How America Got Rich
If you want to understand how the United States became the most prosperous society in the world, start with the ballpoint pen. László Bíró, a Hungarian who had fled the Nazis and gone to Argentina, invented the first working solid-ink pen. When the owner of Goldblatt’s department store in Chicago showed the contraption to a passing salesman named Milton Reynolds, Reynolds decided he could do it better.
The year was 1944. American factories were producing a warplane every five minutes, 150 tons of steel every hour, eight aircraft carriers a month. Milton Reynolds knew nothing about this kind of heavy industrial production. Born Milton Reinsberg in Minnesota (he changed his last name because he feared Midwesterners wouldn’t buy from a Jew), the 52-year-old had spent the war years selling customer signage to department stores, including a “talking sign,” of his own invention, that sat on store counters.
Bíró had leased his design to two American pen makers, Eversharp and Eberhard Faber. The pen had proved popular with British Royal Air Force crews because, unlike a traditional fountain pen, it wouldn’t burst at high altitudes. But Goldblatt’s owner was wondering if it would sell in the United States. Reynolds wasn’t sure. The Bíró pen depended on a complicated rolling-ball mechanism to spread its ink. Someone might be able to make a simpler and cheaper pen, Reynolds decided, by letting gravity feed the ink to the point.
Milton Reynolds had never made a pen in his life. Still, he rented an indoor tennis court that had fallen into disrepair and opened Reynolds Pen Company with two employees. They made the pen’s roller ball from surplus Air Force bombsights and the barrels from surplus aluminum.
On October 29, 1945, just 10 weeks after VJ Day, Reynolds not only beat Eversharp and Eberhard Faber to market, but had 10,000 pens ready for sale in the front window of Gimbel’s in New York City. More than 5,000 shoppers stormed the store. Fifty cops had to be called in to control the crowds. At $12.50, the Reynolds pen cost almost as much as an overnight stay at the Waldorf Astoria. But New Yorkers in the aftermath of war were looking for the perfect present to give returning GIs—and thanks to their wartime jobs, they all had money to spend. Before the day was out, Milton Reynolds had sold every pen.
The story of the ballpoint pen showcases what turned the United States into the world’s most affluent society after 1945: entrepreneurship, innovation, cheap and readily available raw materials, a built-in bias toward competitive production, and a voracious consumer demand—made more voracious by the deprivation of the Depression years and restrictions of World War II.
Periods of economic growth had been known in the past—the 1920s—and they would be known again in the future, as in the Reagan years. But never had there been anything quite like what happened in the 15 years after 1945. It was nothing less than a material transformation of American life that gathered momentum in the coming decades.
In 1945, less than half of American households had a telephone. Making a long-distance call was a cumbersome business, requiring the help of an operator. By 1960, it was rare to find a household that didn’t have a phone. And with the introduction of direct-dial long distance in 1965, the number of such calls rose from 3 million in 1940 to 26 million in 1970.
On the eve of World War II, an electric washing machine was a rare luxury. In 1960, almost 75 percent of households had them. Twenty years later, 70 percent also had an electric dryer.
In 1940, more than a fifth of Americans lived on farms; less than a third of those farms had electricity. A third of those farms had no indoor running water; a tenth had flush toilets. Barely half of all American households had a refrigerator, and 58 percent had no central heating. The typical workweek was 50 hours, with more than half the workforce earning a living through physically demanding labor such as farming, factory work, construction, and mining. With average life expectancy pegged at 63 years, it was common for a person to work until he lost his health.
In just 20 years the existence of an American home without electricity or indoor plumbing had gone from being a fact of life to a national scandal demanding federal action. National income rose from $78 million in 1940 to $409 million in 1960, and then quintupled to $2.3 billion in 1980. Life expectancy for American males rose to almost 70 by the time of John F. Kennedy’s inauguration. A comfortable retirement with a private pension virtually became a human right; by 1980, 70 percent of all workers had one.
Even more remarkably, despite a steady expansion of government programs such as Social Security and the Pentagon and projects such as the Interstate Highway system, national debt between 1946 and 1960 rose by only 6 percent, even as GDP grew by 237 percent. Indeed, achieving an average annual GDP growth rate of 4.75 percent while running a budget surplus during 7 of those 14 years must have seemed a miracle to those who remembered the Great Depression. Today, in the shadow of the slowest economic recovery in modern history—with a growth rate at 1.5 percent—it looks like one, too. Understanding what triggered the Great American Transformation, and what didn’t, might be a valuable guide to the future for the current resident of the White House and those who follow.
