The demands of war

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At Nuremberg, judges acquitted Hjalmar Schacht (President of the Reichsbank and Hitler’s Economics Minister) of participating in the Nazi conspiracy to wage aggressive war. 

Exculpation rested on a kind of ‘double-effect’ justification. Schacht was held to have voluntarily performed actions – floating government securities used to fund re-armament – which had as a foreseeable consequence an increase in Germany’s capacity for crimes against peace. But he was held not to have intended that this specific consequence should come about.

In turn the plausibility of this defence rested on Schacht’s having been removed from his position by Hitler in 1939. Schacht had protested when Hitler’s Finance Ministry exceeded its agreed level of borrowing. In a kind of before-its-time concession to today’s Maastricht conditions, he refused to let the central bank re-finance government debt. It was this fiscal orthodoxy (born, no doubt, of the 1920s) that saved Schacht’s neck in 1945:

After Goering’s appointment, Schacht and Goering promptly became embroiled in a series of disputes. Although there was an element of personal controversy running through these disputes, Schacht disagreed with Goering on certain basic policy issues. Schacht, on financial grounds, advocated a retrenchment in the rearmament programme, opposed as uneconomical much of the proposed expansion of production facilities, particularly for synthetics, urged a drastic tightening on government credit and a cautious policy in dealing with Germany’s foreign exchange reserves. As a result of this dispute and of a bitter argument in which Hitler accused Schacht of upsetting his plans by his financial methods, Schacht went on leave of absence from the Ministry of Economics on 5th September, 1937, and resigned as Minister of Economics and as Plenipotentiary General for War Economy on 16th November, 1937.

As President of the Reichsbank, Schacht was still involved in disputes. Throughout 1938, the Reichsbank continued to function as the financial agent for the German Government in floating long-term loans to finance armaments. But on 31st March, 1938, Schacht discontinued the practice of floating short-term notes guaranteed by the Reichsbank for armament expenditures. At the end of 1938, in an attempt to regain control of fiscal policy through the Reichsbank, Schacht refused an urgent request of the Reichsminister of Finance for a special credit to pay the salaries of civil servants which were not covered by existing funds. On 2nd January, 1939, Schacht held a conference with Hitler at which he urged him to reduce expenditures for armaments. On 7th January, 1939, Schacht submitted to Hitler a report signed by the Directors of the Reichsbank which urged a drastic curtailment of armament expenditures and a balanced budget as the only method of preventing inflation. On 19th January, Hitler dismissed Schacht as President of the Reichsbank.

Today, the world’s chief belligerent power faces no spending or balance-of-payments constraints, whatever Congressional demagogues may tell the public.

The Pentagon’s annual $US800 billion-or-so budget is made possible by an international financial system running on the US Treasury-bill Standard, in which Washington borrows abroad in its domestic currency, and where, in consequence, servicing overseas liabilities represents no more of a challenge than does domestic debt. Around two-thirds of US government debt is held, as a long-term investment, by foreign central banks and their associated sovereign-wealth funds. Even if the Federal Reserve refused, in a fit of conservative pique, to monetize the fiscal deficit, these foreign central banks would continue happily to do so.

There does exist, however, a real constraint on US military spending and government arms procurement. To see why, it’s necessary to consider the economic nature of the defence/military industries.

An economy can be partitioned into a basic sector (made up of all industries whose output is technically necessary, in that their goods provide material inputs for a wide range of other activities) and a non-basic sector (output of which does not feed back into production of other goods, or which only enters into production of other non-basic goods). This non-basic sector exists by the support of the physical surplus product of the basic sector. The latter sets an upper limit on the material product available for unproductive purposes, such as armament production.

This is why, speaking generally, conflicts involving force or the threat of force are resolved to the advantage of that contending party which can produce and mobilize a larger freely disposable surplus available to be squandered on the demands of war.

Take the typical production process of a federal-government-contracted armaments firm like Lockheed Martin, Boeing, Northrop Grumman, General Dynamics, United Technologies, Raytheon, British Aerospace, etc. The output of these military producers typically takes the form of weapons, munitions, armour, vehicles and warplanes, etc. These latter goods do not enter, directly or indirectly, as inputs into production of other goods. They do not add to the economy’s productive capacity or stock of accumulated wealth, being merely destructive (i.e. they don’t persist over time or enter into future rounds of production). They do not enter into the consumption bundle of the working population and its dependents (i.e. they don’t make up part of the real wage).

Suppose that, due to some advantageous new invention or design at Skunk Works, an assembly line or production unit at Lockheed now produces more output with the same inputs or uses less input for the same output. This increased efficiency does not flow on to reduce the cost of producing anything else. (It’s true that some intermediate components of defence/military producers may have alternative non-military purposes, e.g. a turbofan jet, produced by a Boeing, Pratt & Whitney or a Rolls-Royce, can be installed in a military fighter or in a passenger aircraft, in which latter case it enters into the wage bundle. By contributing to reproduction of the employed population this output therefore is productive).

