Review of a Book by David W. Slater from Meltdown, volume 1

War Finance and Reconstruction, The Role of Canada’s Department of Finance, 1939-46

by
William Krehm

We came by this interesting volume in a bizarre way. After months of negotiation the Executive of the Ontario Federation of Agriculture arranged a debate between Jack Biddell and myself for COMER and two champions of Bank of Canada policy. To defend its policy the Bank of Canada chose William Robson and David W. Slater, a prominent Keynesian. Even knowing the current scarcity of career opportunities for Keynesians, I was intrigued by the choice of Slater to defend a key position of the people who managed to do away with the Economic Council of Canada he had once headed.

We were informed that he was a last-minute substitute for David Laidler. Slater opened the debate by reading a document that seemed to betray the fine Italian fist of the other David, Laidler not Slater. I referred to the BoC’s citing the German hyperinflation of 1923 to warn us what we would be in for if we neglected even a small amount of inflation.

Connecting the two situations implied some miraculous retroactive effect: had Germany only pushed interest rates high enough, it apparently would have not lost the First World War, the Allies would not have exacted crushing reparations, the French would not have occupied Germany’s industrial heartland, the Ruhr, there would have been no virtual civil war in the Ruhr, and indeed throughout Germany. During an intermission chat with me, Slater remarked, "Of course, I taught monetary policy for many years, and always emphasized that there was no connection between what happened in Germany in 1923 and our problem in Canada."

There were other patches of common ground in our private chat. And shortly after, Slater sent me his book that sheds light on the brightest period of Canadian economic policy.

Who could sum up matters better than Slater in the first chapter of his book? "In terms of economics, the war, despite all its sacrifices, was the road from depression to prosperity. The potential productivity and income of the Canadian economy turned out to be much greater during the war than they appeared at the beginning. The potentialities after the war were even larger than those of wartime, despite the reduction in certain advantages of scale and specialization.

The war showed what could be achieved by a fully employed economy, compared with the output during the unemployment of the 1930s. That is hardly the song the Bank of Canada had been singing, and that the author joined the colours to defend.

Rethinking the Musty Certainties of the Banks

The Slater book recounts the efforts of the Finance Department to whittle down the aid requested by the besieged allies to what it felt we could prudently afford. "Despite the primitive, uncertain, and incomplete state of national income accounts, the government used them as the basis for determining what the country could afford to contribute to the Commonwealth Air Training Plan.

The method was to forecast national income for 1940 and subsequent years, and determine the proportion that could be devoted to all government purpose including the military effort. The calculation was based on a 10% increase in the national income. Finance and the Bank’s macroeconomic argument did take account of a number of factors that made the air training plan as good fit for Canada’s war capacities: large uncluttered spaces, plenty of lumber and building materials; experienced and underemployed road-building firms, a large supply of rough carpenters off the farms; romantic interest in the air inherited from the Canadian aces in WWI and the epoch of bush pilots opening up the north. And the men involved in the errors of judgment included the first Governor of the Bank of Canada, Graham Towers, and Clifford Clark, the guiding spirit in recruiting the young mandarins who were to run the Bank of Canada during its most brilliant period. Eventually it became the watchword of war finance that anything that could be produced or devoted to the war effort could be financed."

Slater provides thumb sketches of the group responsible for rethinking the musty certainties of the banking community. A few like R.B. Brice and A.F.W. Plumptree had studied under Keynes at Cambridge, others at Oxford and the London School of Economics. Clark set rigorous tests on monetary topics for applicants both at Finance and the BoC. Graham Towers, the first Governor of the BoC, was one of the few people in the banking community with a university degree and a good grounding in economics. He understood credit creation not only in the practical way of bankers, but in the broader social sense of monetary economists.

"The seekers of more effective economic policies in Canada were also convinced of the need for constitutional change. They regarded the relief programs that were the main response by governments to unemployment as inadequate, inefficient and unfair. Tax and expenditures policies and public works programs to improve income and employment were inhibited by the political structure as by worries over debt. Though the successful launching of the BoC had equipped the country with an improved financial structure and policies, the BoC was deeply concerned with debt problems of Canadian provinces and municipalities.

"Taken together all the wartime tax changes amounted to a virtual revolution in taxation policies. Canada moved from a regressive to a progressive system, from one in which only a minority paid income taxes to one in which the majority paid them, from one in which the provinces and local governments collected the majority of tax revenue to one in which the federal government collected the most."

"The ratio of gross national debt to GNP, as we know it, peaked at 170%, much higher than the 70% that became so worrisome in the early 1990s after years of large government deficits.

"The price controls imposed in November 1941 were the most severe that any country used during the war. They froze every individual retail price at its level two months earlier. When the war began, wholesale prices were about 26% below pre-depression values. The cost of living was about 17% below pre-depression level. Canada’s GNP increased by more than 65% between 1939 and 1944.

"Maintaining low interest rates was the kingpin of the government’s strategy against inflation. "The government was committed to maintaining low interest rates into the postwar period, as Towers stated in the Bank’s 1944 annual report. This implied government willingness through the BoC to support the price of government bonds if the public began to sell them heavily. The government was also committed to maintaining the consumer price ceiling at the 1941 level into the transition period, and to gradual and orderly price and wage control thereafter.

The government believed in the interdependence of these policies. If inflation mounted, a spending spree could ensure, fueled by the liquidation of wartime savings. If the interest rate was to be held in such circumstances, the BoC would have to acquiesce in a further inflationary expansion of money and credit. But if interest rates were not held, the market value of the public’s holdings of government bonds would fall, perhaps triggering a sell-off. The resulting success of Canada’s restraint of inflation contrasted with the hasty deregulation of price control in the US."

Slater’s book has the immense merit of disinterring much that was crucial at a key moment in our history. Significantly it is self-published, and when the above extract was made could be obtained from Prof. David W. Slater, 199 Crocus Avenue, Ottawa, K1H 6E7