The Economy of the Great War – and After

<>Rethinking War: A Stout Research Centre Conference: 28-30 November 2013.

 

Keywords: Political Economy & History;

Introduction [2]

 

The conference title invites us to ‘rethink war’, to shift away from traditional approaches to war history. There is a tendency to think of the war as about events which occur during it. That too, but it is my contention that the Great War was not just an incident in the 600 million odd years of New Zealand’s history. It had subsequent long-term effects, not just the personal grief of those who had lost loved ones (or found them greatly incapacitated), not only the impact on the demography, but on the way we governed New Zealand. Towards the end of this paper I shall argue that Muldoonism was its grandchild. Earlier illustrations include the changes in fiscal management and the introduction of producer boards.

 

Diverting Resources for War [3]

 

The modern economic historian thinking about the Great War is handicapped by the lack of a comprehensive data base. At the heart of a war economy is that a substantial portion of the production available to the economy has to be diverted to the war effort. Unlike today, unlike that which Jack Baker had available when he wrote his history of the economy during the Second World War, there is not the standard statistical framework to analyse the extent to which resources were diverted. Hence what can be discussed is a bit sketchy

 

How much diversion of resources? We dont know with any precision. During the war the troops overseas at any time, plus those in domestic training – amounting to at least 65,000 and even 100,000 men, over a fifth of the labour force – were not available for civilian production but they were still consuming. There are no annual labour force figures at this time, so we can but conjecture the precise impact of having so many workers unavailable for domestic production. Some of the labour deficit would have been made up by running down the unemployed (although that was not a huge reserve), by drawing women into the labour force (although we dont know how many) and by working longer hours.

 

That fifth of the labour force in uniform is less than the aggregate resource diversion in the Second World War which according to Jack Baker exceeded 30 percent of GDP between 1939 and 1944. But it is a similar order of magnitude if we add in production diverted to war purposes. While the economists and politicians of the day did not have the quantities, they knew there was a challenge to pay for the war from the public purse. The essence of the economic problem was a general cut back in domestic spending.

 

Suppose the diversion to war spending was a third of aggregate output, about the same proportion as in the Second World War. In effect the goods and services available for peace time pursuits was reduced by a third. That would mean that consumption and investment levels had to be cut back to where they were in the 1880s; reducing the material standard of living to where it had been a third of a century earlier.

 

The Fiscal Impact

 

But where to cut back? Government domestic expenditure was restrained (but only a little) and probably private investment declined (we dont know because the data does not exist). So cut backs in private consumption were necessary, and the government raised taxes. Its tax revenue trebled between 1914 and 1919 including what must have seemed swingeing increases in income tax; the top rate was increased a third from 6.7 percent to 10 percent and there was a super tax of a further third; land tax went up too. A nice illustration of the broadening of the base was that the number of (income) taxpayers trebled from 14,000 in 1913/4 to 44,000 in 1919/20 (although still a small proportion of the 430,000 adult males).

 

One of the most radical changes in our tax system occurred over the six years to 1919/20. Income tax made up just 9 percent of total tax receipts in 1913/14, behind customs duties (58%), land tax (13%) and death duties (10%). Six years later income tax was the single largest source of tax revenue at 39%, with the other three behind: customs 30%, land tax 9% and death duties 6%.

 

Despite the tax increases there was a deficit in the government accounts which was covered by borrowing. In those days the public debt was allocated into categories, including an unproductive ‘war and defence’. It amounted to £6.4m in March 1914; by March 1920 it was £86.2m. In the six years there was an £80 million increase, when annual GDP was probably about £125m.

 

In the nineteenth century New Zealand had largely borrowed non-New Zealanders’ savings through the London market. From the time of the Liberals, the government began to tap into domestic savings with less recourse to London,  partly because of John Ballance’s principle of self-sufficiency, partly because London was not as generous with its advances. Access to London’s funds would become acute during a major war since Britain was also struggling to divert resources into its war effort. From 1916 New Zealand agreed to raise at home all funds for war expenditure(apart from the costs of maintaining troops in the field).

