The Wealth of a Nation

It was the era right after the second Great War, which was now called World War II. England had managed to stem the tide of Nazism (initially almost single-handedly) and was in the process of reconstructing its war-ravaged economy. On the other side of the Atlantic stood a new global power, a new economic colossus, soon to become the world’s lone superpower. Far from being ravaged by the second world war to take place in a quarter century, America was intact; in contrast to Britain, which had lost 500,000 homes in a country of 45 million – or one for approximately every 20 families in the nation – the United States had not had a single home destroyed, a single factory or shipyard put out of commission, a single church or monument wiped out by bombers or rockets. All it took for America to begin a wave of prosperity was some re-tooling of tank factories so as to start cranking out cars. And Americans were buying American cars, despite having a much stronger currency than England. Paul Reid (in his collaborative manuscript, written jointly with William Manchester to complete the Churchill trilogy called “The Last Lion”) described the U.S. recovery thus: Americans were buying American – GM, Studebaker, Ford, Packard, and Chrysler automobiles and electric clothes dryers, radios and televisions. American children rode bright-red Schwinn bicycles, which – as with all American products – benefited from tariffs slapped on European imports. The British lacked the physical assets and the capital necessary to benefit from the comparative advantage of having to comply with the famous Bretton Woods agreement, which required all participating countries to float their currency against the U.S. dollar. As a result, the British pound had been devalued by 30 percent, from $4.08 to $2.80. That, combined with generous loans from the United States, amounting to $3.75 billion at a measly 2% interest rate, should have placed England among the world’s great exporters of goods. Alas, it did not work out that way – among other things, because of trade barriers posed by the United States. Reid explains: A devalued currency results in a nation’s products becoming cheaper in foreign markets, but Britain had little to export, and very little that Americans wanted….[O]ther than shipping their best scotch whiskey to America, Britons were not exporting much, not producing much, and not buying much…. Currency devaluation should have been accompanied by free trade, yet tariffs remained high after the war. It was not until 1947 that the world’s economies were joined in an orgy of tariff reductions by what came to be called the “General Agreement on Tariffs and Trade” (GATT). The existing trade barriers did not hurt the United States much, since its enormous population and contiguous land mass, diverse regional weather and free-market tradition and laws enabled it to prosper by producing and consuming internally. Today we would compare the U.S. economy not to Britain, but to the entire European Union, which has a comparable population, diversity of weather and only slightly more socialized economies, with no trade barriers. It is not a coincidence that the Gross Domestic Product (GDP) for the European Union as a whole is comparable to that of the United States. But let’s get back to the initial theme of this preface, which was to compare the economies of the two great industrial nations of the world, at the beginning of the twentieth century. What is evident from the above is that by the end of the Second World War there was no real comparison. America reigned supreme and England was forever destined to be a secondary economic power. The British Empire reigned no more. And yet, the prevailing economic theory of the times belonged to an Englishman. His name was John Maynard Keynes; his theories were bound to set the tone of all economic discourse in the Western world for at least a half century. Therefore, it was no coincidence that he had been sent by the British Prime Minister (Clement Atlee) to negotiate the huge and favorable reconstruction loan mentioned before. Keynesian economics was a theory based mainly on a serious defect in the British economy between the wars – an endemic high unemployment. After the Second World War, and for a period lasting a little more than half a century, the U.S. economy thrived under essentially free-market conditions, while the British economy lagged, under more socialized conditions. Keynesian prescriptions of high government involvement in capital formation – so useful in an economic crisis – were not particularly helpful to the American economy of the last half of the twentieth century. But neither were the laissez-faire theories of the Austrian school, as championed by Ludwig Von Mises and Friederich Hayek. By the fourth quarter of the twentieth century, America had converted its economy to a modified, quasi-European mixture of private and collective. The idea that a pure, laissez-faire, totally free-market economy would ever take hold in America was quickly becoming an illusory dream engaged in by a handful of Austrian-school economists. “Hayek v. Keynes” was a nice, theoretical juxtaposition of inapplicable extremes – useful for academic and political debate, but not for actual implementation, as we shall see. They are like the left and right wooden edges of a painting, which hold up the canvass but are not the venue for the actual painting. They are the explanatory book-ends, but not the actual text of the book. They define the fringes of the discussion with eloquence and quantitative models. Their interaction frames the debate. In the succeeding chapters, we shall explore the two opposing theories and attempt to show that each has useful principles for the kind of hybrid economy that the U.S. has evolved into.