A Fallacy Exposed Again

October 3, 1955

In his column in The New York Times of Sept. 8, Arthur Krock presented one “obviously important reason why the Secretary of the Treasury and other Presidential advisers believe that the budget can soon be balanced . . . without depressing the buoyant national economy.”

This reason is that private spending in this country, in Krock’s words, “has been steadily replacing . . . and topping, the billions cut from the budget by the Eisenhower Administration.” This conclusion is supported by a table (at the bottom of this column) of comparative official statistics for the second quarters of 1953, 1954, and 1955. The figures are expressed in billions of dollars at seasonally adjusted annual rates. They show that while government spending was running at an annual rate of $3.4 billion less in the 1955 quarter than in 1954, and $15.8 billion less than in the corresponding 1953 quarter, nongovernment activity was running in the second quarter of 1955 at a rate $30.6 billion higher than in the same period of 1954 and $31.3 billion higher than in 1953.

Krock calls this “one of the most remarkable aspects of economic development in the United States for years. For,” he correctly says, “the view has been, and still is, strongly held that shrinkages in the Federal budget must in time, and at a certain point, start the economy downward.”

Yet there is really nothing astonishing about this development except to those who have so tenaciously held this completely false view. I hope I may be forgiven if I cite the new comparisons with special satisfaction. In my Newsweek column of Jan. 12, 1953, I remarked: “What troubles me about the current crop of forecasts for 1953 [including one by the Department of Commerce] is that most of them rest on [the] fallacious . . . assumption that the future of business activity at this time depends primarily on the government’s defense-spending program. If that rises, we are told, business activity and prices will rise . . . but if it declines, there’s no telling how much business will deteriorate.”

This assumption, I pointed out, would lead to the absurd conclusion “that the more resources we are forced to devote to making guns and tanks and shells, instead of consumer goods, the richer we become. . . . The fallacy consists in looking only at the government’s defense payments and forgetting that the money for these comes ultimately from taxes. If defense payments suddenly dropped from the present $50 billion a year to only $10 billion, taxes could also be cut by $40 billion. Then the taxpayers . . . would have $40 billion more to spend than they had before, to make up for the $40 billion drop in government spending. . . . There is no reason to suppose that the overall volume of output or activity would decline.”

I went on to show that the whole theory that defense spending is necessary for prosperity “got a crushing refutation at the end of the second world war. Immediately after Japan surrendered in August 1945 there was a sweeping cancellation of war contracts. Government economists predicted that unemployment would reach 8 million by the following spring. Nothing of the sort happened.”

Yet this fallacy was still raging so strongly a year and a half later that in Newsweek of July 19, 1954, I pointed out again: “In the fiscal year 1944 the Federal government spent $95 billion; in the fiscal year 1947 it spent $39 billion. Here was a drop in the annual Federal spending rate in this three-year period of $56 billion. Yet, far from there being a recession in this three-year period, there was a substantial increase in employment, wages, and prices.”

A particularly hardy myth has once more got a crushing factual exposure.