The Third Pillar

by Raghuram Rajan

  The postwar resurgence was driven by five elements: reconstruction, the resumption of trade, technological upgradation and the movement of workers away from agriculture, greater education and labor-force participation, and the broad political consensus for growth.3 The immediate task of repairing the destruction caused by war was a source of employment for the semiskilled in the workforce, and it generated household income that would fuel demand for other goods and services. Reconstruction needed funds, and strapped postwar European governments could tax their populations only so much. This is where American liberality under the Marshall Plan for aid to Europe, announced in 1948, helped tremendously.

  The amount was not the most important aspect, though it was substantial and generous—a grant of about two percent of recipient country GDP between 1948 and 1951, or about $115 billion in today’s money at a time when the United States was much less rich. What made the difference was the timing, the nature, and the manner in which it was delivered.4 Europe needed capital goods and machinery, as well as raw materials like cotton, which only the United States could supply at that time. Few European importers had dollars. The Marshall Plan addressed this directly. Importers could order goods from US producers, the US government would pay the American producer directly out of Plan funds, and the European importer would pay its government. In short, the Plan addressed a dollar shortage, even while cleverly giving American politicians and labor a reason to support the plan; it would mean more US jobs.

  Moreover, the funds were grants, which meant that the European government could use the “counterparty” funds paid into its coffers to finance domestic infrastructure spending without worrying about paying it back. Finally, the United States encouraged Europeans to discuss among themselves how best to use the funds, thus attempting to instill more economic cooperation among erstwhile enemies. For instance, with everyone looking for dollars, there was a fear that European countries would not import from one another, so as to preserve scarce foreign exchange. To avoid this mutually harmful path, they set up the European Payments Union in 1949, whereby countries agreed to offset claims against all others in the Union, with dollars used only to pay the net remaining claim.

  Some of the early postwar structures, both within Germany and across Europe, had the explicit aim of addressing the fear that a resurgent Germany might go to war again. General Lucius Clay, the American military governor of defeated Germany, summarized American goals for the postwar German order as the four Ds: denazification, demilitarization, democratization, and decartelization. He could have added a fifth, decentralization.5 In addition to breaking the power of the strongest corporations, the postwar administration did not want an overly strong center. The West German national government ceded a variety of powers to the subnational units, the Länders, with a powerful independent Federal Constitutional Court overseeing relations between the various units.

  At the same time, pan-European structures sought to tie Germany economically to its traditional rival, France. Perhaps the most important new structure was the European Coal and Steel Community launched in 1951. Steel was critical to manufacturing, and for armaments. French Lorraine had massive reserves of ore, while the best coking coal was in the Ruhr Valley in Germany. Both sides had begun past wars trying to seize the other side’s resources. The Coal and Steel Community was an attempt to address the issue by creating a supranational authority that would oversee a single market for coal and steel. It worked well enough that the six initial participants, Belgium, France, Italy, Luxembourg, the Netherlands, and West Germany, signed the Treaty of Rome in 1958, establishing the European Economic Community (EEC) and moving toward a common European market in goods and services.

  Even outside the EEC, global trade grew as new multilateral organizations like the General Agreement on Trade and Tariffs pushed for lower import tariffs across the world. The IMF helped by monitoring exchange rates so that no country attempted to get an undue advantage from the increased openness by depreciating its exchange rate and exporting more, the “beggar-thy-neighbor” strategy that was much feared during the Great Depression. In addition, if a country started running excessively large trade deficits, the IMF offered it foreign currency loans to give it time to adjust its balances, so that it would not have to curtail its citizens’ consumption abruptly. The World Bank initially helped the reconstruction effort in Europe. It shifted focus when Marshall Plan funds started pouring into Europe, to fund infrastructure in other, less-developed, parts of the world.

  There was a fundamental change in assumptions underlying this new postwar rules-based order. Countries were no longer on their own bottom, alone unless they were lucky enough to have powerful friends. Implicitly, the new order asked countries to abandon the prewar zero-sum model, where one country’s growth diminished the power and security of others. Instead, it urged countries not to be suspicious of one another’s growth but to recognize they had a stake in it. Every country’s growth and development was seen via increased trade and investment as beneficial to all, especially as the rules constrained selfish behavior or coercive threats by the economically powerful. The system assumed responsibility to help every country in need, provided they signed on to behaving reasonably and following the rules of the system.

  American idealism was reflected in the largely democratic governance structures that the United States worked into many of the new multilateral institutions. Moreover, the new international order was rules-based. This meant that even the weakest country had some rights and protections and even the most powerful country, the United States, was theoretically subject to the rules—though practically it could find some outs. The postwar system could only have been set up by a country supremely confident of its capabilities, motivated by a genuine appreciation of the collective potential and possibilities if countries came together. The United States was that country. The reality of the postwar system fell short of its aspirations, but its aspirations were truly inspirational.

