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2 - Phoenix from the Ashes

Published online by Cambridge University Press:  25 August 2021

John L. Campbell
Affiliation:
Dartmouth College
John A. Hall
Affiliation:
McGill University, Montréal

Summary

Adam Smith died in 1790, just before the French Revolutionary and Napoleonic wars. The long peace of the nineteenth century that followed rested on an implicit geopolitical deal. For decades after the Congress of Vienna of 1815 had established a framework for peace, no one wanted to challenge Britain, in part because they were exhausted from war but also because doing so might upset the balance of power in Europe and strengthen one’s rivals. Furthermore, the world’s leading economies subscribed to the gold standard – fixing their currencies to the price of gold – thereby ensuring a stable international payments system that steadied capitalism. The hope was that trade would now replace military conquest, and that peace and prosperity would be assured. The first half of the twentieth century crushed that hope. It was a time of war and economic catastrophe.

Type
Chapter
Information
What Capitalism Needs
Forgotten Lessons of Great Economists
, pp. 36 - 65
Publisher: Cambridge University Press
Print publication year: 2021

Adam Smith died in 1790, just before the French Revolutionary and Napoleonic wars. The long peace of the nineteenth century that followed rested on an implicit geopolitical deal. For decades after the Congress of Vienna of 1815 had established a framework for peace, no one wanted to challenge Britain, in part because they were exhausted from war but also because doing so might upset the balance of power in Europe and strengthen one’s rivals. Furthermore, the world’s leading economies subscribed to the gold standard – fixing their currencies to the price of gold – thereby ensuring a stable international payments system that steadied capitalism.1 The hope was that trade would now replace military conquest, and that peace and prosperity would be assured. The first half of the twentieth century crushed that hope. It was a time of war and economic catastrophe.

Our first task in this chapter is to understand what went wrong. Our explanation focuses on three factors: the breakdown of social cohesion within countries as a result of rising nationalist and class divisions; limited state capacities, both domestically and internationally; and the absence of international hegemonic leadership. We need to explain the forces that determined capitalism’s fate during the first half of the twentieth century because it will help us to understand, by sheer contrast, the unprecedented stability and economic prosperity that came after 1945.

Our second task is to understand this sharp about-face. Like the phoenix of Greek mythology rising from the ashes, the era immediately after the Second World War turned out to be the Golden Age of capitalism – a time of remarkable peace and economic prosperity. Nationalist and class divisions were curtailed, and social cohesion was restored domestically by states more conscious of social needs and enjoying the capacities to achieve them, with both factors playing out within a stable international order led by the United States, capitalism’s new hegemonic power. But behind all this is a paradox: War can destroy economies, but its consequences can quite unintentionally create the conditions for future prosperity.

The Darkest Days

By the end of the nineteenth century, thanks to trade policies of the sort advocated by List, every major European country had a similar portfolio of the industries needed for geopolitical autonomy. Wilhelmine Germany had become the largest European economy, its profits overwhelmingly coming from its large internal market and from trade with other developed areas. Nevertheless, what matters are often perceptions rather than facts. During the late nineteenth and first half of the twentieth centuries, many political leaders believed that imperialism was necessary if capitalism were to thrive, insisting that economic strength would ensure survival and prosperity within a world of geopolitical competition. They believed that huge territorial possessions were essential to state power because size enabled states to secure access to their own sources of raw materials and to their own markets, and hence to be geopolitically independent.2 But with increased size came problems of nationalism, an immediate cause of war in 1914.

Several elements were involved. First, large territorial size meant the presence of different national groups – ethnic, religious, and linguistic – within the same empire. National diversity began to create demands from below. These might have been managed with the sort of inclusive cultural policies recommended by Hirschman, but that route was largely ruled out by the intense geopolitical rivalries of the era – a time, by the way, when Europe lacked a hegemonic leader able to hold these rivalries in check. What mattered most was a dreadful game of mirrors. The great powers sought to create nations within each other’s territories. The Tsars encouraged Kurdish nationalism, knowing that it would irritate and weaken the Ottomans. The Habsburgs did the same for Ukrainian nationalists, thereby making it very difficult for the Tsars to force the Ukrainians in their territory to fully assimilate as “little Russians.” In other words, geopolitical rivals tried to undermine social cohesion in each other’s territories.

Second, the thought that diverse nationalities might be disloyal to the empire increased the pressure to assimilate them into a new shared identity. Empires sought to nationalize their peoples. The trouble here was that forcible assimilation added to the politicization of national groups, which exacerbated tensions and undermined cohesion inside the empires, not to mention irritated one’s rivals outside, thereby further threatening international cohesion and stability.

There is a final factor concerning nationalism and social cohesion. The likelihood of German participation in geopolitical conflict was boosted by radical, right-wing, middle-class pressure for a much more aggressive nationalist policy than the political elite wanted. This is nationalism within a state, not nationalism wishing to secede. It reflected an inability to modernize politics – to integrate both the middle and working classes, so as to create loyalty to the regime.3 The lack of voice undermined social cohesion.

