Slashing Government Works

It Can Happen Here

Government really can be cut: case studies from Canada, New Zealand, and the United States

Arnold Kling, David Henderson & Maurice McTigue from the November 2010 issue of Reason

In an era of frightful budgets and frightened politicians, cutting government may seem like a flatly impossible task. But a look around the world—and at our own recent economic history—turns up a few inspirational examples of knife work that not only trimmed back budget deficits but created the conditions for unprecedented prosperity.

New Zealand, Canada, and the postwar United States all managed to slash the state on a grand scale. Governments shed responsibility for forests, railways, radio spectrum, and more while relaxing labor markets, slimming the welfare state, and ending price controls. Far from damaging economies or increasing unemployment, these reductions in the size and scope of government boosted GDP, improved services, and created jobs.

Government cutters faced opposition along the way, from skeptical Keynesians to Kiwi bureaucrats. But they also found unlikely allies, with left-wing parties playing major roles in the Canadian and New Zealand examples. The stories below should encourage would-be cutters and reassure skeptics: It can be done.

Turning Guns to Butter
How postwar America brought the boys home without bringing the economy down
Arnold Kling

When World War II ended in 1945, President Harry Truman faced a problem. Public opinion called for a rapid demobilization that would bring the boys home as soon as possible. But the Keynesians who were gaining prominence in the economics profession warned that a rapid decline in government spending and the size of the public work force would produce, in the late economist Paul Samuelson’s words, “the greatest period of unemployment and dislocation which any economy has ever faced.”

Thankfully, Truman ignored the Keynesians. Government spending plummeted by nearly two-thirds between 1945 and 1947, from $93 billion to $36.3 billion in nominal terms. If we used the “multiplier” of 1.5 for government spending that is favored by Obama administration economists, that $63.7 billion plunge should have caused GDP to fall by $95 billion, a 40 percent economic decline. In reality, GDP increased almost 10 percent during that period, from $223 billion in 1945 to $244.1 billion in 1947. This is a rare precedent of a large drop in government spending, so its economic consequences are important to understand.

The end of World War II thrust more than 10 million demobilized servicemen back into the labor market, but without the catastrophic consequences Keynesians feared. Close to 1 million took advantage of the GI bill to attend college. In addition, some of the increase in the male work force was offset by a decline in female labor force participation from World War II levels. But if Rosie the Riveter became a housewife, many of her friends continued to work outside the home. Over all, from 1945 to 1947 the civilian labor force increased by 7 million, or 12 percent. The vast majority found work, as civilian employment rose by 5 million, an increase of 9 percent.

In addition to the demobilized servicemen, the federal government let go of more than a third of its civilian employees—over 1 million workers. Many of these civilians had been engaged in government attempts to manage the economy. As the economist Gary M. Anderson has pointed out in The Freeman, more than 150,000 people were employed by various wartime economic regulatory agencies, such as the War Production Board, the War Labor Board, the Office of Civilian Supply, and the Office of Price Administration.

With responsibilities that extended well beyond wartime production to include restrictions and controls on the civilian nonmilitary economy, those agencies and boards disbanded with great reluctance. The 1946 election, which gave Republicans a majority in the House of Representatives for the first time since 1930, prompted a change of heart, with Price Administrator Chester Bowles removing virtually all remaining price controls five days after the vote.

The conversion to a peacetime economy was a remarkable undertaking by the private sector. It did not merely involve converting wartime manufacturing to peacetime uses. For example, of the 2.8 million workers let go by the “other transportation equipment” sector between 1943 and 1948, when military vehicles were no longer needed, just half a million were absorbed by the civilian automobileindustry. The big employment gains turned out not to be in manufacturing at all. The sectors that saw the most hiring were retail trade, services, contract construction, and wholesale trade, which together added nearly 4 million workers.

There are important differences between circumstances today and the circumstances in 1945, of course. Back then, federal spending was much larger as a share of GDP (40 percent, vs. less than 10 percent today), and government employment was a much larger share of the labor force than now (20 percent vs. 2 percent), so a more significant adjustment was required.

But there are other factors that make change more difficult today. During World War II, the personalsavings rate climbed to more than 20 percent, so after the war households were able to offset the decline in government spending by consuming a larger share of their incomes. Today, with a savings rate of about 5 percent, households have much less room to expand. In addition, the skill requirements of today’s industries make it more difficult to match workers with jobs than was the case in the much simpler economy of the 1940s.

Any way you look at it, though, America’s experience from 1945 to 1947 demonstrates that the private sector is capable of overcoming a tremendous drop in government spending. As a percentage of GDP, the decrease in government purchases then was larger than would result from the total elimination of government today. While no one can be sure what would happen if the government were to shrink that quickly, the ’40s boom offers a hopeful example.

Reason