  Western Europe, the first beneficiary of this new order, became much more productive. Output grew not just from new investment in machinery, but also from the increased use of motor vehicles and the spread of electrification, the resumption of the interrupted rollout of the Second Industrial Revolution. These developments created a variety of virtuous circles.

  For instance, as farmers started using tractors, labor left agriculture and moved to work in new factories (that were being set up to utilize the cheap labor), and to live in the growing cities. Manufacturing required more educated workers, and average education attainments improved substantially across Western Europe. An increasing number of graduates filled the huge demand for skilled workers in the industrializing economies. Growing worker incomes then led to greater demand for consumer goods, completing the virtuous circle. As one example of the tremendous growth in manufacturing, in 1951 Italian factories made just 18,500 refrigerators, two decades later they were producing over five million a year.6 The explosion in supply was absorbed by a matching increase in demand. In 1957, fewer than 2 percent of Italian households had a fridge, in large part because few owned cars with which to shop in sufficiently large quantities to stock fridges. Indeed, Italy had just 7 cars per thousand people in the early 1950s.7 Today, such a low level of car ownership would rank it at 172 out of 191 countries, putting Italy at a similar level to poor developing countries like Gambia and Niger.8 By 1970, however, Italian car ownership had increased by more than thirty times that, which would put Italy at the same level as Thailand today.9 With widespread car ownership came fridges. By 1974, 94 percent of Italian households owned refrigerators, the highest ownership in Europe.

  Western European income growth was truly spectacular. Real income per person grew by an average of 6 percent every year between 1946 and 1975 in Germany, by 5.6 percent in Italy, by 4.2 percent in France, and by 2 percent in the United Kingdom. Growth rates seem less impressive in France and the United Kingdom, but that is because their postw
ar income was not so depressed as that of the defeated powers. By 1975, income per head in these four countries ranged from a low of $10,619 (in 1990 dollars) in Italy to a high of $12,957 in France. By comparison, US per capita income in 1975 was $16,284. Therefore, Western Europe had reached about three-quarters of US income levels from about a third of its level when the war ended. In addition, the postwar baby boom added to its population and to overall economic growth, with the French population growing by nearly 30 percent between 1946 and the late 1960s.10 No wonder French writer Jean Forastie, writing in 1979 about the postwar transformation of France, titled his book Les trente glorieuses, ou, La revolution invisible de 1946 a 1975 (The Glorious Thirty: Or, the Invisible Revolution between 1946 and 1975). The Germans were no less ebullient about their Wirtschaftswunder (“economic miracle”).

  How did Western Europe know what to do to grow? Western Europe was exceptional but not unique. Japan too experienced a growth miracle as, to a lesser extent, did some of the countries of Eastern Europe. In a sense, growth for all these countries was largely a matter of catch-up, following the tracks of the United States. Specifically, economic growth first comes from putting more people and equipment to work in the most productive sectors (so, for instance, much of the growth of developing countries comes as people leave agriculture for more productive jobs in manufacturing and services). Once resources are allocated to the right sectors, though, and each worker there has sufficient capital equipment and knows the latest techniques of production, more productivity can come only from inventing new useful products or yet better techniques of production.

  For much of the first three postwar decades, Europe was putting people to work outside agriculture, equipping them with the right machinery and skills, and imitating and improving on US technologies and production methods developed in the Second Industrial Revolution. Not only did these follower countries have a long way to go to catch up with where the United States already was, the United States was gradually expanding the technological possibility frontier further, with new discoveries and techniques extending the scope and benefits of the fundamental discoveries earlier in the century. As a result, per capita US income growth was a steady 2 percent over those three decades, much the same as its growth since 1870. Despite spectacular growth, and even though Western Europe narrowed the gap significantly, it had not fully caught up even by the early 1970s.

  It is one thing to know what to do politically, it is an entirely different matter to do it. That leads us to perhaps the most important element responsible for the three decades of strong postwar growth—consensus politics. Perhaps Western European politicians remembered all too well the prewar bickering that led to unpreparedness among the Allied powers and the fascist takeover in the Axis powers. Perhaps they feared meddling by the Soviet Union through its local proxies if they gave it a chance. Perhaps they were sufficiently chastened by the terrible war and the subsequent deprivation to try and work together. Or . . . perhaps growth created enough spoils that they were happy sharing it without bringing it to a halt by being greedy. And Western Europe was full of arrangements whereby spoils such as influence over media and the right to appoint supporters to government jobs were shared among the large political parties. So long as grease did not get excessive, it lubricated the paths to political consensus.