Let us turn to the issue of state capacity. Political elites badly miscalculated in the years leading up to 1914. Bismarck, of course, had been an exception, able to abandon imperial demands at a key point, well aware that few economic profits lay in that direction. If only later German elites – and those of other countries – had calculated like capitalists, war might have been avoided. But they did not.

The German case is especially important, because the war involved the Anglo-German rivalry as much as the tensions in the Balkans and Central Europe. Imperial Germany lacked a cabinet government; it was a court society whose character was deeply affected by the personal character and whims of Kaiser Wilhelm II. This institutional thinness undermined the state’s intellectual capacity for making well-reasoned policy, which was torn instead in different directions. One faction supported by heavy industrialists and the Social Democrats wanted to gain imperial possessions overseas; another faction, favored by the army, wished to continue the traditional policy of expansion to the east. The lack of unitary cabinet government meant that both sides influenced policymaking, thereby inspiring enemies on all sides – and so creating the encirclement by Russia and France from which Germany sought to break free in 1914. This was a self-inflicted wound, stemming from thin state capacities and setting the stage for war and economic disaster.

But limited state capacities ensured that elites in other countries made mistakes as well. Consider Conrad von Hotzendorf, chief of the Austrian General Staff. Desperately in love with a married woman, he advocated war, believing that military success would lead to a successful petition for divorce. More importantly, Conrad and his military peers wanted to prevent political reforms that threatened their elite privilege and power. They believed that, by taking Austria-Hungary to war, they could silence the voice of reformers at home.4 This was a desperate move by a politically threatened faction of the state elite, who put their interests above those of their society as a whole.

Nationalist pressures combined with state elites prone to miscalculating created a fragile and febrile situation in July 1914. The assassination of Archduke Ferdinand, heir to the Habsburg throne, was the occasion for a war that changed the world. The hideous bloodletting that resulted hurt capitalism badly. Over the course of the war, gross domestic product (GDP) per capita declined, on average, by 12 percent in Europe. The population declined by about 3 percent.5 Of the 65 million men who fought in the war, 10 million were killed in battle or died of disease, and 21 million were wounded. Some 7 million civilians were killed as well. The direct financial cost of the war for the participating countries was roughly $186 billion.6

The war damaged social cohesion. At the domestic level, the rise in labor militancy was marked.7 Keynes observed that the prewar system had depended on what he called a double bluff: The working classes had accepted only a small piece of the economic cake that they helped to make, while the capitalists took the rest but with the understanding that they would consume only very little of it in practice.8 This had been a source of social cohesion and stability. But working-class acquiescence now deteriorated because it had suffered the most during the war: food shortages, disease, and often the death of the family’s primary earner pushed many families into poverty. Governments had promised military recruits a higher standard of living, but it never materialized. Internationally, the Ottoman, German, Habsburg, and Tsarist empires collapsed, allowing for the emergence of small new nation-states in Central Europe and the Balkans. None were culturally homogenous, and most had reasons to fight with their neighbors – which meant that international conflict was likely. Of course, the Russian empire was reconstituted under different management, but its communist principles threatened both capitalism and the geopolitical order – and later provided a model for Chinese communism. Equally importantly, the war destroyed the monetary foundations and economic stability of capitalism going forward. Crucially, France and Britain were deeply indebted to both American banks and the American state, and accordingly they unwisely demanded large reparations from the losers that led to endless political struggles undermining social cohesion in defeated Germany.

Problems of thin state capacities were equally apparent after the war. For instance, many states returned to the gold standard, beginning with Britain in 1925. This was a resurrection of economic orthodoxy that protected investors’ interests by defending the value of the national currency. By pegging their currencies to their gold reserves – a scarce resource that states could not easily increase – states limited their institutional capacities for expanding the money supply to stimulate their economies when necessary, most obviously when the working class demanded help.9 Furthermore, the reparations imposed on Germany and her allies were harsh, and they paid no attention to Germany’s ability to pay – failing as well to realize that an impoverished Germany would not be able to buy British goods. Keynes bluntly chalked this up to the stupidity of political leaders in establishing the conditions for peace. He also argued that because France and Britain had suffered so much in the war, they lacked the institutional capacities to enforce the peace established at Versailles should Germany again turn to aggression. But the most obvious problem was the failure of statecraft on the part of the United States.10 President Wilson wanted to establish a leading role for the United States in matters of European security, but his naivety at Versailles and in congressional politics at home undermined the League of Nations, his mechanism for bringing peace and stability to the world.11 As a result, the interwar period lacked the sort of hegemonic leader that would prove to be so important for fostering international social cohesion and stabilizing capitalism in the second half of the century.