Certain long-standing clichés surround the story of America’s “economic takeoff” in the two decades before 1960. One centers on the role of World War II and the federal government’s massive spending to win (some $284 billion, if we include the Lend-Lease program that took place before the U.S. entered the fray). The fact that GDP almost doubled in those same years, with unemployment shrinking to little more than 1 percent, has led many historians and economists, including nearly all Keynesians, to conclude that the two phenomena must be connected. Here is a passage from a typical college textbook:
World War Two ended the depression in the United States. Before the war was over, net farm income almost doubled, and corporate profits after taxes climbed 70 percent. From a total of more than 8 million unemployed in 1940, the curve dropped below a million in 1944….There had been no comparable economic boom in American history.
This is wrong.
World War II did not end the Great Depression; in crucial respects, it may have prolonged it.
Even its amazing rise in industrial production—26 percent in just five years—was only half of what the 1920s had achieved without the same massive government spending. Rather, what the war-production effort did do was to restore American industrial production to something approaching normal levels and raise savings rates to fuel an economic recovery afterwards.
Even the amazing numbers usually given to illustrate the “wartime boom” are softer than they appear at first glance. For example, a drastic drop in unemployment isn’t difficult to engineer when almost 12 million of the eligible workforce get conscripted into the armed forces. Likewise, to quote the economist Robert J. Barro, “The data show that output expanded during World War II by less than the increase in military purchases.” Real non-government GNP growth, which was moving ahead in 1940, actually slowed down in 1942 and then slowed still further in 1943.
In fact, far from having a multiplier effect as Keynesians might suggest, spending on the war may have interrupted an economic recovery already under way. In 1940–41, just before the bombing of Pearl Harbor and when government spending was still at relatively low levels, GNP jumped from $90.5 billion in 1939 to $124.5 billion. Then, with mobilization, private consumption and investment headed south while government deficit spending headed sharply north, rising from $6 billion in 1940 to $89 billion in 1944.
And while millions of Americans found work in wartime factories and shipyards and farm and non-farm incomes steadily rose (for industrial workers, by an average of 70 percent), it was impossible for them to buy new durable goods, from cars to refrigerators, and they found many basic consumer goods, such as coffee, meat, sugar, gasoline, shoes, and newsprint, strictly rationed. In addition, nearly everyone was paying out a growing sum of their income in federal taxes to pay for the war—a tax on incomes as low as $645 a year (less than $7,740 in today’s dollars).
Yet despite the wartime restrictions, Americans still ate better, consumed more meat, bought more shoes and clothing, and used more energy than they had before the war. And even though the United States wound up producing the most munitions of any country in World War II, it was also the least mobilized of all the major combatants. At no time did more than 40 percent of its economy switch over to war material production. That allowed 60 percent of American women to stay home and men such as Milton Reynolds to make sales calls at department stores as if nothing were happening, and dream of better days.
All the evidence suggests, then, that the war didn’t create a strong U.S. economy. It was the strong economy that made mobilization for war possible without impoverishing the country (which is what happened to Great Britain and the Soviet Union). What World War II actually did was sacrifice real present growth in order to defeat the Axis. Yet it also set the table so that “as the war ended,” writes economist Robert Higgs, “real prosperity returned almost overnight.” It was the crucial period of 1945 to 1947 that really marked the start of economic takeoff.
And the key reason was tax cuts.
That brings us to our second myth: that the immediate postwar period saw a second economic surge driven by consumer demand, as Americans flush with victory rushed out to spend their wartime savings on cars, houses, washing machines, radios, televisions, and Milton Reynolds’s ballpoint pens. In this version of the boom, aggregate consumer demand replaced government demand for bombers, submarines, and artillery shells. “During the war, people had accumulated large stores of financial assets,” a prominent economic history textbook published in 1990 put it. “Once the war was over, these savings were released and created a surge in demand.” In short, the Keynesian formula was proved right again.
Is that true? No. It is true that savings rates rose to record heights during the war. After all, there was almost nothing to buy, even as incomes were soaring. But long ago Milton Friedman and Anna Schwartz noted that the postwar period saw no drop in total savings. People’s liquid assets actually continued to grow after the war, from a record $151 billion at the close of 1945 to $168.5 billion by the start of 1948. In other words, few if any consumers really believed good days were here to stay. Most believed what leading economists believed, including many Keynesians: that the war would be followed by a prolonged period of empty factories, unemployment, and renewed depression. People tucked away their savings and battened down the hatches—everyone, that is, except American business.
What really triggered the first takeoff burst wasn’t the unwinding of personal savings but business savings, in the form of a sharp and steady rise in private capital investment. And that was helped by the Big Tax Cut of 1945.
As the war came close to its end, the political consensus among everyone except leftist Democrats was that taxes were too high. Income-tax rates had soared to the point that revenues in 1944 were almost quadruple those of 1940. In addition, a punitive “excess profits” tax had been imposed on businesses on top of the usual corporate rates.