 

Inflation

 

The ideal is that the government’s borrowing soaks up domestic spending power thereby offsetting war expenditure. The reality is that the strategy was accompanied by inflation. Consumer prices rose 67 percent between 1914 and 1920, faster than at any time in recorded history before the inflation binge of the second half of the 1970s.

 

With hindsight we are not surprised that the policy response was price controls. It was not entirely a new one, but certainly at a far greater intensity than what had gone before – an intensity which was repeated even more vigorously during the Second World War and during the great inflation of the 1970s and early 1980s. An economist would say, wearily, that the purpose of the inflation – it was an international phenomenon of the times – was to reduce people’s real wealth. As the price controls did not address this, they would ultimately fail.

 

Observe that I am drawing a process of policy responses across time. It seems likely that the vigorous price controls of the 1940s reflected the experience of the Great War. They were trying to avoid a repeat of that inflation and were reasonably successful, for prices in the Second World War  rose at only one-third of the rate of those in the first. However, as the history I am writing explains, after the Second World War the suppressed inflation returned, reducing the value of savings accumulated during the war. Those savings had been used to fight the war, There was no matching investment. So they had to be written off – inflated away.

 

After the War [4]

 

There was another important aftermath of these fiscal policies. Although there were reductions in income tax rates in the mid 1920s, in aggregate taxes were not returned to their pre-war levels after the war ended.[5] Debt servicing aside, the additional revenue was used for public works and social transfers, among other things. Public works in this era are associated with Gordon Coates whose natural political abilities and energy were displayed by spending big on his portfolio.

 

We dont usually think of rehabilitation (repeated after the Second World War) of returned service personnel as a part of the transfer state. It differed from what are conventionally thought of as transfer policies because grants tended to be one-off – setting the returned up in business or in a home – and not ongoing (although veteran’s pensions are). The rehabilitation schemes after the Great War are usually thought of as a failure but, while some of the farm settlements were less than successful, the grants for home purchase were a major success.

 

This illustrates a frequent feature of policy development. There is rarely a single event which initiates what proves to be a major policy, but there can be steps which accelerate its development. Thus the rehab policies after the Great War might be thought of as starting the practice of widespread home ownership. Similarly the war’s broadening of the role of income tax was on the way to today’s dominant role of income tax in the revenue system. It seems likely, although it has not been explored, that the administration of veterans’ pensions was part of the basis for the social security one set up in 1939.

 

Note that each of these policies are remembered as First Labour government policies but their early nurturing was by the government of Bill Massey which Michael Bassett sniffily describes as ‘dirigiste’, with the central government actively involved in directing the entire economy. It was; with the exception of the government in which Bassett was cabinet minister and the one which followed, all New Zealand’s governments have been dirigiste.

 

The Development of Producer Boards

 

Not only were there profound changes domestically, but external trade relations changed. (Any account of the New Zealand economy which does not pay considerable attention to New Zealand’s external economic relations is defective.)

 

New Zealand had been a significant supplier of pastoral products – dairy, meat and wool to Britain – for some years before the Great War. When it started, Britain faced two food issues. It was cut off from some of its alternative supplers, while the shipping routes to Britain were insecure. Britain and New Zealand negotiated a bulk purchase agreement at agreed prices with the British government accepting responsibility for freight (including any losses from enemy action) and storage.

 

While at first the exporting was carried out by agents and the private and cooperative factories, shipping shortages required the coordination of transportation and hence marketing of dairy products, meat and wool. (It was said one ship took 90 days – more than the time to get to Britain – going from coastal port to port, waiting about for product to be loaded.)

 

The Imperial Commandeer – as it was called; ‘commandeer’ refers to taking possession or control of something for military purposes –  developed in the usual tortuous way of trial and error but by 1917 New Zealand had an agreement with the British Government that all the supplies available for exports would be requisitioned for the British market.

 

At the end of the war there was a considerable quantity of meat and wool in store. As more shipping became available it, plus the annual production, was unloaded on the British market, as were South American supplies at the same time. Prices collapsed. Private enterprise had seemed to fail again, and the farmers turned to the public sector – with only a little resistance from business. In February 1922 – note the speed of reaction – the government, with dirigiste (‘Farmer Bill’) Massey at the forefront, passed legislation which established the Meat Producers Board with very wide powers. A little later the Dairy Board was created almost as quickly although interrupted by the 1922 election. (The Wool Board was established in 1944. Earlier wool had been involved in the imperial commandeer and in 1921 there was the Board of Trade (Wool Industry) Regulations.)