In sum, just as thin state capacities, deteriorating social cohesion, and the absence of hegemonic leadership had precipitated the Great War with such devastating consequences for capitalism, they also made it impossible to place capitalism on a sound footing during the interwar years. Nonetheless, some things improved during the 1920s – at least for a while. The reparations question was addressed, and efforts were made to bring Germany back into the fold. Tariffs were reduced. Even the threat of militant communism diminished. But, driven in part by the return to the gold standard, mass consumption was weakening by the late 1920s, and many countries were slipping into recession. This, of course, was Keynes’s great fear: that economic demand would diminish to a point at which growth stalled and unemployment rose. Farmers were hit particularly hard, but workers in manufacturing suffered too. Economic inequality increased, further threatening social cohesion.

The problems of austerity in Germany was compounded by the fact that it had taken loans from the United States to pay its postwar reparations. Because the United States maintained high tariffs on imports, averaging 33 percent, it was difficult for Germany to export enough to the United States to pay for those loans.12 European countries scaled back tariffs because their industries and agriculture needed to recover; the United States kept tariffs high so as to protect already well-established producers from competition because their share of European markets was shrinking. This was a predatory move by a state on the verge of becoming a hegemonic power.

When the American stock market crashed in 1929, the situation went from bad to worse. Vast sums were suddenly lost, and banks began calling in loans, thereby setting off a vicious chain reaction. With less money available, people and businesses spent less, demand for goods and services declined, production was cut back, unemployment rose, and prices fell in a vicious deflationary spiral whereby falling prices created incentives for people to hoard money and delay their purchases. All this also made it harder for people and businesses to keep up with loan payments, so banks began to fail. Yet the U.S. Federal Reserve, refusing to abandon economic orthodoxy, did little to stop the financial hemorrhaging. Reflecting on the Depression over half a century later, economist Ben Bernanke, former head of the Federal Reserve Board and an expert on the events of the 1930s, remarked that one of the great lessons of the Depression was that “policymakers confronted with extraordinary circumstances must be prepared to think outside the box, defying orthodoxy if necessary.”13

This, of course, is a matter of state intellectual capacity, unfortunately lacking in this case, because economic policy was dominated by the upper classes at the expense of the lower classes. Gold-standard austerity would please finance capital and investors; easing fiscal and monetary policy would please the populace.14 But thin state institutional capacities were also to blame – specifically, lax financial regulation, which was corrected later, for example, by the separation of commercial and investment banking under the 1933 Glass-Steagall Act.

Meanwhile, as the crisis metastasized internationally, it unleashed new nationalist forces. German and Hungarian nationalists had already demanded not only an end to reparations but also the return of lands they had lost at Versailles. Furthermore, to boost export-oriented recovery, countries turned again to economic nationalism, further undermining international stability. Twenty countries abandoned the gold standard and devalued their currencies. Yet, because so many did the same, nobody gained a competitive advantage for very long. Several countries abrogated trade treaties and imposed higher tariffs that undermined international trade.15 Between 1926 and 1931, tariff rates in France, Germany, Japan, Sweden, Great Britain, and the United States jumped anywhere from 1.5 to 3.5 times their initial levels.16 This was virtually inevitable, because there were no international institutions to manage the crisis or coordinate national responses. Bankers and governments saw the need for more international economic cooperation, but they could not muster the domestic political support to make it happen. Had a hegemonic power pushed for coordinated policies across countries, things might not have spiraled out of control.

The Depression also undermined social cohesion domestically. Part of the problem was that capitalist economies were already transitioning from heavy manufacturing industries, such as textiles, mining, steel, and iron, to mass consumption industries, such as automobiles, consumer appliances, tobacco, and processed foods. This was the sort of creative destruction that Joseph Schumpeter described – but with an unfortunate twist. The productivity gains involved had not yet been matched with employment gains in these new industries. As a result, income inequality grew, and there was not enough consumer demand to absorb what was being produced. Yet, for a while, economic orthodoxy remained the preferred solution: Stick to austerity, balance government budgets, and – if possible – reduce wages, abolish unions, and get rid of fixed-wage contracts. But the workers rebelled, and social cohesion broke down further as rent strikes, food riots, and labor walkouts erupted in many countries.17 As a result, the Labour Party came to power in Britain. But its tenure was brief. In contrast, the Social Democrats who won office in Scandinavian countries were able to begin building welfare states. In the United States, Franklin Roosevelt won the presidency, Democrats controlled Congress, and the New Deal was born. These new regimes finally began moving in Keynesian directions, building up – that is, thickening – institutional and intellectual state capacities to stimulate their economies and restore some semblance of social cohesion.

