“Jobs Issue Dominates Defense Cuts Debates,” the Los Angeles Times proclaimed in a recent article. The story informed us that the end of the Cold War has brought about layoffs for many workers in the defense industry. This, in turn, has led members of Congress to wonder if the reductions in military spending associated with the end of the Cold War should be reconsidered.
Variations on the same theme have been a subject of discussion in many communities around the nation. “Cold War’s End Devastating to Defense Jobs” was a headline in the Atlanta Journal. In Boston, the Globe reported “Study Cites Defense Cuts’ Harm to Northeast.” All across the country, concerned citizens are alarmed that reductions in the nation’s defense budget will create significant unemployment and aggravate the sluggishness in economic conditions that has characterized recent years. In a study for the Congress, the U.S. Office of Technology Assessment estimated that the defense cutbacks may well cost the nation 250,000 jobs a year until the year 2001. All told, some 2.5 million jobs could be lost. The chairman of the Senate Armed Services Committee, Sam Nunn (D-Georgia) opined that the defense reductions are “going to have certainly a detrimental effect on jobs in America.” George Bush, in proposing a multibillion-dollar job training program, stressed the importance of retraining defense-related workers.
Is the concern justified? Should we slow down our reductions in defense to deal with the inevitable unemployment problem? Should we initiate, as Senator Nunn, George Bush, Bill Clinton, and others suggested, new training programs designed to help unemployed workers from defense industries? History suggests that the correct answers to these questions is a resounding “no.”
By far the most dramatic shift of resources from war to peace came at the end of World War II. Two things about the postwar demobilization make it particularly instructive. First, it was by far the largest conversion of resources from war to peace in the nation’s history. Second, it happened rapidly. In June 1945, some 12,130,000 Americans served in the Armed Forces of the United States, nearly 9 percent of the country’s population (the equivalent today would be 22 million persons). Exactly one year later, this number had shrunk almost 75 percent to just over three million. Adding the nearly 900,000 civilians released from the federal payroll, total federal employment fell by precisely ten million—in 12 months. And that does not count hundreds of thousands of others who lost their jobs working in privately owned defense plants.
Like today, economists and others were worried that the end of the war would bring about massive unemployment. The dean of American Keynesian economists, Alvin Hansen, writing in 1943, said, “W^hen the war is over, the government cannot just disband the Army, close down munitions factories, stop building ships, and remove all economic controls.” Yet that is exactly what it did, with no major ill effects. In 1945, as the war was ending, prominent Keynesian economist Robert Nathan predicted six million unemployed by the spring of 1946, implying an approximate 10 percent unemployment rate. He was optimistic compared with some. Veteran Department of Labor economist Isador Lubin predicted that as many as nine million would be out of work—roughly a 14 percent unemployment rate. Virtually no economist forecast postwar prosperity. The forecasters, almost all newly converted disciples to the thinking of English economist John Maynard Keynes, figured that the decline in “aggregate demand” associated with a drastic reduction in federal spending would send the nation into an economic tailspin.
As we document in our new book Out of Work: Unemployment and Government in Twentieth-Century America, published by Holmes & Meier for the Oakland-based Independent Institute, the postwar resumption of the Great Depression never came. Unemployment, widely projected to reach double digits, only reached an annual rate of 3.9 percent in 1946, lower than the long-run average rate of unemployment in American economic history, before or since.
America went, virtually overnight, from having an extraordinarily expansionary fiscal policy, with a budget deficit equal to about 20 percent of the national output, to the most contractionary fiscal policy in modern American economic history, with a substantial budget surplus, hi relation to today’s economy, it was equivalent to going from a budget deficit of well over one trillion dollars to a budget surplus of over $200 billion—in one year. The federal government spending component of gross domestic product fell 46 percent in 1946—and that ignores inflation. At the same time, the creation of money also slowed substantially.
How did it happen? How was the American economy able to absorb millions of returning veterans and munition plant employees without major retraining programs, fiscal interventions, or the like? How was the nation able to absorb a significant reported decline in real output without massive joblessness? The answer is simple: the invisible hand of the labor market worked, lowering the price of labor (what we more technically term the adjusted real wage) so that hiring civilian workers was profitable for employers. Aiding the transition process was the removal of tight wartime wage and price controls that had stifled the operations of free markets.
One of the least well-known lessons in American economic history is that the market mechanism solves problems of unemployment and depressed output and that government interventions designed to solve those problems typically add to rather than alleviate them. The best example is the Great Depression. A well-meaning but economically ignorant Herbert Hoover thought economic depression could be averted by paying workers high wages, increasing purchasing power and thus the demand for goods. Hoover’s high-wage policy, followed scrupulously by an American business establishment that revered him, in effect priced labor out of the market, preventing the falling wages that could and would have ended the downturn that began in the fall of 1929. After 193?, the Depression was needlessly prolonged when Franklin Roosevelt’s New Deal similarly pushed wages up by such legislation as the National Industrial Recovery Act and the Wagner Act, thereby keeping unemployment rates in the double digits until 1940, far longer than in any other major Industrial nation.
