How to Pay for the War


L. Randall Wray | New Economic Perspectives – TRANSCEND Media Service

Remarks by L. Randall Wray at “The Treaty of Versailles at 100: The Consequences of the Peace”, a conference at the Levy Economics Institute, Bard College, May 3, 2019.

16 May 2019 – I’m going to talk about war, not peace, in relation to our work on the Green New Deal—which I argue is the big MEOW—moral equivalent of war—and how we are going to pay for it. So I’m going to focus on Keynes’s 1940 book— How to Pay for the War—the war that followed the Economic Consequences of the Peace.

Our analysis (and the MMT approach in general) is in line with JM Keynes’s approach. Keynes rightly believed that war planning is not a financial challenge, but a real resource problem.

The issue was not how the British would pay for the war, but rather whether the country could produce enough output for the war effort while leaving enough production to satisfy civilian consumption.

To estimate the amount left for consumption we need to determine the maximum current output we can produce domestically, how much we can net import and how much we need for the war.

My argument is that this is precisely how we prepare for the Green New Deal. “Paying for” the GND is not a problem—the only question is: do we have the resources and technological know-how to rise to the challenge.

While in normal times we operate with significant underutilization of capacity, during war, Keynes argued, we move from the “age of plenty” to the “age of scarcity” since what is available for consumption is relatively fixed.

At the same time, more output produced for military use means more income, which, if spent on consumption would push up prices. Hence, some of the purchasing power must be withdrawn to prevent inflation. Thus, Keynes rightly viewed taxes as a tool for withdrawing demand, not paying for government spending.

He thought taxes could be used to withdraw half of the added demand. The other half would have to come through savings, voluntary or “forced”.

Voluntary savings would only work if everyone saved enough, which can’t be guaranteed. If households don’t save enough, they bid up prices while consuming the same amount of resources, but paying more. The business ”profiteers” would get a windfall income, some saved and the rest taxed away (so businesses would effectively act as tax collectors for the Treasury—the extra consumer demand facing a relatively fixed supply of consumption goods would generate extra tax revenues on profits).

Thus voluntary saving plus taxes would still withdraw demand, but on the backs of workers and to the benefit of profiteers. If workers demanded and got higher wages, the process would simply repeat itself with wages constantly playing catch-up to price increases as workers consumed the same amount of real resources.

Keynes’s preferred solution was deferred consumption. Instead of taxing away workers’ income, which would prevent them from enjoying the fruits of their labor forever (and possibly reduce support for the war effort), he proposed to defer their consumption by depositing a portion of their wages in “blocked” interest-earning deposits.

This solution would avoid inflation, while at the same time more evenly distribute financial wealth toward workers.

Furthermore, this would solve the problem of the slump that would likely follow the war, as workers could increase consumption after the war at a measured pace, spending out of their deferred income.

Keynes recognized that it is not easy for a “free community” to organize for war. It would be necessary to adapt the distributive system of a free community to the limitations of war, when the size of the “cake” would be fixed.

One could neither expect the rich to make all of the necessary sacrifice, nor put too much of the burden on those of low means. Simply taking income away from the rich would not free up a sufficient quantity of resources to move toward the war effort—their propensity to consume is relatively low and they have the ways and means to avoid or evade taxes.

But taking too much income away from those with too little would cause excessive suffering—especially in light of the possibility they’d face rising prices on necessities.

To avoid a wage-price spiral, labor would have to agree to moderate wage demands. This would be easier to obtain if a promise were made that workers would not be permanently deprived of the benefits of working harder now.

In other words, the choice facing workers is to forego increased consumption altogether, or to defer it. In return for working more now, they would be paid more later—accumulating financial wealth in the meantime.

He recommended three principles to guide war planning:

  • use deferred compensation to reward workers;
  • tax higher incomes while exempting the poor; and
  • maintain adequate minimum standards for those with lower incomes such that they would be better off, not worse off, during the war.

The deferred compensation would be released in installments, timed with the slump that would follow the war.  The system would be “self-liquidating both in terms of real resources and of finance”—as resources were withdrawn from the military they could turn to civilian production, with the deferred compensation providing the income needed to buy that output.

