Courtesy Everett Collection
This election will be one of the most consequential in recent history. One issue, above all, has surfaced as the dominant question before the electorate: What should be the role of government in American life?
The GOP ticket is an assault on the role of government and an embodiment of the view that markets must be left alone if they are to operate for the benefit of the collective good. This attitude ignores the lessons of history, namely that free markets require supportive and effective governments.
Rarely do we think that foreign policy can teach us something about the role of government in our domestic life. But it can. The cold war would not have been won had US leaders and their allies in Western Europe and Japan not learned how to use the “state” to make free markets operate effectively. Largely forgotten today is that at the end of World War II—after two global wars and a great depression—capitalism was in disrepute in much of the world. In The Road to Serfdom (1944), Friedrich Hayek lamented, “If we take the people whose views influence developments, they are now in the democracies all socialists. Scarcely anybody doubts that we must move towards socialism.” A decade later, journalist Walter Lippmann wrote, “We are living in a time of massive popular counterrevolution against liberal democracy. It is a reaction to the failure of the West to cope with the miseries and anxieties of the Twentieth Century.”
As the guns fell silent in the summer of 1945, American policy-makers worried that pestilence and famine would spawn revolution. In Europe, membership in the Communist Party was soaring, the role of the state was expanding, experiments with nationalization were spreading, and enchantment with “planning” was growing. In free elections in France, Italy and Finland, for example, the vote for communist parties was 20 percent or more by 1946.
Elsewhere around the globe, revolutionary nationalist movements were forming against the colonial powers. These movements clamored for independence and sought transformative changes in political economy, national identity and race relations. Planned economies, many of these revolutionary leaders believed, might rapidly propel their emerging nations into modernity and deliver to their people the dignity they yearned for.
Western leaders such as Franklin Roosevelt and Harry Truman in the United States, Clement Attlee and Ernest Bevin in England, Robert Schuman and Jean Monnet in France, Alcide De Gasperi in Italy, and Konrad Adenauer and Ludwig Erhard in West Germany grasped the challenges ahead. “People who are hungry, people who are out of a job,” Roosevelt said in 1944, “are the stuff of which dictatorships are made.”
These leaders realized that governments had to innovate in order to revive faith in free markets and social democracy. In Britain, the Labour government passed legislation giving cash payments to poor families, benefits to the unemployed and healthcare to everyone. Over time, social services as a percentage of GNP rose from 11.3 percent in 1938 to 23.2 percent in 1970; total public expenditures rose from 30 percent of GNP in 1938 to 47.1 percent in 1970.
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Similar trajectories occurred all over Western Europe. The French government insured citizens against the perils of sickness and old age and provided generous family allowances. So did Italy, West Germany and others. Between 1950 and 1973, the public sector in the average Western industrial country went from 27 to 43 percent of GDP, while social transfers rose from 7 to 15 percent of GDP.
In the United States, the role of government also grew. The GI Bill of 1944 provided unemployment, housing and education benefits to 16 million veterans. From 1947 to 1958, the Veterans Administration and the Federal Housing Administration financed almost 50 percent of new single-family homes purchased. At the same time, between 1945 and 1960, the number of people receiving Old Age, Survivors and Disability Insurance increased from 1.3 million to 14.8 million. As overall government spending as a percentage of GDP increased from about 17.1 percent in 1948 to 29.5 percent in 1970, poverty fell dramatically, from 51 percent of the American people in the mid-1930s to 30 percent in 1950, to 20 percent in 1960 and 17 percent in 1965.
The US government also played a decisive role in encouraging technological innovation. Its spending for research and development increased from $940 million, or 2.4 percent of total government expenditures, in 1949, to $13.8 billion, or 11.7 percent of total outlays, in 1965. It vigorously supported the electronics, computer and communications revolutions. In 1959, a congressional committee estimated that about 85 percent of electronics research and development was funded by the government, much of which went to major corporations like IBM, Burroughs, Control Data and Sperry. At this time, the government was paying for about two-thirds of all computer-related research and development.
In the quarter-century following World War II, Western states embraced new fiscal and monetary policies, created safety nets, helped mobilize capital and socialize risk, promoted international trade, and sustained purchasing power in bad times. The result was a remarkable period of prosperity and social peace. GDP in the United States grew by about 3.5 percent in the 1950s and 4.2 percent in the 1960s. In Western Europe between 1950 and 1970, GDP grew at 5.5 percent per year and 4.4 percent per capita; depending on the country, annual per capita income soared between 250 and 400 percent over that period.