In Germany, however, the breakdown of social cohesion took a very different turn. Germany had suffered more than any country after the Great War and during the Depression. Germans felt humiliated by the steep reparations demanded of them – and even the eventual fact that they did not pay failed to soothe their resentment. The combination of extreme right-wing paramilitaries, anti-Semitism, vicious hyperinflation, rigid upper-class naivety, and nationalism led to the rise of the Nazi Party. Hitler’s drive for empire represented a return to the belief that territorial size was essential to self-sufficiency and geopolitical independence. This was scarcely surprising: Germany was close to starvation by the time war ended in 1918. But Hitler’s empire was to be different from that of Imperial Germany: This was not to be an empire ruling over different nations; this was to be an ethnically homogenous, sanitized nation-state – the most horrible and divisive form of nationalism imaginable.

In East Asia, similar forces were in motion. Imperial Japan had established colonies throughout the region to ensure access to raw materials, but it sought further expansion into Dutch and British territories to obtain access to oil and rubber. The military was largely in charge of the government – especially the state bureaucracy, whose power far exceeded that of the parliament and political parties. The emperor, deemed to rule by divine right, had little political impact other than inspiring devout patriotism and nationalism, which leaders used to build an ultra-nationalistic culture among the Japanese. But Japanese nationalism was fueled too by Western racism toward Japan at the League of Nations in the 1920s and 1930s – another example of social cohesion undermined at the international level. So, the need for natural resources and the growth of Japanese nationalism, compounded by fears of outside aggression from the Western powers as well as Russia and China, eventually led Japan to align with Germany and enter the Second World War.18

This war was even more destructive than the first in terms of lives lost, monies spent, and sheer economic destruction.19 Some 75 million people died in the war as a consequence of combat, genocide, disease, bombings, massacres, and famine. The twelve leading West European countries saw their GDP decline by 23 percent between 1939 and 1946. It was especially severe in Germany, where GDP had grown slowly during the war but suddenly plummeted 67 percent between 1944 and 1946. The story in Japan was similar: GDP dropped by 50 percent between 1944 and 1945.20 It is scarcely surprising that, at the height of the Second World War, both Polanyi and Schumpeter argued that capitalism was doomed.

They were wrong.

The Golden Age

The darkest days came before a new dawn. The capitalist world’s rebound from the devastation of the Depression and Second World War was rapid and impressive, and it was a rebound that benefited the many rather than the few. Average annual economic growth per capita in Europe and Japan, which hovered around 1 percent from 1913 to 1950, jumped to about 4 percent and 8 percent, respectively, between 1950 and 1973. It also rose in the United States, although more modestly.21 Exports, which had sagged especially during the Depression, bounced back sharply following the war and continued to climb throughout the rest of the century.22 Unemployment rates dropped to about 2.5 percent in Europe and were even lower in Japan. They averaged about 4 percent in the United States.23 Finally, inflation fell well within manageable bounds throughout the capitalist world.24

This Golden Age rested on new international and domestic foundations, with a good deal of institutional variation added in different areas of the world. Let us consider these elements in turn.

The Second World War ended very differently from the First – without a treaty, but with the ability to create stable political and economic rules of the game that went a long way toward restoring peace and prosperity to the capitalist world. Three crucial background factors were responsible for this. One was that social cohesion increased as nationalist conflicts diminished sharply. Ethnic cleansing and mass murder had been so extensive that European societies had become much more homogeneous, making such liberal openings as there were far easier to achieve. A second factor was that the United States and the Soviet Union, the two world powers that had done the most to win the war, restrained competition both between and within their two spheres of influence. It did not matter if Korea and Germany were divided if order were maintained. The leaders of the capitalist and socialist worlds imposed, as Stalin put it, their own social system on the areas under their control. Finally, a crucial change had immense global significance: Nuclear weapons were so powerful that they were not to be used; enemies had to cooperate so as not to annihilate each other.

The threat of communism, as well as the enormous financial and military power of the United States, helped to facilitate social consensus internationally within the capitalist world. States always face a security dilemma. With great skill and luck, peace can be achieved through balance-of-power politics. The tragedy of Europe lay in its inability to do this in the first half of the twentieth century. After 1945, the United States helped to provide the stability that Europeans had not been able to find themselves. The security dilemma of both Japan and Europe was solved by the power of the United States – guaranteeing military protection for the former and taking a leading role in the North Atlantic Treaty Organization (NATO) in the latter. This went a long way toward ensuring that international cooperation and consensus replaced conflict. But other things did too. France and Germany, the two great continental powers, signed the Treaty of Paris in 1951, which created the European Coal and Steel Community (ECSC). This was an agreement designed to pool French and German steel and coal production, thereby effectively removing complete geopolitical independence from each country and establishing interdependence instead. France was the driving force: having been invaded three times by Germany in a single lifetime, the French figured that if they could not beat their neighbor, then they should join them. This agreement was the opening gambit of what would eventually become the European Union (EU) – a set of institutions further integrating Europe, opening markets, and harmonizing economic activity. The United States played a role here: Jean Monnet, the French diplomat who spearheaded the ECSC, was able to push the project because of the help he received in Washington, D.C.

