The Nazi Economy
I made a comment to Robert Alley on how Germany couldn’t continue its rearmament program for long without a war. To substantiate that, here is some information on the Nazi economy before the war. For anyone who read my post to the newsgroup about this topic, what is contained here does not differ substantially. My source is The Nazi Economic Recovery 1932-1938, by R.J. Overy, prepared for the Economic History Society.
Rearmament spending was not the chief architect of the German economic recovery. Spending on armaments was only 10% of government spending in 1933, gradually increasing to 25% by 1935. By FY (Fiscal Year) 35-36 the majority of increase in GDP, decrease in unemployment, and other such indicators that would happen prior to the war had occurred. Analysis indicates that during this period, some of the largest contributions to growth were spending on motor vehicles, transportation infrastructure, and construction. The Nazi policy in these areas was to link increases in government investment with increases in private investment, and to explicitly manipulate economic policy to maximize investment and increase in employment.
From FY 33-34 to FY 35-36, government expenditure exceeded government income by roughly 50%. This is actually consistent with the revenue/expenditure balance present since at least FY 28-29 (before the Nazis came to power). Thus Hitler’s government actually continued a deficit spending trend that was in place before the Nazis came to power.
It's interesting to note that the German government did not follow Keynsian economic policies, though there is a stimulating effect on the economy. Their intent was not to stimulate consumer demand through an increase in public spending, and in fact the Nazis go to a lot of effort to prevent an increase in consumer demand, in favor of increasing investment and savings. This may be one of the reasons why the "multiplier" effect they obtain (the Reichsmarks of total economic activity generated by one Reichsmark of government spending) is 1.5. This figure is quite low compared to that obtained by western countries engaged in Keynsian stimulation policies, which is typically at least 2.5. Thus the actual economic benefit of German government spending was rather less than what modern governments, who engage in similar activities from time to time, obtain.
In fact, the Nazis were in the process of implementing strict controls on the economy, so that by the beginning of the war financial institutions are effectively reduced to being government stockholders. Corporations were encouraged to cooperate with Nazi policies by being given favorable deals. The government assumed a role over the economy that was primarily supervisory, rather than executive, in nature. The Nazis mostly trusted the large corporations to run things for themselves, and intervened from time to time to ensure compliance with the goals of the state, rather than assuming direct control over all of the operations of industry.
Things changed somewhat around 1936 when explicit plans for war began. Government spending increased dramatically, while increases in government revenue did not keep up. By FY 38-39, the last fiscal year before the war, expenditure exceeded revenue by 86% and total debt load exceeded annual revenue by 136%. Government spending reached 33.5% of GNP, up from 19% in 1933. Total production was up 25% above 1928 levels (and up around 100% from what it was at the height of the depression in 1932), almost all of which is due to increased production of capital goods (infrastructure, heavy industry, etc.) rather than consumer goods. Remember, the Nazis were a totalitarian government interested in increasing the power of the state, their goal was not to produce a wealthy consumer economy or to promote trade. While Nazi Germany was technically still a capitalist economy, it was an entirely isolated one with tremendous levels of government involvement, and was never intended (nor, really, able) to engage in long-term competition with the western free market economies.
In 1936 rearmament spending doubled from what it was in the previous year, and jumped ahead of the combined figures for transportation and construction for the first time. It also changed its character. In the early years spending had involved significant amounts of research, development, and capital investment. In 1936 rearmament switched to being primarily intended to produce and maintain actual military equipment, an activity which is on the whole less economically beneficial. By FY 38-39, rearmament accounted for 46% of German government spending. This all contributed to a substantial debt load, financed by predominantly by internal borrowing rather than foreign borrowing. Germany's trade agreements were deliberately restricted to the import of critical goods, paid for primarily by bilateral barter agreements. It was explicit Nazi policy to isolate the German economy from the rest of the world, trading only when they had no alternative way to obtain what they needed.