 

We may ponder whether these producer boards would have been established as quickly – or at all – had there been no commandeer, had there been no Great War.

 

Towards Muldoonism

 

Thus far I have described long-term microeconomic responses to the war. There was a macro one too. New Zealand’s response to the problems which the economy faced during the Second World War was based upon lessons learned from the First, less than twenty-five years earlier. Sometimes the actions were a replication of the earlier war – the commandeer was reintroduced; sometimes they were lessons learned – Peter Fraser, jailed for dissent in 1917, insisted that capital as well as labour would be conscripted this time. In order to avoid the high inflation of the Great War; price controls were more comprehensive.

 

The result of this analysis is that I have had to revise my understanding of the sources of post-war economic management. I had long assumed that it had been shaped by the economic policies which the First Labour Government had been elected on in 1935. There are always continuities and evolutions, but I now think that the highly centralised economic management that was necessary during the Second World War had a major influence for the first forty years after the war. I am not sure that New Zealand was particularly more centralised than many other of the war economies but undoubtedly New Zealand was slower to unwind its interventions.

 

This was most evident in the draconian wage and price freeze which the government of Robert Muldoon introduced in May 1982. The earlier war administrations would have been admiring. Of course, perhaps in ways that Muldoon never appreciated, the economy and society had moved on. The unwinding of centralised economic control that the successor government – the Rogernomes – undertook might be said to represent the end of the centralised Second World War approach to economic management of forty years earlier, itself a response to the Great War approach to economic management some twenty-five years earlier.

 

Counterfactual history is always difficult especially when the alternative is that there was no Great War, or perhaps New Zealand did not join in. But it is possible to imagine alternative scenarios which could well have led to a very different New Zealand economic management from that we had for the following half century and more, something we might ponder on when we are rethinking the Great War.

 

Endnotes

[1]  I am grateful to comments from Elizabeth Caffin, Richard Hill and Malcolm McKinnon.

[2]Among the texts referred to in the preparation of this paper are

Baker, J. V. T. (1965) War Economy.

Bassett, M. (1998) The State in New Zealand 1840-1984

Condliffe, J. B. (1930) The Making of New Zealand

Easton, B. H (1996) In Stormy Seas

Easton, B. H. (Forthcoming) Not in Narrow Seas; A Political Economy of New Zealand. Chapters 20, 21, 30.

Hawke, G. R. (1985) The Making of New Zealand: An Economic History.

Lloyd Prichard, M. F. (1970) An Economic History of New Zealand

Goldsmith, P. (2008) We Won, You Lost. Eat That!

McKinnon, M. (2003) Treasury: The New Zealand Treasury 1840-2000.

New Zealand Official Year Book, various years.

Taxation Review Committee (1967) Taxation in New Zealand.

[3] There is not time for presentation to describe the track of the aggregate economy, not least because the data base is so problematic. The best estimates I have been able to synthesize suggest the economy grew quite quickly in the Liberal Boom to 1908, after which it entered a long period of stagnation in per capita GDP terms which ended 27 years later as the economy came out of the Great Depression (it had, of course, dipped sharply then) and went into the Labour Boom. There is little evidence of a boom in production during the Great War (in contrast to the boom of the Second World War) probably because of the withdrawal from the labour force of overseas service personnel. Given that there was not a drop in production (as far as we can tell) productivity must have risen.

[4]  There was also a loss of manpower in the inter-war period due to the deaths of the 18,500 odd service men. They amounted to over 5 percent of the male labour force while the incapacitated added to the loss. There was no corresponding reduction in those who were not directly contributing to market production – the young, the old, and women working in the non-market sector, so average market incomes across the entire population were reduced by, say, 5 percent.

[5]  Income Tax Revenue

Year

GDP

Tax Revenue

1914/15

0.55%

9%

1919/20

4.2%

39%

1924/25

2.1%

21%