But why was the United States prepared at the end of the Second World War to embrace the leadership role it had rejected after the First? To begin with, American policymakers were susceptible to the demands of domestic capitalists to open world markets for them. Second, the political elite enjoyed the power and institutional capacities it had developed during the war, including a host of fiscal policy tools – notably, the massive expansion of the income tax. Of course, there was a considerable overlap between these two sets of actors, even though some state leaders were more worried about national security than the needs of the American economy, which is why, for instance, the Truman administration accepted continental involvement in NATO. In short, the political elite had arrived at an accommodation: It realized that political naivety and isolationism – the result of thin state capacities – had had dreadful consequences after the First World War; it was determined to do better. But it is important to note that European states reinforced this consensus, clamoring for American leadership. As Britain’s Lord Ismay, NATO’s first Secretary General, is said to have put it, the idea was “to keep the Russians out, the Americans in, and the Germans down.”

The institutional foundations of postwar capitalist society were established in July 1944 when representatives from the forty-four allied countries met at the Mount Washington Hotel in Bretton Woods, New Hampshire. Recognizing that the allies would win the war, they assembled to design an ambitious system of multilateral institutions to regulate trade, facilitate national fiscal prudence, stabilize currencies, control inflation, encourage full employment, cope with national economic crises, and inspire economic development. The idea was to build international institutional capacities that would help the world to avoid another Great Depression after the war – something that allied leaders feared. There were two intellectual rationales for all this: First, the Depression had made it clear that markets required firm political foundations to function properly; second, there was a general realization that one country’s domestic economic policies could affect those of others, and that policymakers should take this into account. The protectionism and economic nationalism of the interwar period had to be avoided.25 President Franklin Roosevelt emphasized the point in his opening remarks at Bretton Woods: “The economic health of every country is a proper matter of concern to all its neighbors, near and far.”26 This was a call for institutional thickening – the establishment and continued maintenance of international institutions that could regulate things such as trade, exchange rates, and capital flows that affect capitalist prosperity worldwide.

The two principal negotiators were Harry Dexter White and Keynes, representing, respectively, the United States and Great Britain. White wanted to peg exchange rates to the dollar and open world markets to American exports and capital. Keynes strove to protect the sovereign right of nations to change their exchange rates. He also tried to preserve preferential trade relations within the British Empire. Already in declining health, Keynes was bested by White, particularly in the crucial area of exchange rate controls. This was the end of the British Empire and the rise of a new era in the international political economy – an era led by the first genuinely hegemonic power of capitalist society, the United States. One representative from the Bank of England called Bretton Woods “the greatest blow to Britain next to the war.”27 Among other things, it meant that the center of world finance would move from London to Wall Street.

The Bretton Woods agreements involved five major components. The first was a fixed, yet flexible, exchange-rate system. Currencies were pegged to the dollar, whose value was set to gold at $35 an ounce – a move designed to stabilize currencies and mitigate inflation. This cemented the dollar’s international supremacy, because most of the world’s trade-related transactions across borders would now be settled in dollars.28 Second, the International Monetary Fund (IMF) was established and charged with policing the system, monitoring countries’ economic performance, and providing financial assistance to those suffering serious balance-of-payments problems. The IMF could also give permission to countries that wanted to devalue their currency to resolve balance-of-payments problems and promote full employment. Third, the International Bank for Reconstruction and Development (IBRD) was established, which eventually became part of the World Bank. Its job was to provide loans and underwrite securities to facilitate the rebuilding of those economies that had been devastated by war and those otherwise in need of development assistance. Fourth, national governments were permitted to impose controls on capital flows across their borders. Finally, the Bretton Woods agreement laid the foundation for the General Agreement on Tariffs and Trade (GATT), signed in 1947, which decades later became the World Trade Organization (WTO). Its purpose was to reduce tariffs and import quotas, and to ensure global free trade. If a country were to want to protect a domestic industry such as automobiles or steel with tariffs, GATT officials would determine whether and how much it could do so without imposing excessive costs on foreign exporters of those products.29

This, then, was the new international architecture of capitalism. It provided the background and encouraged developments within states, to which we now turn.