But by the 1970s, the contest with communism was by no means clear. Annual economic growth rates in the Soviet Union in the 1950s and ’60s outpaced those in the United States (starting from a much lower base, of course). In Eastern Europe, growth rates were also impressive—about 5.1 percent in the 1950s and 4.3 percent in the ’60s. Soviet leaders bragged that their countries would overtake the capitalist West. They took great pride in the growth of life expectancy and the expansion of social services and healthcare. Developing nations looked to the Soviet Union as a model for their own growth to modernity. Harvard historian Charles Maier has written, “On the basis of their overall economic performance into the 1960s, serious-minded economists could still argue that central planning might serve developing countries better as a model than Western capitalism.”
In the 1970s, however, capitalist and communist economies faced new challenges. Monetary disarray, skyrocketing oil prices, wage-price spirals and soaring unemployment upended Western economies and catalyzed political turmoil and social ferment. In July 1975, Time magazine even ran a cover story titled “Can Capitalism Survive?”
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The familiar narrative is that Western governments responded by jettisoning their Keynesian commitments, raising interest rates, deregulating their economies, privatizing state-owned enterprises, lowering taxes and embracing more open markets. In this analysis, Jimmy Carter, Margaret Thatcher and Ronald Reagan led the way, and Helmut Kohl and François Mitterrand followed; a neoliberal turn occurred, one that rejected the state and embraced a globalized future.
This is true, but it’s only part of the story. This narrative omits the continued role of government in cushioning people from hardship, sustaining purchasing power and modulating even more severe fluctuations in the business cycle. In fact, noncommunist governments in the West increased spending as a percentage of GDP. They sold off public assets, but used the proceeds to subsidize key industries, augment exports, and help preserve safety nets and minimal social provision. In England, Thatcher talked about reconfiguring the relationship between the state and the individual, but welfare spending as a percentage of government expenditures and welfare spending as a percentage of GDP remained virtually constant. In France, Mitterrand ceded power from the state to the market and embraced privatization and deregulation, but social expenditures as a percentage of GDP actually went from 20.8 percent to 24.9 percent. Across the border in West Germany, social expenditures as a percentage of GDP grew between 1970 and 1982, and contracted only minimally thereafter. As the European Union took shape in the late 1980s and early ’90s, social protection as a percentage of GDP reached its peak, amounting to 28.7 percent of GDP in 1993.
Nor did social spending drop much in the United States, and neither did the size of the public sector. Notwithstanding all the rhetoric about a Reagan “revolution,” total government expenditures as a percentage of GDP in 1980 were 31.3 percent; in 1990, they were 32.5 percent. Social Security and Medicare spending were 5.5 percent of GDP in 1980 and 6.2 percent in 1990. The Department of Health and Human Services received 11.6 percent of government outlays in 1980 and 14 percent in 1990. And during these years, the hidden welfare state grew dramatically as Congress amended the tax code in various ways to achieve social purposes, mostly helping the middle class.
Through deregulation, liberalization, global integration, social welfare and minimal social provision, the West staggered through the 1980s, trying to reconcile the state and the market without provoking social revolution. Compensatory social spending by government served to maintain consumption despite growing unemployment in Western Europe and inequality in the United States. Safety nets, unemployment insurance and retraining initiatives helped preserve individual opportunity and standards of living, even as liberalized trade increased competition from low-wage producers in Asia and Latin America.
Communist regimes were unable to make similar adjustments. After 1968, Eastern Europe retreated from economic reform, failed to adjust to the oil shocks of the 1970s, and became increasingly dependent on loans from the West. Communist leaders could not institute a price system that provided incentives to innovate; nor could they boost productivity, satisfy consumer demand at home or compete abroad. As a percentage of Western European per capita GDP, Eastern Europe declined from 49 percent in 1973 to 37 percent in 1989. Infant mortality rates and life expectancy statistics also suffered in comparison to what was happening in the West.
The state without the market just did not work. But communism was bested by peoples in democratic polities who expected their governments to structure, support, regulate, liberalize and ameliorate market forces. This required judgment, fine-tuning, and continual recalibrations in the role of the state and the market. Different governments in the West proceeded in different ways, but they all recognized that states and markets were codependent.
When we think about the choices before us today, we should seek to learn from the past. What revived capitalism following World War II was the realization that free markets require strong governments to nurture economic growth, stimulate innovation, empower civil society and enhance living standards. The crisis of the 1970s was handled through gradual, piecemeal changes rather than any radical transformation of the safety net or erosion in the role of government. Governments can complement, structure and liberate markets, and also help to allay the hardships caused by them. Getting the right balance between the “state” and the market—forgetting the importance of neither—is indispensable in meeting people’s desire for a decent standard of living, education and opportunity, as well as in sustaining an effective foreign policy abroad. We forget this at our peril.