P36. Financing Britain's Rearmament

[Spectator 163, 21 July 1939, Banking and Insurance Supplement, p. 113. © the Spectator ]

21 July 1939

Rearmament may be divided into two phases, the phase of moderate activity, in which we are at present, and the phase of intense activity into which we may be driven by increasing international tension or by war itself. The method of finance appropriate to the first phase is borrowing and a solid base of borrowing may be retained throughout. But, to finance the extra activities of the intense phase, increased taxation should be imposed. [1]

This maxim may strike the casual reader as paradoxical. Should not taxation be the normal method of finance and borrowing be reserved as the last desperate expedient of crisis? Some such doctrine is implicit in old-fashioned financial orthodoxy. The cling to it now would be to turn a blind eye to all we have learned from our recent experience of depressions and the study of the trade cycle.

The maxim which I have advanced may be most easily demonstrated by reference to the realities which lie behind the veil of money. For many years there has been much slack in our industrial system ready to be taken up. A considerable programme of rearmament can be carried out by taking up this slack. The unemployed can be brought back to work.

Taking Up Slack

So long as there are available unemployed resources, the provision of military goods and services can be made without any serious restriction of productive activity in other lines. The ordinary consumer need not tighten his belt. The arms will constitute an extra not a substitute product, the possibility of the extra being due to the employment of hitherto unemployed resources. In this phase the imposition of extra tax burdens is both unnecessary and harmful. By depriving the consumer of purchasing power and reducing his private demand, it would release productive resources which are not yet wanted elsewhere; it would condemn some section of our people to remain in unemployment. So long as the consumption of ordinary people can be maintained it should be maintained, for it keeps up their own health and moral as well as providing employment which is also healthy.

But the point may come when the available slack is taken up, when any further intensification of rearmament effort can only be achieved by reducing production in other lines. Then consumers must draw in their belts. At this point increased taxation is desirable. For the only alternative to it is inflation.

Danger of Inflation

When the resources available to produce goods for the consumer begin to fall off, it is expedient that his demand should be restricted by taxation. Otherwise the general excess of demand over supply will bid up prices, and instead of his demand being restricted by taxation it will be restricted because he will find that his money will not go so far. Prices will rise, surplus profits will occur, and the burden of rearmament will be most inequitably distributed. In such circumstances it is idle to fulminate against profiteering, for the excess profits are the direct result of insufficient taxation or, what is the same thing, excessive borrowing.

It is not necessary to expatiate upon the evils and injustices of inflation of this sort. The excess borrowing of itself produces these evils; but the matter may be made worse if wage- and salary-earners succeed in obtaining increases to meet the rising cost of living. We then have the spectacle of progressive rise in prices, with wages following prices but never catching up. Such a development may be called pernicious inflation and its consequences on the continent of Europe in the post-War period are well known.

It is quite a mistake to suppose that these phenomena have any special relation to the printing press; they are the inevitable consequence of increasing borrowing, when there is no more slack to be taken up. It must not be inferred that, when full employment is reached, all borrowing should cease. The pre-existent rate of borrowing may be maintained, but it must not be increased.

In one way we have been lucky in the last year, in that the decision to increase arms expenditure met a depression phase of the trade cycle. If private enterprise had been more active, the extent to which the government might borrow without producing inflation would have been more circumscribed, and it may again become so.

It may well be held that in the very short period, that is for the duration of the immediate prospective arms programme--and, of course, of a war, if it occurred--some restraint should be placed on the demand of private enterprise for capital if and when an increase of taxation becomes necessary. When the point is reached at which a serious increase in tax burdens is the only alternative to inflation and consumers have to pull in their belts, it seems right that resources should not be employed in capital expansions, other than those required for war-like purposes. If this view is accepted, the increase in taxation should be accompanied by an embargo on new private issues and on plant extensions, other than those of national urgency.

If the situation deteriorates, the increase in taxes required may be extremely heavy, and in addition to raising the rates of existing taxes, it may be expedient to seek out new ways of obtaining money, such as a sales tax.

Short-term Borrowing

So long as borrowing is kept within the prescribed limits there need be no fear of inflation. Subject to this maxim, therefore, it is desirable that the Government should borrow in the cheapest way. A substantial increase in the national cash basis is long overdue, and the Government should look in the first instance to increasing its borrowing from the banks at short term. It might well adopt the rule never to borrow at more than 3 per cent. and, if it cannot borrow at long term at this rate, to increase its borrowing at short term. When international tension is relieved--with or without the intervention of a war--it may be expedient to write down internal capital claims by a capital levy. Such a levy can only usefully be employed to redeem debt. In the absence of a debt redemption scheme, it cannot be made a source of funds, since the sole source available for a government to tap for expenditure purposes is the current income, that is the current expenditure and savings, of the community.

The only meaning that can be attached to the expression "conscription of wealth" is high taxation together with a capital levy if and when a scheme for debt redemption is executed. The sentiment that, if men are to be conscribed, money should be conscribed also is a right and proper one. And this is a further reason for rigidly eschewing inflation, since by inflation one section of the wealthy classes escape their fair share of the burden. But there should be no hurry to conscribe money (i.e. increase taxation heavily), since to do so prematurely would entail an increase of unemployment and would thereby reduce the health and power of the nation. [2]

  1. 1. Harrod had argued along similar lines in his speech to the House of Commons Monetary Committee of 11 November 1938, reproduced here as essay 20 .

    2. The theme was further developed in "The Conscription of Wealth" (Harrod 1939:16 ).


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