Even before the bomb was dropped on Hiroshima, Congress passed the Tax Adjustment Act, speeding refunds for businesses that were ending their government contracts. Two months later, Congress passed the Revenue Act of 1945, which lowered tax liabilities for 1946 by roughly 13 percent of total federal revenues—one of the most massive tax cuts in American history. At the same time, Congress repealed the corporate excess-profits tax, cut the top marginal tax rate from 94 percent to 86.45 percent, and the lowest marginal rate from 23 percent to 19 percent.
This was a clear-eyed exercise in what would later come to be known as supply-side economics. Senator Walter George of Georgia, chair of the Senate Finance Committee, predicted the tax cut would “so stimulate the expansion of business as to bring in a greater total revenue.” He was right. Revenues soared even as government expenditure continued to fall, and America’s postwar boom was on track.
The Big Tax Cut was helped also by the repeal of wartime wage and price controls—something liberal Democrats and President Harry Truman fiercely resisted. Then, in the 1946 midterm elections, Republicans campaigned on a further tax cut of 20 percent, to be matched by a 50 percent reduction in federal spending. Americans rewarded the GOP with control of both houses of Congress that fall, which led to the phasing out of the last remaining wartime rationing regulations and the passing of a new round of tax cuts in 1947. Democrats won back the House in 1948 and reelected Harry Truman. But it was too late to halt the tide of prosperity that the Big Tax Cut had let loose.
Business investment, which had gone flat during the war, jumped from $10.6 billion in 1945 to $40.6 billion in 1948, a fourfold increase, as plants expanded and retooled for the production of civilian goods. Even as the overall personal-savings rate fell from its wartime highs, the private-investment rate soared from 5 percent to almost 18 percent, with the biggest leap coming in 1946—a leap that would not be reflected in GNP numbers until two years later. Corporate profits soared by nearly 20 percent, as unions scrambled to keep up by pushing for higher wages and more benefits—demands a new, flush corporate America was inclined to meet.
Meanwhile, business savings almost doubled in the same period, from $15.1 billion to $28 billion, providing a sure way to finance expansion and new hiring. For the first time since 1929, companies began to turn heavily to the capital and bond markets to raise funds. Stock prices surged, and by 1947 shares had appreciated 92 percent.
At the same time, the ingenious productivity that American corporations had shown in making planes, ships, and tanks—steadily lowering their cost year after year—translated into the same efficiency in making consumer goods, from radios and TVs to cars and suburban homes. The growth included raw materials from oil and rubber to aluminum and food stuffs, as the end of wartime rationing and price controls boosted production and lowered costs. The cost of feeding Americans, for example, fell to 10 percent of GDP from 25 percent during the war.
In 1947, the GDP numbers began to reflect the economic explosion under way. The gross domestic product of the United States stood at $231 billion–roughly what it had been in 1945. In 1948, it rose to $258 billion, paused there for 1949, and then bloomed from $285 billion in 1950 to $398 billion in 1955. In the decade and a half after 1945, GNP grew at an average annual rate of 4.75 percent. Unemployment, which had stood at 3.9 percent in 1948, then dropped to 3 percent in 1952 before settling in at 4.1 percent in 1956.
As the tide surged, other boats rose, as well. Median family income in the United States grew by almost 38 percent. And alongside the big corporations that emerged from the war stronger than ever, such as General Motors and U.S. Steel and Westinghouse—or Lockheed and Boeing, which would become pillars of the Cold War military-industrial complex—there were hard-charging entrepreneurs such as Milton Reynolds. His Reynolds Pen Company grew to 400 employees as competition drove the price of a pen from $12.50 to less than 50 cents.
Another was Ray Kroc, a traveling Dixie Cup salesman who in 1955 bought a hamburger stand belonging to two brothers named McDonald. Then there was William Levitt, who transferred the skills he learned in making defense-worker housing in Virginia and Hawaii to suburban homes around the country; and William Boyle, a manager at the Franklin National Bank on Long Island, who in 1951 came up with the idea of the credit card.
Before the 1950s were out, the entrepreneurial wave would reach northern California, with what would come to be known as Silicon Valley.
Here we come to the final myth about the great period of postwar prosperity: that it was fueled by a close cooperation between Big Business and Big Government, aided by deficit spending that “fine-tuned” the economy’s natural upswings and downswings. According to Robert Samuelson’s The Good Life and Its Discontents: “The wartime boom…created an economic and political model that seemed to work….Government and business could collaborate, as they had during the war, to engineer peace and progress.” They did so with gusto in the Eisenhower years. The federal budget did soar: The annual outlay in 1959 was more than double what it had been in 1950. Much of it was military spending for the Cold War, which led many to assume such action was not only good for the free world but good for business, as Boeing and Lockheed and Grumman became pillars of the economy.
