Downside: After the Returns Stop Diminishing, Part II

“You can’t be too safe,” is an expression you hear from time to time. The government takes it upon itself to protect its citizens. It suggests that you can’t spend too much on military preparedness and that defense is too important to be left to popular preference. Leaders think they know better; they insist. But is military spending really not subject to declining marginal utility? And what happens after even the marginal returns are gone?

Germany’s experience in WWII shows what you can get from ‘too much’ military spending; it was almost pure downside. But it was not obvious at first. Central planning can do a good job of imitating real progress — at least in the short run. And in the ’30s, Germany’s economy began to look a lot like a success. Factories — reacting largely to orders form the military — began to recruit more labor. At the same time, the ranks of the army grew, removing able men from the workforce. The result was a lower unemployment rate. Joblessness had been as high as 6 million at the beginning of 1933, with capacity utilization as low as 50%. That was when the ‘Battle for Work’ began. Only 6 months later, East Prussia was declared “free from unemployment.” How was this miracle achieved?

“The jobless of East Prussia were ruthlessly conscripted,” explains Adam Tooze in his book The Wages of Destruction. “Thousands of married men were herded together in ‘camps of comradeship.’ Where they were subjected to a heavy program of earth-moving and political education…”

Economists, as we have mentioned, are not able to measure quality, only quantity. They cannot distinguish a ton of steel used in a battleship from the same quantity rolled out and pressed into automobiles. They cannot tell the difference between a man who is growing wheat from one who is distributing propaganda leaflets.

But from an employment point of view, the Nazi war economy was rarely surpassed. Unemployment went down after 1933…and kept going down for the next 12 years. When the end came, Germany not only had zero unemployed workers. It had an unemployment rate that had gone deeply negative, with millions more people holding jobs than there were people in the German workforce.

How did it achieve this amazing result? Not by increasing the number of real jobs. It did it be reducing the labor force, not only in Germany, but throughout Europe.

In Germany alone, 4 million men were taken out of the labor pool for service in the Wehrmacht. When they overran France in May of 1940, the Germans captured 1.2 million Frenchmen. And in 1941, the Third Reich relieved 3.3 million Russians — most of them permanently — from the need to seek employment.

As the war continued, Germany’s labor force continued to shrink. Forty thousand people were killed in the firestorm set off by the British air force in Hamburg. But losses at home were nothing compared to the losses abroad. Stalingrad cost them 91,000 soldiers. Tunisia cost them 230,000 German and Italian troops. The Wehrmacht was then fighting on three fronts. East. West. And South. Losses to its armies had to be replaced. By the war’s end, a third of the boys born between 1915 and 1924 were either dead or missing. This forced the planners to reach further into the population…particularly the farm population.

Economists could do some fun ciphering with these numbers. The unemployment rate dropped to zero early in the war…and then it kept going down. Women — who were not really part of the workforce, since they had never worked in the job market and had no desire to get a job — were nevertheless dragooned into the factories to replace their fallen husbands and brothers. And when this source was exhausted, the unemployment went negative even further.

A slave is not usually considered part of the labor pool. He is not someone who is looking for work. He is not someone who responds to an ad in the ‘help wanted’ pages. He is not someone who is likely to pay into a pension or sue his employer. And yet, bringing millions of these workers into the German economy had a remarkable effect on the unemployment rate. There were soon far more laborers than the entire measure of the labor force. By the end of the war, nearly one of every 4 workers was a foreigner — many of them there against their will. As a percentage of the workforce, unemployment had reached a phenomenal level — at about MINUS 25%. Economists must have been delighted. Their numbers had never looked so good.

The first large group of laborers were Poles. There was already a precedent for using these foreigners on a seasonal basis in German agriculture. As more German men were called away from farms, more foreign farm labor was used. The first slave laborers in the Fatherland were 300,000 Polish soldiers captured in the 1939 attack. Then, by the spring of 1940 another 200,000 Polish civilians were brought in. Then, after the attack on France, the number of slave laborers swelled by 1.2 million prisoners of war — most of them French.

At first, the Poles were recruited with promises of reasonable pay and food. Thousands signed up. However, the Nazis’ Übermensch delusions soon spoiled the business. The civilian Poles were treated as badly as the captured soldiers. They were housed in prisons and so poorly fed that many died. After a few months, they were so weak from hunger and mistreatment that they had to be shipped back to Poland. Tooze quotes an eyewitness:

“There were dead passengers on the returning train. Women on that train gave birth to children that were tossed from the open window during the journey…people sick with tuberculosis and venereal disease rode the same coach. The dying lay in cars without straw, and one of the dead was thrown onto the embankment.”