More recently, the 1990 recession began when wage increases, which had been about 4 percent a year including fringe benefits in the late 1980’s, spurted to an extraordinary 9.2 percent in the second quarter of that year. Again, government policies were largely responsible. On the very first date of that quarter, the federal minimum wage increased more than 13 percent, raising wages for millions of lower-skilled workers and pricing some of them out of the market.
Returning to the postwar demobilization, unemployment was partly averted by the voluntary withdrawal from the labor force of millions of women who returned to the role of homemaker and also of a smaller number of men who had involuntarily served in the labor force as draftees but who now returned home to become students. At the same time, real wages (money wages corrected for the effects of inflation on purchasing power) declined somewhat, as the removal of controls allowed prices to reach levels dictated by the laws of supply and demand.
Before the postwar transition began, Keynesian economists were worried that the fall in demand (government spending) associated with the war’s end would cause a renewal of the Great Depression. When that did not happen they quickly invented a new explanation for the smoothness of the transition: “pent-up” demand for consumer and investment goods prevented a fall in aggregate demand. Keynesian demand-side economics, so it was argued, won out anyhow. The American economics profession blithely accepted this new interpretation, despite massive evidence that it simply did not fit the facts. Keynesian economies’ final triumph in the world of ideas came at the very time the facts were demonstrating its fundamental fallacies.
It is true that American consumers desperately wanted durable goods after years of relative deprivation. Yet the transition to a peacetime economy was almost entirely completed before sales of big-ticket consumer goods reached normal levels. For example, automobile, appliance, and new housing productions did not return to normal peacetime levels until 1947 or even 1948, long after almost all the peacetime transition had been made. Automobile production in 1946 was more than 40 percent below the levels of 1940 and 1941.
The total spending on all goods and services in 1946 was less than in 1945, vet unemployment remained low. In the Keynesian demand-side way of looking at things, a move from deficit to surplus in federal budgets should be accompanied by massive declines in spending (partly because of a “multiplier” effect); lower spending, in turn, should lead to massive unemployment. It simply did not happen. Total spending did fall, but labor costs also fell as a proportion of sales in 1946 and 1947, making hiring increasingly attractive and preventing the surplus of unemployed labor envisioned by Hansen and other Keynesians. If the price is right, workers will be hired. In 1946, the price was right.
Similarly, the smaller demobilizations following World War I and the Korean War were handled adroitly by the market with little governmental involvement. In 1920, the nation experienced a major downturn that can be attributed to the bursting of an inflationary bubble created by the Federal Reserve financing of World War I with monetary expansion. Fortunately for the economy, activist President Woodrow Wilson was incapacitated by poor health and the new President in 1921, Warren Harding, was philosophically opposed to intervention. By 1923, the unemployment rate was below 4 percent, thanks to a downward adjustment in wages that made labor more attractive. The modest demobilization after the Korean War was similarly handled well by the market, because Dwight Eisenhower was a fiscal conservative not inclined to begin new jobs programs for returning Korean veterans (a mild recession in 1954 may not have been caused by demobilization and was over in any ease within a year).
The absorption of a million or even two million military and civilian defense employees over a period of several years should be no problem for the American economy. After all, that economy added an average of 200,000 new employees to the civilian labor force each month from late 1982 to mid-1990. One thing, however, could threaten a smooth transition: governmental interference in labor markets, which raises the real cost of labor per unit of output, thus pricing workers out of such as the Americans with Disabilities Act, the 1990 Clean work.
The recent stagnation in American labor markets is largely attributable to rising labor costs associated with government wages per unit of output and pricing some labor out of the policies. Not only has government directly contributed to higher costs by increasing the minimum wage, it has indirectly raised labor costs by extending unemployment insurance benefits (as of this writing) some three times in less than 18 months. Receiving in many cases $200 or more in weekly benefits for over a year, unemployed workers become finicky about accepting job opportunities. In the jargon of economists, their “reservation” (minimally accepted) wage has risen. This has pushed up wages and led to fewer workers being hired.
Even more threatening to defense workers worried about losing their jobs is the potentially adverse effects of new regulatory initiatives. For labor to receive both higher real wages and greater job opportunities, the productivity of labor must rise. Each widget-maker must make more widgets per hour if the standard of living is to rise. Well-intentioned legislation such as the American with Disabilities Act, the 1990 Clean Air Act, and recent civil rights legislation all have provisions that will probably lower the productivity of labor, raising real wages per unit of output and pricing some labor out of the market. To illustrate, suppose the disabilities statute is interpreted to mean that aisles on buses must be wide enough to accommodate a wheelchair. Suppose that now new buses can only sit three persons across whereas previously they seated four. The productivity of bus drivers may thereby be reduced by upwards of 25 percent. This may force higher fares, cause declining passenger volume, and lead to a layoff of bus drivers.
In short, the best thing the government can do for military personnel and workers in defense plants is to leave them and the markets in which they compete alone. History tells us that interfering in the markets will likely create, not eliminate, unemployment. The invisible hand of the labor market has historically done a remarkably effective job in absorbing millions of Americans into civilian jobs, and it can do the same today.