ment and Government in Twentieth-Century America, publishedrnby Holmes & Meier for the Oakland-based hidependentrnhistitute, the postwar resumption of the Great Depressionrnnever came. Unemployment, widely projected to reach doublerndigits, only reached an annual rate of 3.9 percent in 1946,rnlower than the long-run average rate of unemployment inrnAmerican economic history, before or since.rnAmerica went, virtually overnight, from having an extraordinarilyrnexpansionary fiscal policy, with a budget deficit equalrnto about 20 percent of the national output, to the most contractionaryrnfiscal policy in modern American economic history,rnwith a substantial budget surplus, hi relation to today’srneconomy, it was equivalent to going from a budget deficit ofrnwell over one trillion dollars to a budget surplus of over S200rnbillion—in one year. The federal government spending componentrnof gross domestic product fell 46 percent in 1946—andrnthat ignores inflation. At the same time, the creation of moneyrnalso slowed substantially.rnHow did it happen? How was the American economy ablernto absorb millions of returning veterans and munitionrnplant employees without major retraining programs, fiscal interventions,rnor the like? How was the nation able to absorb arnsignificant reported decline in real output without massivernjoblessness? The answer is simple: the invisible hand of the laborrnmarket worked, loyvcring the price of labor (what we morerntechnically term the adjusted real wage) so that hiring civilianrnworkers was profitable for employers. Aiding the transitionrnprocess was the removal of tight wartime wage and price controlsrnthat had stifled the operations of free markets.rnOne of the least well-known lessons in American economicrnhistory is that the market mechanism solves problems ofrnunemployment and depressed output and that governmentrninterventions designed to solve those problems typically add tornrather than alleviate them. The best example is the GreatrnDepression. A well-meaning but economically ignorant HerbertrnI loover thought economic depression could be averted byrnpaying workers high yvages, increasing purchasing power andrnthus the demand for goods. Hoover’s high-wage policy, followedrnscrupulously by an American business establishmentrnthat revered him, in effect priced labor out of the market,rnpreventing the falling wages that could and would have endedrnthe downturn that began in the fall of 1929. After 193?, thernDepression was needlessly prolonged when Franklin Roosevelt’srnNew Deal similarly pushed wages up by such legislation asrnthe National hidustrial Recovery Act and the \4igner Act,rnthereby keeping unemployment rates in the double digits untilrn1940, far longer than in any other major nrdustrial nation.rnMore recently, the 1990 recession began when wage increases,rnwhich had been about 4 percent a year includingrnfringe benefits in the late 1980’s, spurted to an extraordinaryrn9.2 percent in the second quarter of that year. Again, governmentrnpolicies were largely responsible. On the very first date ofrnthat quarter, the federal minimum wage increased more thanrn13 percent, raising wages for millions of lower-skilled workersrnand pricing some of them out of the market.rnReturning to the postwar demobilization, unemploymentrnwas partly averted bv the voluntary withdrawal from the laborrnforce of millions of women who returned to the role ofrnhomcmaker and also of a smaller number of men who hadrninvoluntarily scr’ed in the labor force as draftees but who nowrnreturned home to become students. At the same time, realrnwages (money wages corrected for the effects of inflation onrnpurchasing power) declined somewhat, as the removal of controlsrnallowed prices to reach levels dictated by the laws of supplyrnand demand.rnBefore the postwar transition began, Keynesian economistsrnwere worried that the fall in demand (government spending)rnassociated with the war’s end would cause a renewal of thernGreat Depression. When that did not happen they quickly inventedrna new explanation for the smoothness of the transition:rn”pent-up” demand for consumer and investment goodsrnprevented a fall in aggregate demand. Keynesian demandsiderneconomics, so it was argued, won out anyhow. The Americanrneconomics profession blithely accepted this new interpretation,rndespite massive evidence that it simply did not fitrnthe facts. Keynesian economies’ final triumph in the wodd ofrnideas came at the very time the facts were demonstrating itsrnfundamental fallacies.rnIt is true that American consumers desperately wantedrndurable goods after years of relative deprivation. Yet the transitionrnto a peacetime economy was almost entirely completedrnbefore sales of big-ticket consumer goods reached nornral levels.rnFor example, automobile, appliance, and new housingrnproductions did not return to normal peacetime levels untilrn1947 or even 1948, long after almost all the peacetime transitionrnhad been made. Automobile production in 1946 wasrnmore than 40 percent below the levels of 1940 and 1941.rnThe total spending on all goods and services in 1946 was lessrnthan in 1945, vet unemploynrent remained low. n the Keynesianrndemand-side way of looking at things, a move fromrndeficit to surplus in federal budgets should be accompanied byrnmassive declines in spending (partly because of a “multiplier”rneffect); lower spending, in turn, should lead to massive unemployment.rnIt simply did not happen. Total spending didrnfall, but labor costs also fell as a proportion of sales in 1946 andrn1947, making hiring increasingly attractive and preventing thernsurplus of unemployed labor envisioned by Hansen and otherrnKeynesians. If the price is right, workers will be hired. Inrn1946, the price was right.rnSimilarly, the smaller demobilizations following WorldrnWar I and the Korean War were handled adroitly by the marketrnwith little governmental involvenicnt. In 1920, the nationrnexperienced a major downturn that can be attributed to thernbursting of an inflationary bubble created by the Federal Reservernfinancing of World Wir I with monetary expansion.rnFortunately for the econonry, activist President Woodrow Wilsonrnwas incapacitated by poor health and the new President inrn1921, Wirren Harding, was philosophically opposed to intervention.rnBy 1923, the unemployment rate was below 4 percent,rnthanks to a downward adjustment in wages that madernlabor more attractive. The modest demobilization after thernKorean War was similady handled well by the market, becausernDwight I^isenhowcr was a fiscal conservative not inclined tornbegin new jobs programs for returning Korean veterans (arnmild recession in 1954 may not have been caused by demobilizationrnand was over in any ease within a year).rnThe absorption of a million or even two million militaryrnand civilian defense employees over a period of several yearsrnshould be no problem for the American economy. After all,rnthat economy added an average of 200,000 new employeesrnto the civilian labor force each month from late 1982 to mid-rn1990. One thing, however, could threaten a smooth transition:rngovernmental interference in labor markets, which raises thern26/CHRONICLESrnrnrn