But armaments production does require, as an indirect input, a bundle of consumption goods (necessary to feed and clothe the workers of the company, plus upkeep of the administrators), plus as direct inputs some capital goods (buildings and equipment), raw-material resources, etc.

The size of this military/defence industry is thus limited by the magnitude of the surplus created in the basic sector (i.e. the wage goods and capital goods industries), a fraction of which enters as a material input into the former’s production and without which surplus it, accordingly, could not exist.

In procuring the output of defence contractors, the Pentagon thus appropriates part of the US’s surplus product (economic output over and above that necessary to reproduce the domestic working population, its dependents or the country’s productive capacity).

As a net creditor, it also appropriates part of the surplus product of other economies. China’s positive balance with the US in merchandise trade (along with that of other big exporting countries like Japan and Germany) represents a free transfer of part of the East Asian country’s surplus product. The flipside to this subsidy is the accumulation of dollar holdings by the state banks of these exporting countries. China and Japan alone hold over $2 trillion in US Treasury securities.

Note that this process is self-reinforcing. The more of the surplus product allocated to unproductive activities like weapons manufacture, the more the investment fund is drained, contributing to a rundown of the US capital stock, and exacerbating the US’s chronic current-account deficit and other global macroeconomic imbalances.

Meanwhile persistent positive balances on their external accounts allow the surplus countries to exert political influence through the offer of credit and building up their stock of foreign assets, i.e. capital export, as for example Beijing currently does throughout southern Africa, and as Japan did throughout southeast Asia during the 1980s. If its international position relative to its rivals is not to decline, this leaves Washington with little strategic recourse than naked military aggression, seizure of territory rich in energy resources and raw materials, etc.

Update: None of this means that expenditure by the state on weapons production and research, and the technical innovation that results, does not regularly find civilian applications and productive spinoffs. The example most readily brought to mind is the role in developing the Internet of DARPA, the successor to military-funded “Big Science”, which emerged under the stewardship of Vannevar Bush during WW2 and the Cold War, and which allowed carryover into various commercial domains. A recent post on this blog discussed the links between armament producers, educational institutions, federal agencies and armed services, and private firms in the home-entertainment and consumer-electronics industry. The Orlando research park can be added to the United States’ other better-known clusters of aerospace/ICT/engineering/high-tech R&D: northern California, North Carolina, Boston and the Baltimore-Washington-Arlington metro centre. In general, it’s impossible to miss the extraordinary proportion of social activity (and the dependence of the most capital-intensive, high-tech sectors of the US economy) on the Security State, especially in the Sun Belt.

This kind of spatial concentration and proximity of private firms and military agencies has an orthodox theoretical explanation. It is interpreted by Paul Krugman and the ‘New Economic Geography’ as a matter of increasing returns to scale due to ‘knowledge spillovers’ and ‘agglomeration economies’ (an emergent macro outcome of decisions by individual producers, who each chose locations thanks to existing specialised labour markets and reduced transport costs).

Military production is very susceptible to technical advance. But when assessing whether or not the military is the cradle of capitalist innovation, we must keep two things in mind. The first is the ‘productivity paradox’ observed by Robert Solow and others, i.e. that the introduction of computers did not appear to make a measurable contribution to economy-wide productivity. This empirical example illustrates the general point that very salient technical advances may have little impact on an economy’s productive capacity if  the technology is used, or the increased efficiency occurs, mostly in the non-basic sector. The second point is one about opportunity cost. Great concentrations of engineering and scientific talent employed by the US armed forces, intelligence agencies and military contractors may produce innovations that, sometimes and in a roundabout fashion, can be applied commercially. But suppose these same workers were re-deployed in civilian R&D and directed towards productivity improvements in consumer goods or machinery. In such a case, how much greater would be the level of technical advance and the long-run improvement in material living standards? This conditional counterfactual can be illustrated by comparing the actual contemporary US to its ‘nearest possible worlds’, namely the advanced economies of Japan and Germany, which since the Second World War have been under the US security umbrella, and which consequently have spent little on armaments. The productive capacity of each country has grown more swiftly than that of the US. 

Finally, none of this should be taken to suggest that high military spending is in some sense dysfunctional or unpropitious for US capitalism. Recall that deductions from the social surplus product (e.g. military expenditure, but also other kinds of unproductive consumption such as the advertising industry, finance, legal services, public administration, luxuries, etc.) mean that less can be spent on investment, prompting slower growth in the stock of fixed capital, and thus, ceteris paribus, higher profit rates. Here, again, stagnating Japan can serve as the example.

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11 Responses to “The demands of war”

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