Word got around. Recruiters could no longer get the Poles to sign up as voluntary ‘Ostarbeiter’ But the demand for labor did not slack off. It increased, and voluntary recruitment soon turned into outright slavery. The biggest source of slaves, or near-slaves, was the Soviet Union, where approximately 2.7 million Soviets are believed to have been rounded up to work in Germany after 1941.

Surprisingly one group who fared particularly badly in the hands of German employers was their own erstwhile ally — the Italians. Italy dropped out of the war in the autumn of 1943. Rather than let them go over to the allies, Germany took prisoner every Italian soldier it could lay hands on. These were worked mercilessly during the following winter, with 32,000 succumbing to starvation and related diseases.

At the beginning of Operation Barbarossa, the plan was for captured Russians and Poles to be cut off from food and allowed to die; Jews were murdered. But as the labor shortage worsened, even the Jews were given an opportunity to work for the Third Reich. As many as 1.65 million concentration camp internees were put to work for Germany during the war years. Approximately 3/4 did not survive the war.

While Germany enjoyed some of the lowest unemployment rates the world has ever seen, its economy boomed. Literally. The English…and then the Americans…were bombing the hell out of it. This too had a remarkably beneficial effect — at least from the point of view of a numbers-addled economist. Capacity utilization — a key measure of economic health — rose to almost impossible levels. Every factory. Every railway car. Everybody who could walk and every corner or every workplace was pressed into service of the war economy.

Full capacity. Full employment. What was not to like?

Statistically, the German economy in the ’30s and early ’40s was in rude health; but the health of the people who lived and worked in it deteriorated. They had less to eat, and less fuel for heat and transportation. Their houses were smaller, colder, more dilapidated…if they hadn’t been destroyed completely. From the very beginning in 1933, the domestic economy was stripped in order to provide resources to the military. Food, housing, clothing all were soon rationed in order to prevent price inflation. Ration coupons for clothing, for example, helped cut demand. But nothing could boost supply, not when so many people and so much capital had been diverted to war.

As the war intensified, of course, so did the shortages. The farms lacked labor and equipment. The factories were converted to supplying guns, uniforms and ammunition. And the houses were deteriorating or being destroyed. Allied bombers were overhead more and more frequently as the war went on. Americans had brought in thousands of Mustang fighter planes that were faster and more maneuverable than the Luftwaffe’s planes. This made it possible to undertake massive daylight bombing raids.

In terms of built-up demand, Germany’s builders never had it so good. Domestic housing construction had peaked out in 1937. Five years later, there was hardly a house in the country that didn’t need building…or rebuilding. A quarter of a million houses were damaged in the bombing of Hamburg alone. Trouble was there were no domestic builders to fix them; they had all been drawn into the war effort, along with everyone else.

This left Germans with worse food, worse housing, and less income than they had before the Nazis took over. As early as 1941 — in the first years of the war — civilian consumption was already down 18% from 1938…and the collapse was just beginning.

With so few workers and so many jobs, you’d expect a substantial increase in real incomes. But that presumes there is a freely-functioning labor market. In Germany, labor rates were controlled by the central planners, who had ideas of their own. And their main idea was to wring out as much of the wealth of the private sector as possible, so that it could be directed to the military industry. By war’s end, there was little left.

Putting aside the millions of dead and the bombed-out, ruined landscape of Germany, in purely economic terms the war was a catastrophe. In 1945, it was the Germans’ turn to starve. In many urban areas, the daily calorie ration was no more than 1,000. Diseases linked to malnutrition were rampant. The birth weight of newborn babies was dangerously low. In terms of GDP per capita, Germany had wiped out 6 decades of progress. Not since 1880 had Germans lived with so little material output. But that assumes the GDP measured real, useful output. It did not. It measured primarily military output. The real living standards of the Germans were much lower than even these numbers reveal.

But by then, the chief central planners were dead or in the custody of the allies. It was horribly expensive and painful, but Germany had provided a good lesson. Germans were probably ‘safe enough’ in 1933. Perhaps the first few extra tanks and airplanes didn’t hurt. They may have been useful. Maybe not. Perhaps they merely brought German security spending to the point of declining marginal utility. But then they continued and increased…above and beyond the point where diminishing returns become negative returns; that is, they soon brought Germany to the DOWNSIDE.


Bill Bonner
for The Daily Reckoning

The Daily Reckoning