What mattered most immediately was the decline of political extremism. In Europe, the extreme right had been defeated in war and replaced by Christian Democracy, perhaps the most important pillar of postwar social stability. The extreme left had been defeated too. Rarely did communist or socialist parties enter, let alone form, governments in capitalist countries. More moderate labor and social democratic parties took this role. These developments were aided by the United States, supporting the former and making life very difficult for the latter, given the context of the Cold War. But the result was clear: Between the two world wars, the average share of votes cast for far-right parties in twenty democracies was just shy of 7 percent; that figure dropped below 2 percent between 1950 and 1973, before rising again to about 6 percent between 1976 and 2014.30

Not only did this move to the center reflect diminished nationalist tensions in many countries, but also it involved historic class compromises that engendered national reconstruction and economic growth.31 The voice of the working class in economic affairs, which Hirschman recognized as being so important, was institutionalized in ways that reduced class conflict. Furthermore, the capitalist class sought, as noted, to moderate national politics. Business elites strove to establish relatively peaceful relations with the labor unions and, as a result, were supportive of social spending and the taxes necessary to pay for it.32 Finally, the threat of communism helped to foster moderation politically and economically within all the advanced capitalist countries, both the left and right recognizing communism as their common foe.33

At the very basis of everything was what French economist Thomas Piketty has called the “Great Compression” – a massive reduction in economic inequality in advanced capitalist countries. Equalizing social conditions has been extremely difficult historically, resulting characteristically from disaster, from war and revolution, and from plague and total societal collapse. It is war that matters most here. Two world wars, not to mention the Great Depression, had led to the widespread destruction of capital and property, thereby lessening the power of the rich. At the same time, mass conscription, together with a good deal of suffering on the home fronts, meant greater political pressure from the masses below for a voice in political affairs. As a result, vast amounts of wealth were wiped out, government spending soared, and progressive taxes, landing most heavily on the upper classes, hit record heights to pay for varied equalization policies. So, after the Second World War, economic inequality was comparatively low, and it remained so in most of the countries involved. It was only in the late 1970s and early 1980s that it began to rise again. For instance, the share of national income going to the richest 10 percent of Americans dropped from about 45 percent to 35 percent during the Second World War, and it remained stable for the next three decades.34 Similar trends were present in other countries.35

Sound political judgement was called for here. The First World War provided the chance to establish greater equality, but political elites took only limited steps in that direction, chiefly through early efforts at building a welfare state in the 1930s. They had learned their lesson by the end of the Second World War, accepting and then amplifying a variety of state capacities – notably, in various forms of welfare, which helped to bolster political stability. In other words, improvements in the states’ intellectual capacities – that is, learning from past mistakes – helped to thicken some of their institutional capacities in ways that improved social cohesion. For instance, the U.S. Congress passed the Servicemen’s Readjustment Act of 1944, commonly known as the GI Bill, which established hospitals, vocational training programs, and unemployment benefits for veterans. It also provided veterans with low-cost mortgages and stipends for college tuition. A few years later, President Truman signed the Housing Act of 1948, providing liberal mortgage insurance for low-cost housing. The Eisenhower administration launched a massive national highway construction program that provided thousands of jobs. Millions of veterans benefited, the American economy boomed, unemployment remained low, wages rose, and much of the United States prospered.36 The Europeans put more effort into building generous welfare states, had stronger unions that could cut better deals on wages and benefits, and had stronger center-left political parties protecting working- and middle-class interests. Nevertheless, on both sides of the Atlantic, this was the democratic expression of Polanyi’s double movement.

This new world was Keynesian – one in which states developed thicker capacities for managing aggregate demand through the prudent use of fiscal and monetary policy tools to keep capitalism on an even keel, maintain relatively low levels of unemployment and inflation, and avoid severe recessions and depressions. Some countries had flirted with Keynesian-like policies in the 1930s. In the United States, a few Keynesian economists had gained jobs at the Federal Reserve Board in the early part of the decade, and the Roosevelt administration had started experimenting with Keynesianism in 1937.37 Proto-Keynesians also began to find their way into government positions in France, Sweden, and a few other European countries. Having to cope with the Depression and increasing their military capabilities during a time of escalating geopolitical tensions caused some governments to engage in deficit financing during the 1930s.38 Still, it was the enormous military spending during the Second World War that pulled the United States out of the depths of the Depression, creating in the process an economy large enough to allow for the workings of Keynesianism. In the postwar period, more and more policymakers recognized the virtues of Keynesianism, thereby improving the intellectual and institutional capacities of their states – although experience with hyperinflation in the 1930s limited its appeal in Germany, where the fear that inflation might stem from excessive deficit spending was very much on policymakers’ minds.39 Nevertheless, in many countries, the acceptance of Keynesianism led to larger government budgets, heavier tax burdens, and more aggressive central bank policies, which afforded states greater capacities for managing their economies.40

