Putting Government on a Diet: 1945-1950

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The recent
mid-term elections were a citizen referendum for reductions in the
size and scope of the federal government. But can federal spending
and the budget deficit actually be reduced substantially without
sending gross domestic product (GDP) into a tailspin and increasing
unemployment to extraordinary levels?

Liberals and
economists with Keynesian sympathies have always argued that substantial
reductions in federal spending when economic activity is weak (like
now) would be disastrous. Really? Let’s see what actually happened
the last time the Congress actually reduced government spending
in any meaningful way.

The period
1945-1950 is (almost) a scientific test of the Keynesian hypothesis.
Despite repeated warnings by most mainstream economists that cutting
government spending at the conclusion of WW 2 would bring back the
Great Depression, the Congress dramatically lowered government spending
between 1945 and 1950. Federal government expenditures fell from
$106.9 billion in 1945 to $44.8 billion in 1950. Defense spending
took the biggest hit falling from $93.7 billion in 1945 to just
24.2 billion in 1950. In just 5 years, government spending (as a
% of GDP) fell from 45% in 1945 to just 15% in 1950 and the annual
federal budget deficit fell from $53.7 billion in 1945 to only $1.3
billion in 1950.

But what happened
to overall economic output and unemployment? Despite the massive
economic transitions from wartime to domestic production, GDP actually
increased (confounding all of the Keynesians) from $223 billion
in 1945 to $244.2 billion in 1947 and then to $293.8 billion by
1950. And despite millions of returning servicemen and women, the
unemployment rate averaged a very low 4.5% between 1945 and 1950.
Economic disaster? Hardly.

History, of
course, never repeats itself exactly and 2010 is not 1945. But one
thing is clear: Cutting back federal government spending and annual
deficits in the immediate post-World War 2 period did not hamper
the economy; far from it. Indeed, as government spending and wartime
price controls receded, the private market economy expanded strongly
and unemployment stayed reasonably low. The Keynesians, dead wrong
in theory, were also dead wrong in practice as well.

December
4, 2010

Dom
Armentano [send him mail]
is Professor Emeritus at the University of Hartford (CT) and the
author of Antitrust
and Monopoly

(Independent Institute, 1998) and Antitrust:
The Case for Repeal

(Mises Institute, 1999). He has published articles, op/eds and reviews
in The New
York Times, Wall Street Journal, London Financial Times, Financial
Post, Hartford Courant, National Review, Antitrust Bulletin
and many other journals.

The
Best of Dom Armentano

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