While Keynes argued that “some measure of rationing and price control should play a part” he argued that these should be secondary to taxes and deferred compensation.  Rationing impinges on consumer choice and inevitably has differential impacts across individuals. Price controls can create shortages.

In any case, he argued that an effective program of deferred income will make rationing and price controls easier to implement.

What Keynes wanted to avoid was the UK experience of WWI when the cost of living rose an average of 20-25% annually over the course of the war, and wage hikes tended to match price hikes, but with about a one year lag.

This allowed sufficient but permanent loss of consumption by workers to shift resources to the war.

By contrast, both the US and the UK managed to contain inflation pressures much more successfully in WWII—the UK hit double digit inflation only in 1940 and 1941, and had remarkably low inflation during the remainder of the war; the US barely reached above 10% only in 1942 and in other years inflation ranged from 1.7% to 8%.

Both of them adopted a variety of anti-inflation policies that approximated Keynes’s policy. Given the circumstances, the policies were remarkably effective.

Note that in the US, government spending rose to nearly half of GDP—with the budget deficit rising to 15% of GDP and the national debt climbing to 100% of GDP. In light of that massive mobilization, it is amazing how low inflation was.

I think this will also happen as the GND is phased in—the growth rate will accelerate sharply and the government’s share of GDP will grow from the current 25% or so toward 35% of GDP. At the same time, there will be reduction of private spending on healthcare so we end up with maybe an overall boost of GDP of maybe 2.5%.

If desired, we can reduce the stimulus through deferred consumption—perhaps through a surcharge on payrolls that will be returned through more generous benefits after the GND “war” cools down. Me? I’m an optimist. I believe the GND boost will put us on a sustained higher growth path, without inflation, that will generate the additional resources required.

If we compare that to the WWII build up, all of this seems quite manageable. And the inflation effect will be much lower—in part because we are not producing stuff to blow things up and in part because we face strong deflationary pressures from the east—a couple of billion workers have joined the global production force to keep inflation down.

And some of this shift toward the GND will be reversed quickly once the new infrastructure is in place and we have greened our economy. We will release the deferred compensation and we might end up with a government that is permanently bigger but not by that much—say a third of the economy instead of a quarter. Again, that is no big deal.

We long ago became a post-agricultural society. Since WWII we’ve transitioned to a post industrial society. It makes sense that we are going to have a bigger government since most provisioning already is, and will increasingly be, coming from the service sector—an area where public service Trumps private service—in education, care services—aged and young, healthcare, the arts, and many forms of environmentally-friendly recreation. More parks, less shopping.

In another important contribution—Economic Possibilities for our Grandchildren— written in 1930, Keynes speculated about our future– a time when “for the first time since his creation man will be faced with his real, his permanent problem—how to use his freedom from pressing economic cares, how to occupy the leisure, which science and compound interest will have won for him, to live wisely and agreeably and well.”

By Keynes’s timeline, this should have been reached by 2030. We’ve timed our GND to be completed by 2030. We have 10 years to make Keynes’s vision become reality. The alternative is annihilation.

Some (both heterodox and orthodox alike) argue we just cannot “afford” survival. It is cheaper to just keep doing what we’ve been doing and hope for a different result. That is not only the definition of insanity, but it is—as Keynes would say—unnecessarily defeatist.

The challenge is big; the alternative is unacceptable.


* Our report, How to Pay for the Green New Deal, by Yeva Nersisyan and L. Randall Wray, will be published soon at the Levy Economics Institute.

L. Randall Wray is a professor of economics and research director of the Center for Full Employment and Price Stability at the University of Missouri-Kansas City. His current research focuses on providing a critique of orthodox monetary policy, and the development of an alternative approach. Wray is the author of Money and Credit in Capitalist Economies, 1990, and Understanding Modern Money: The Key to Full Employment and Price Stability, 1998. He is also coeditor of, and a contributor to, Money, Financial Instability, and Stabilization Policy, 2006, and Keynes for the 21st Century: The Continuing Relevance of The General Theory, 2008. He taught for more than a decade at the University of Denver and has been a visiting professor at Bard College, the University of Bologna, and the University of Rome (La Sapienza).

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