Indeed, according to conventional wisdom, so successful was the Eisenhower-era formula of combining government with business investment, from the military-industrial complex to the Interstate Highway system and the race to the moon, that some economists wondered if the business cycle hadn’t finally been abolished—just as they had in the 1920s. America’s leading Keynesian, Paul Samuelson, would write in 1964, “Our mixed economy, wars aside, has a great future before it.”
The truth was very different. In fact, business’s “cooperation” with the federal government in the 50s—some of it, such as arming for the Cold War, urgently necessary—would have the same effect on the economy as driving a sports car with the parking brake on. Indeed, it was a tribute to the underlying strength of the earlier Great Transformation that a series of missteps in the Eisenhower years didn’t grind the process to a halt.
The first cloud on the horizon was the sudden burst in military and government spending, triggered by the Korean War. It was World War II all over again, except that this time the diversion of economic resources to non-economic purposes would last through the 1950s and beyond. In 1950, the coming of war pushed federal outlays up from $38 billion a year (less than two-fifths of what they had been in 1945) to $42 billion, creating a budget deficit for the first time in four years. Deficits would continue to pockmark the Eisenhower years (1952, 1953, 1954, 1955, 1958), with the worst coming in 1959, when the federal government went almost $13 billion in the red. The rise in deficits in the Eisenhower years was matched by a rise in recessions, which hit in 1953–54, 1957–58, and 1960–61.
Fortunately, a still growing economy was able to supply plenty of guns as well as butter. But the steady rise of other kinds of domestic spending at the same time, including Social Security, signaled what was coming. President Eisenhower’s military-industrial complex, which he worried would become the principal driver of runaway federal spending, would soon be dwarfed by domestic entitlements.
The standard view is that one of the offshoots of the military-industrial complex of the 1950s was a range of technologies, from transistors and jet propulsion to satellites and computers, that spurred innovation in the private sector. Perhaps. But the fact remains that during the 1950s, when America’s electronics firms were firmly focused on supporting the defense sector, the growth of technological advance lagged behind Germany’s and above all Japan’s, both of whose electronics industries came roaring back from the war’s aftermath in the same period. The launching of Sputnik in 1957 revealed that something was very wrong with America’s supposed technological edge, despite the arms and space race. Overall, as George Gilder has written, “The 1950s were a disastrous period for American technology and economic advance.”
Far from “fine-tuning” the economy, rising federal spending sucked away resources that might have gone into extending and deepening economic growth. Such growth might have helped groups such as African Americans and non-union workers, who continued to lag behind their white and unionized counterparts. Instead, taxes rose—in the case of the top marginal rate, to 97 percent—to try to constrain the spreading rash of deficit spending.
Even so, it was impossible to take away what had been achieved in reviving American productivity and transforming material life. “In 1946, we did not have a car, a television set, or a refrigerator,” reported the son of one Johnstown, Pennsylvania, steelworker. “In 1952, we had all those things.” What would sustain this standard of living weren’t the big corporate firms, the Fords and General Motors and U.S. Steels and AT&Ts. Increasingly hampered by rising costs, internal micromanagement, and government regulation, these firms could see by 1960 the end of their heyday.
It was instead the undercapitalized start-ups, especially in areas such as consumer electronics where government intervention was almost nonexistent and the rewards for rapid innovation were large, that would point the way to the next stage in the Great American Transformation. It was in 1955, the same year Ray Kroc bought McDonalds, that physicist William Shockley left his employer at Bell Labs to set up his own firm in a shed in Palo Alto, California, to make his first semiconductors. In 1958, engineer Jack Kilby turned up for work at a Dallas-based company called Texas Instruments to develop what would become the integrated circuit.
A new consumer revolution was coming: the computer revolution. It would come under the radar, overshadowed by world and macroeconomic events, just as the Great American Transformation was ending. The most prosperous society on earth was about to extend its powers in ways no one could ever have foreseen.
How did the Great American Transformation take place? Not by government intervention or investment or fine-tuning—or through other modalities Keynesian-minded economic advisers have tried to reproduce, most recently in the Obama $800 billion stimulus.
It was, instead, a threefold combination of renewing economic productivity, imposing tax cuts, and encouraging business savings capitalized as investment—together with the bias toward entrepreneurship and innovation that has always characterized the American economy. It needed its Milton Reynoldses and Ray Krocs, as well as its GMs and U.S. Steels, and in the end the forces that fueled the former have proved more durable than the ones that undergirded the latter.
“You didn’t build that,” President Obama notoriously said in July to America’s entrepreneurs. No, actually, these men did. And men and women like them can do it again if Washington doesn’t get in the way of the next Great Transformation.