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How to pay for Coronavirus: Lessons from previous wars

Photo by Markus Spiske on Unsplash

In this section for submissions by our Fellows, Dr Alan Bollard references his recent book, 'Economists at War' to encourage thinking on the substantial economic costs that will result from Covid-19. He does this by drawing a comparison between the pandemic and World War II experiences.

The Coronavirus pandemic continues to spread across the world and is being countered by a massive economic shutdown. The social and health costs are enormous. But it is time to think about the huge economic costs and how we are going to pay for them.    

Of course this pandemic has huge geo-political-economic implications. The virus that originated in China has now caused major disruption in Europe and the US. In every country there have been huge health and massive fiscal costs as businesses and jobs are being put into economic lockdown. There are going to be all sorts of long term consequences to the structures of economies – face-to-face businesses, especially old generation ones, will diminish and their digital/tele/virtual equivalents will prosper. Supply chain readjustment will bring key production closer to home, and we may see spill-over into concerted localism and nationalism. In that case the sheer magnitude of the international costs will be huge, disputed and disruptive. As usual most of the noise will occur between China and the US, but this time it is going to impact the whole trading world.  

When we look for comparisons and lessons in history, previous pandemics, financial crises and supply disruptions all spring to mind; but the magnitude of this shock is bigger. For a comparative experience of emergency powers, government direction, a huge expansion of the public sector and broad economic disruption, we may seek some comparisons from World War II experiences. The US did well economically from that experience, almost doubling its GDP. But most other major countries traversed the war period with no GDP growth, although this disguised huge flux between government and industry, between markets and direction, and between civilian and military production.    

In a recent book 'Economists at War' I recount how a handful of economists struggled to pay for their countries’ war: Japanese Finance Minister Takahashi Korekiyo could not meet the Japanese military demands for armaments, and paid the price by being assassinated. Governor HH Kung in China survived by identifying those Chinese banks, merchants and peasants who had money, and ruthlessly levying them, and ending up as richest man in the country. Reichsbank President Hjalmar Schacht in Germany struggled to design bond issues to pay for Nazi arms expenditure without re-triggering hyperinflation, and ended up on trial at the Nuremberg War Crimes Tribunal.  

Perhaps the most interesting example for us today is British economist John Maynard Keynes who, working alone in 1939, produced a remarkable document entitled 'How to Pay for the War'. The British Government had assumed it would issue war bonds and ration consumers. Keynes pointed out that the government had wider financing choices than that. He also reminded that its choice of policy instruments would end up hurting different sections of society in different ways, and would also have different impacts on growth. The UK Treasury had put in place a large emergency wartime budget, thinking they were following modern Keynesian reflationary policy. Keynes soon disabused them, pointing out it was counter-intuitive to stimulate demand when supply was not available.  

He saw four possible wartime funding channels: voluntary private lending to the government, reducing consumption by rationing, bidding for necessary resources through inflationary financing, or increasing taxation to transfer resources to the public sector. He rejected traditional rationing and inflationary financing methods as inefficient, preferring to use monetary and fiscal policy to control demand. His recommendations were put together for articles to be published in The Times, though bizarrely they were first published in an enemy paper Frankfurter Allgemeine Zeitung (due to a leak from a neutral correspondent). Labour politicians disliked the proposal, seeing his proposition for deferred pay as hurting the workers. Keynes rewrote his scheme to include a family allowance to deal with cost-of-living increases, and eventually this formed the basis of Britain’s wartime funding policies.  

Presciently, Keynes also urged the government to think ahead about the post-war recovery: would the recovering economy be held back by supply shortages or by market constraints? Would it require government stimulation or restraint?  This demand/supply trade-off is also a question which will soon confront us.  

As it turned out, most belligerent countries financed their wartime expenditures by a combination of means, particularly by increasing taxes on local populations, by borrowing from the domestic sector through war bond issues (international markets were largely non-functioning), and through extra credit creation by the central bank. In almost all cases in history war has left countries with big national debts. The burden of paying for war was spread across current generations (already suffering heavily reduced consumption) and future generations who would repay the debts. Unscrupulous countries had further options: Japan and Germany imposed harsh levies on conquered territories, while Italian financing ended up causing huge inflation.  

The US funded more of its wartime expenditure by domestic borrowing in World War I, by taxing in World War II, and by inflation during the Korean War, all of which had different distributional and efficiency implications. What happened next is interesting: after World War I the US reverted into isolationism, and the world retreated into protection and depression. After World War II and the Korean War the Bretton Woods agreement, the Marshall Plan and other US initiatives helped lead the Western bloc into a new era of openness; the Washington Consensus rules of the game led to trade growth which brought recovery and growth to the Western bloc. At the same time China went into four decades of inward-looking economic disruption.  

Will it be different this time?  

About the author

Dr Alan Bollard is Professor of Economics at Victoria University of Wellington and Chair of the New Zealand Infrastructure Commission. His recent book is 'Economists at War: How a Handful of Economists Helped Win and Lose the World Wars', Oxford University Press, 2019.  Article originally published in National Business Review.