In short, lessons learned from the disasters of the first half of the century, coupled with the rise of American hegemony and Keynesianism, bolstered social cohesion and thickened state capacities throughout the capitalist world. Yet we need to be careful not to paint with too broad a brush, for there were important differences between the United States and the rest of the capitalist world that we must now highlight. For example, spending in the United States was tilted toward the military.41 The great power lacked corporatist arrangements, but business and labor unions nonetheless still came to certain accommodations – notably, agreements to link productivity increases to wages and benefits, the so-called capital-labor accord. This was established initially in the automobile industry in the 1940s, but it spread to other heavy manufacturing industries such as steel, rubber, and chemicals. Later, unions representing federal, state, and municipal employees, and then farm workers, also signed collective bargaining agreements. These helped to reduce labor strife and to usher in an era of relative calm in labor–management relations. In contrast, most European countries put more effort into building generous welfare states than did the United States. Corporatism in Germany, the Benelux countries, and Scandinavia facilitated all sorts of industrial policies involving the institutional coordination of state, business, and labor activities around issues such as infrastructural development, human capital formation, and financing for selected industries. The British did something similar for a while, although on a far less centralized scale. The French experimented with indicative planning, another form of state-business coordination. Small states seemed to be particularly good at these things, because they tended to be more homogeneous culturally and, as a result, enjoyed more social cohesion and trust, which facilitated cooperation in the national interest.42 But, on both sides of the Atlantic, significant steps were taken to facilitate class compromise and full employment, thereby giving the working and middle classes a sense that their voices were being heard and that they were an important part of society, as Hirschman might have hoped. Again, social cohesion and state capacities developed in lock-step.

There were, however, striking regional developments that caused increasing divergence between the United States and its allies. The Treaty of Paris was the first step, as noted, toward European integration after the war. Members of the new European Union had to accept massive amounts of legislation designed to facilitate the smooth functioning of markets and trade within the region – and to protect those at the bottom of the social scale, including minorities.43 Nevertheless, surveys have shown that, within the Union, most people’s identities remain largely national rather than transnational – albeit with some variation. A stronger sense of European identity is more apparent among the more cosmopolitan upper reaches of European society. Furthermore, the countries that suffered most in the Second World War have tended to be the most Europhile.44 The key point to be made is that European institutions are best seen as providing fora in which heads of state and government officials can meet, settle disagreements, and make deals. They were mechanisms for promoting cooperation among national political elites, in part by collecting and providing vast amounts of data to decision makers and their representatives. This is a sign of thick, developed transnational intellectual state capacity and informed voice for its members.

East Asian countries followed their own paths to prosperity. The Japanese pursued a package of developmental policies, mixing tariff protection, as List might have advised, with combinations of state subsidies and financing, often orchestrated by the Ministry of International Trade and Industry in cooperation with the Ministry of Finance and Bank of Japan. Indeed, the state had a formidable array of institutional capacities at its disposal, and policymakers used them wisely. Automobiles, consumer electronics, and other strategic industries that the state picked were protected and promoted in this way until the quality of their products was good enough to compete in international markets. Japan’s postwar rise as an economic powerhouse was fundamentally the result of intellectual competence among the state’s administrative elites – recruited from the top universities on the basis of merit, carefully screened through civil-service examinations, often possessing wide-ranging general knowledge of the bureaucracy, socialized in the ways of consensual decision making, and among the most powerful of their kind in the advanced industrial democracies.45 In particular, a group of well-trained Japanese economists played key roles in economic policymaking both as advisers to government and as high-level state bureaucrats before, during, and after the war. They were averse to liberal capitalism, as well as communism, and after the war devised their developmental strategy to strengthen the nation’s economic power by engaging in international competition.

A central concern of Japanese strategy was that of cultivating social cohesion. This was done in two ways. The first involved stabilizing labor relations by guaranteeing lifelong job security and annual wage increases, and encouraging dialogue between managers and workers inside firms. The second involved cultivating cohesive networks among policymakers and business leaders in a system based on bargaining and reciprocal consent. In fact, such networks had long existed in Japan between state bureaucrats and large, family-owned business groups – the so-called zaibatsu that morphed into a more modern keiretsu after the war. As a result, the state, business, and labor all adopted a long-term, nationalist, productivity mentality to economic decision making rather than a short-term, individualistic, profit-oriented approach. It was this combination of social cohesion and state capacity that did so much to help Japan to transition quickly from a military-based economy to a trade-based one by the end of the 1960s, thereby becoming one of the world’s largest and most successful economies by the 1980s.46 Of course, American hegemony helped too, by providing military security to Japan, leaving the Japanese state free to devote more resources to economic development. The Japanese strategy worked like a charm. South Korea followed suit later with similar state-led approaches.47

Not all East Asian countries followed the same developmental path, but they did all rely heavily on states with thick intellectual and institutional capacities. Singapore, for instance, did not use protectionism, but in the 1960s it took its first bold steps to attract foreign direct investment from around the world. This was a story of intense strategic state intervention, aiming to create an institutional ecosystem conducive to economic development. The government did this by investing heavily in education, training, technology, and infrastructure. It also encouraged social cohesion, but, in contrast to Japan, it did so by using autocratic sticks as well as more benevolent carrots. The sticks included repressing opposition to the ruling party, cracking down on student political activities, emasculating the unions, preventing strikes, and handing out harsh penalties for minor infractions of the law. But the carrots entailed facilitating business networking, joint ventures, and public–private partnerships, ensuring religious freedom, and reminding citizens in this ethnically diverse country of ever-present external threats. The state also provided public housing to all ethnic groups and established English as the overarching state language, while allowing people to speak their first language at home.48

