppressed until the Khrushchev thaw.
The US, with its huge wealth, resources, industrial structure, freedom from invasion, and late entry to the war, managed its reallocation of resources relatively smoothly. The government used its extensive industrial resources to mass-produce ships, planes, tanks, and other equipment. The war effort was administered by new agencies employing many economists, including Soviet and European emigres.
On leave from Harvard University, Wassily Leontief joined the Office of Strategic Services. His job was to investigate whether the USSR had the resources to hold out against the German invasion. Leontief built an input-output model which used scarce Soviet data to show that the Soviet economy was more robust than had been thought.
Leontief’s input-output provided an economic mapping that the generals could readily understand. The techniques were adapted by another group of Office of Strategic Services economists in London to identify the most vulnerable points of the Axis economies and to direct Allied bombing more effectively. They used input-output mapping to estimate potential damage to the enemy war effort, directing Allied air forces to bomb aircraft factories, marshalling yards and oil plants.
The aftermath of war
World War II created big government, big debt, and big reconstruction needs, all consistent with an increasing role for economists. The tools of macroeconomics, managerial economics, and computing were all born during this time. In the early post-war years, economists grew in numbers and confidence, becoming embedded in official government positions and establishing themselves as the applied professional discipline we see today.
Bollard, A (2019), Economists at war: How a handful of economists helped to win and lose the world wars, 1935-55, Oxford: Oxford University Press (forthcoming).
Harrison, M, ed. (1998), The economics of World War II: Six great powers in international comparison, Cambridge, UK: Cambridge University Press.
Kantorovich, L V (1965), The best use of economic resources, Oxford: Pergamon Press.
Moggridge, D, ed. (1972), Essays in persuasion, The collected writings of John Maynard Keynes, vol. IX, Cambridge, UK: Cambridge University Press.
Skidelsky, R (1983-2000), John Maynard Keynes, vols. 1-3, London: Macmillan.
Smethurst, R J (2007), From foot soldier to finance minister: Takahashi Korekiyo, Japan’s Keynes, Cambridge, US: Harvard University Press.
Weitz, J (1997), Hitler’s banker: Hjalmar Horace Greely Schacht, New York: Little Brown & Co.