It is interesting to note that German productivity only grew 1.3% per year from 1929 to 1938, roughly half the growth rate of Britain in the same period. The primary effect of the Nazi policies was to recover from the substantial collapse of the German economy early in the Great Depression, not to stimulate unusual amounts of fundamentally new capacity. The German economy actually had a lot of structural problems, including the fact that many plants had invested heavily prior to 1929 and so later increased their capacity by putting old equipment back into use. German industry was also slow to adapt many more modern production methods. Thus it may be seen that the “miraculous” Nazi recovery was not in fact miraculous in terms of what modern economic policies can do. It was clumsy and inefficient compared to what we are now capable of doing through the application of counter-cyclical economic policies. It was helped significantly because the German economy had collapsed to such artificially low levels during the Depression, and in the end German economic growth during the period was not at all impressive.
This information has some ramifications for WIs involving alternate Nazi rearmament patterns. Two frequently raised WIs are a significant earlier increase in rearmament expenditures, and what would happen if WW2 did not occur or ended very quickly. Mr. Alley’s scenario dealt with the second.
To deal with the first situation, we must simply look at the recovery of the German economy. Earlier mass rearmament would be altogether not as good at encouraging growth as the policy of investment in infrastructure, and would require a significant increase in government spending (and thus debt) at an early point as well. The net result is a negative for German economic recovery/growth prior to the war, how negative depending on the extent of rearmament. Pushing forward military spending by a year could end up delaying growth of the overall economy by a significant portion of a year. While it would certainly have been possible to increase military spending early on, the effects would not have been trivial, especially if Germany did not declare war on schedule. This is a substantial problems for AH scenarios based on the mistaken assumption that speeding up German rearmament substantially in the prewar period would be “easy” in terms of economic ramifications.
This brings us to the second question, how well Germany could have maintained expenditures without other countries to invade and loot. Though I don't have figures for 1939, government expenditures immediately prior to the war were more than double government revenues. New sources of revenues were not forthcoming, and prospects for economic growth are in any case not good. The systemic problems of Nazi inefficiency, industrial inefficiency, the old infrastructure, and more, were still looming problems. The potential of the German economy for overall new growth was not favorable compared to that of other competing economies such as Britain. Furthermore, Germany had mostly been isolated from the world economy by Nazi restrictions on trade, which were not beneficial to medium to long term growth. Removing these restrictions could create significant problems for the increasingly government-controlled economy, which had not had any pressure of international competition.
It is my conclusion that regardless of whether or not levels of deficit spending were decreased, Germany would be very poorly placed to compete in international trade, and would likely be outgrown by their major economic competitors. In the short term, they were not well placed to outgrow even the Communist economy of the USSR, which had experienced substantial levels of industrial growth while the rest of the world experienced the Great Depression.
The other big problem would be debt. The government was spending almost twice as much as it brought in, and half of that spending was on the military. Since government expenditures were a third of the economy as a whole, this led to a very rapidly growing debt. It was an internal debt, which means that up to that point Germany was not particularly beholden to foreign creditors. That, however, carried its own problems. The government cannot borrow an infinite amount of money internally. Put another way, the government could not continue to increase its debt by approximately 15% of GDP per year indefinitely.
Spending must be cut, indeed must be radically cut, by the early 40s. Such levels of internal borrowing could not continue for long without a financial collapse of some kind. External borrowing could not be increased to cover for it, because no nation would loan Nazi Germany that much money at a continued rate. It would be a horrible credit risk. This means, basically, that there must be a substantial absolute drop in government spending including and especially armaments. Armaments, at such a high level of total expenditure, are the easiest place to cut large amounts of spending. Not only that but so much is spent on armaments that if the deficit were to be eliminated without reducing armament spending, non-armament spending would essentially have to drop to nothing (an impossibility). To maintain stability of the German economy and government, it seems to me that non-military spending would likely have to remain at 50-66% 1939 levels of expenditure. This means that to attain a balanced or nearly balanced budget, rearmament spending would have to be reduced to 33-50% of 1939 levels.