Other developing East Asian countries, such as Taiwan and Hong Kong, shared important developmental characteristics. One was bureaucratic coordination structures in which insulated, well-trained state bureaucrats, largely immune from intense private-sector lobbying, gathered information on the industries in question and formulated developmental policies accordingly. Another common trait was the formal and informal linkages and communication channels that existed between the state and industry. This facilitated information sharing helped to alleviate conflict between policymakers and business and bolstered social cohesion.49 It was this paradoxical combination of state insulation with public–private connectedness that was the key to success in these, as well as other, developing countries – something sociologist Peter Evans calls the state’s “embedded autonomy.”50 That many of these countries were culturally homogeneous surely enhanced social cohesion and the ability of policymaking and industrial elites to work together for the national economic good.51

There is an important point to be made here about the relationship between Hirschman’s voice, social cohesion, and capitalism. Authoritarianism, as well as democratic voice, can ensure the social cohesion that capitalism needs. Our preference is for the latter but not only for normative reasons. Authoritarianism is a less politically stable mechanism for achieving social cohesion than is the provision of democratic voice. It is not surprising that South Korea eventually abandoned autocracy for democracy as its capitalist economy prospered. Prodemocracy demonstrations, the emergence of progressive political elites, and pressure from the United States helped to usher in the change. Nor is it surprising that China has witnessed uprisings in Tiananmen Square and, more recently, Hong Kong as Chinese capitalism has flourished. Our point is that while social cohesion is a necessary condition for capitalist prosperity, voice is not a necessary condition for social cohesion – although it may provide more stability in the long run.

Overall, then, during its Golden Age capitalism was extraordinarily successful: an international economic order combining free trade and capital mobility, on one side, with domestic Keynesian-style stabilization policy, on the other, all nestled within the Bretton Woods architecture.52 It was rooted in high levels of social cohesion and state capacities at both the domestic and international levels. The United States played a crucial role in facilitating all this as the world’s hegemonic leader.

This does not mean that relations between different classes and ethnic, religious, or other groups were perfectly harmonious. Despite major breakthroughs in labor–management relations in the United States, there were still significant conflicts between the two sides – notably, over right-to-work laws and prohibitions on union activity at the state level.53 Race relations have remained extremely fraught as well, although the U.S. Congress responded to the civil rights movement and international pressure by passing civil rights legislation affording Black and marginalized ethnic communities more political voice and economic opportunity than they had enjoyed previously. In some European countries, tensions revolved around ethnic groups, especially in Spain and Northern Ireland, with further tensions set to arise only later in response to immigration.

Conclusion

The story told in this chapter is utterly remarkable. Sheer hell was followed by decency and prosperity. Some have argued that this postwar period was merely one of catching up, or returning to normal, following the devastation many countries suffered in the Second World War. There may be some truth to that. However, catching up after war is neither automatic nor inevitable; it requires the right state capacities and a modicum of social cohesion. After all, Germany and Japan bounced back much better than did Italy. And there was much less catching up in the capitalist world following the First World War than there was following the Second. So, while there may be some credibility to the catching-up argument, one still needs to understand how state capacities and social cohesion were at work.

The remainder of this book explains how things eventually came unglued after the Golden Age and what the implications of this are going forward. For now, we can preview at least three critical reasons why this happened that are central to the arguments in the rest of this book. First, the key advance of the period was conjunctural – not fully anchored in permanent social structural change. The fundamental class compromise rested on the greater equality and societal escalator that resulted, in part, from mass participation in warfare. The sense of shared sacrifice that lay behind greater equalization was not to last. Upper classes everywhere almost always find ways of increasing their share of the cake and gaining more for themselves than for the many. The basis of social cohesion was always likely to be challenged. Second, in their push for self-enrichment, the upper classes eventually turned away from Keynesianism and, in doing so, launched an attack on state capacities that weakened the institutional and intellectual foundations of the postwar order. Third, the behavior of the United States changed. The proponents of “hegemonic stability theory” claim that the stability of capitalist society always depends on a leader capable of providing both a top currency and defense for its allies.54 The military power and economic leadership of the United States did help capitalism to flourish after 1945. But it is important, as noted, to recognize a crucial contrast between two relatively distinct periods of American hegemony, the benign and the predatory. It was most often in the United States’ interest to act generously in the years immediately after 1945, and that relatively benign role was made possible by the untrammeled power that it then possessed. As the hegemon’s power has diminished, a predatory alternative has become increasingly attractive.

The institutional and social conditions of the Golden Age were never going to last.

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