  Policy was left to the technocrats, like Ludwig Erhard, who led Germany’s postwar reforms, or Jean Monnet, the French champion of an integrated Europe, and given that there were few questions about the broad directions, they were left alone as growth continued. The steady opening up to external trade, for example, would have been difficult if politicians were willing to be disruptive in an environment where the public was still wary of competition. As it was, few objected, and growing trade lifted all countries. The willingness to trust technocrats allowed them to build a system that was beneficial for all countries, and therefore beneficial for each country. Growth would have been much more difficult if each policy had to meet today’s test of being clearly and immediately beneficial for a country.

  THE GATHERING PROBLEMS

  Across the developed world, there was a sense that states had finally learned how to tame markets and use their powers effectively. During the thirty heady postwar years, downturns were shallow. Economists believed their Keynesian stabilization policies were effective in smoothing demand and reducing the depth of the recessions; when the economy weakened, the central bank cut interest rates, and the government spent more, and these policies were reversed when the economy strengthened once again. How much the underlying strong intrinsic growth potential of the economy contributed to the effectiveness of Keynesian policies was not something policy makers dwelled on. Instead, they extrapolated strong growth, with minor dips, well into the future. And so they became more expansive on the promises they made, as well as the people they drew in to their countries.

  PROMISES MADE . . .

  War is perhaps the most extreme exertion of collective national will, and when waged by democracies, it requires tremendous shared sacrifice. In most twentieth-century wars, young working-class men bore the brunt of the war effort, many not returning from the fighting, while others returned physically disabled or mentally scarred. The Second World War did not even spare those who stayed at home. Ordinary civilians, even in countries like the United Kingdom that escaped occupation or a ground war, had experienced severe food rationing, bombing, and fear of invasion, even while they were exhorted to work hard for the war effort. As people came together to fight for the nation, there was a sense that the nation owed something to them and their communities. Therefore, as growth stayed strong and sustained in the postwar years, developed countries loosened their purse strings and promised to share the fruits of growth more widely.

  Perhaps the quickest to do so was the United Kingdom. Despite the reforms of the Liberal government in 1908–1911 that we listed in the last chapter, the United Kingdom still had a patchwork of social insurance programs that did not amount to a comprehensive safety net. In the darkest days of the Second World War, economist William Beveridge was asked to chair a committee with the somewhat tedious task of examining the existing safety net and seeing how benefits could be better coordinated—perhaps more as a make-work assignment that would keep the radical economist at a safe distance from immediate policy.11 His report in 1942 was, however, an instant bestseller, extraordinary for a work that contained 461 numbered paragraphs and appendices filled with detailed calculations. Final sales figures were over half a million, including fifty thousand in the United States. A cheap edition was even printed and circulated to troops at the front, explaining what they were fighting for.

  Beveridge proposed a single system of insurance against the important risks faced by a working-class family: childbirth, sickness, disability, unemployment, and old age. He outlined a contributory system where every working person paid into the system at the same rate, and anyone hit by one of these risks was helped with the same subsistence level of assistance. The idea was one contributory rate for one level of benefit for everyone, without any screens, such as whether the individual earned too much. Beveridge emphasized the principle that everyone would contribute, though employers and the state would also chip in. His aim was not to redistribute income between classes, though some redistribution was unavoidable, but to move an individual’s income “between times of earning and not earning, and between times of heavy family responsibility and of light or no family responsibility.”12

  The mandated contributions ensured that people would treat the safety net as their property right, much as Roosevelt wanted Americans to view social security in the United States. The setting of benefits at a subsistence level ensured that they did not deter anyone from arranging for additional personal buffers such as private insurance, or become so comfortable that a worker would not seek employment when adversity abated. In addition, the Beveridge Report recommended child allowances to alleviate the burden on you
ng families at their point of maximum need, free universal health insurance, as well as government responsibility for delivering full employment.

  Even though there were critics—some Conservatives saw Beveridge as “a sinister old man who wants to give away a great deal of other people’s money”—the Report captured the prevailing sense of national unity and egalitarianism in a nation under attack.13 If the nation had to come together, from the richest to the poorest, to defeat the Axis powers, it was incumbent on the rich to not let those of more modest means drown when normal life resumed. In the national election after the war, both Conservatives and Labor promised to implement the Beveridge Report, and the victorious Labor Party did implement much of it. Indeed, in 2012, the National Health Service, which delivers free universal health care in the United Kingdom, was featured in the opening ceremonies of the London Olympic Games as “the institution which more than any other unites the nation.”

  Much of continental Europe also strengthened its safety nets in the years of plenty. For example, the West German Social Security Reform Act of 1957 assured workers of a very generous pension that was tied to their wage on retirement, and further adjusted with the cost of living. The United States was initially the exception among developed countries. It did do its bit for returning military personnel with the GI Bill in 1944, which paid tuition and living expenses for them to attend high school or college, and ensured they got a low-interest mortgage or a loan to start a business. And it did raise marginal tax rates on the wealthy to 94 percent in 1944, arguably as their payment for the war effort.14 However, it did not go further in strengthening the safety net immediately after the war, despite being the richest country in the world.