Trade in the Ruins (Wonkish)

On misunderstanding the postwar boom

I got a lot of comments in response to my post about the postwar boom, which conservative ideology says couldn’t have happened. I appreciate that — feedback is valuable in this new venture of mine, and so far there have been very few trolls on this platform. (PS: I’m mostly not accepting direct messages — with >70K subscribers already, DMs would quickly become overwhelming.)

Many of the commenters suggested that America’s postwar boom was the result of the war, specifically the fact that America’s main competitors had been reduced to rubble. That story sounds plausible. But I can’t think of any serious economist who believes it. And I thought it might be worth explaining why destruction of other economies doesn’t work as an explanation of our success.

This is actually a very old discussion, dating back precisely to that postwar period when much of Europe had been reduced to rubble. Some Europeans worried that America had emerged with an economic advantage so large that their nations would never be able to compete with us. The British economist John Hicks formalized these concerns with an analysis of what he called the long run dollar problem, which focused on the effects of technological progress in one country on the real incomes of its trading partners.

Hicks’s analysis and the elaborations that followed showed that economic growth abroad can hurt your nation, and conversely that economic retrogression in other nations — say, the result of bombing their industrial bases — can make you richer. But that’s not a foregone conclusion; the effect can go either way, because while foreign economies are competitors, they’re also markets for your products. When they grow, which effect predominates: the increase in competition or the expanded market? It depends.

Specifically, it depends on the bias of foreign growth, whether it’s tilted toward goods you export or goods you import. But let me not wear out my readers by elaborating.

For one thing that’s clear from all of this analysis is that reducing your trading partners to rubble definitely makes you poorer, not richer. Why? Because there are gains from international trade, and you can’t achieve these gains if you effectively have nobody to trade with.

The truth is that America did very little foreign trade during the postwar boom; exports were only 4 percent of GDP in the Eisenhower years, and a lot of that was sales to Canada and Mexico:

So if your explanation of the postwar boom is that America could sell lots of stuff on world markets because we’d wiped out our competitors, you have a problem: we actually weren’t selling much on world markets. Certainly not enough to explain why living standards doubled in a generation.

All too often, I fear, the argument that we got rich because we had no competitors is an attempt to avoid admitting that an economy could prosper with high taxes on the rich and unions that gave workers a lot of bargaining power. Oh, and did I mention low overall income inequality?

What went right? Nobody really knows, but the best guess is that in the relative stability of the postwar environment businesses were able to fully exploit already existing technologies like electrification and the internal combustion engine. The key point is that the pro-labor, redistributive policies of the post-New-Deal era don’t appear to have gotten in the way of that success.

And if your ideology says that couldn’t have happened, you should reconsider your ideology.