05/27/2016 02:17 pm ET Updated May 28, 2017

A Martini or Two to Economic History!

The wonderful Australian-born economist, Arthur Smithies, became a warm friend of mine one summer long ago in Saigon. I drank beer, he drank martinis. Neither I nor the Vietnamese could believe his capacity. In Saigon as was his habit at Harvard, he ran every morning, sculled at Noon, churned up and down a swimming pool in the evening and then polished off a bottle of gin, or so it seemed. John Kenneth Galbraith, Smithies' colleague, wrote when his friend died after rowing on the Charles, that "unlike many economists, (he) correctly believed that the difference between a good economist and an inferior one is his sense of history." That was Smithies in a sentence.

I remember him best for an incident in his class in the old Littauer auditorium seven or eight years before we reconnected in Viet Nam. I had written a paper about economic growth in India and Egypt during World War I. It showed that both economies had grown prodigiously during that awful slaughter because England had poured money into them to supply its war effort. Britain borrowed enormous sums to pay for the war and great chunks of that money flowed to Egypt, India and many other places including the U.S. The huge increases in output in India and Egypt in response to that spending showed that unemployed labor and resources were available even in the poorest places. It was the lack of borrowers and spenders not the lack of labor and resources that made them poor.

I remember where I was sitting in Smithies' course at Harvard when he surprised me by saying in front of the whole class that he had been "thinking about Mr. London's paper for three weeks." He went on to explain to the class that Keynesian demand-side economics and deficit spending were usually thought of as something for developed countries in recessions, not for poor places like India and Egypt in ordinary times. Smithies liked the paper because he said I was making the broader argument that countries with idle resources and labor were the rule not the exception, and that they could produce more goods and services if there were more credit-worthy borrowers spending more money. Think of the U.S. "output gap" today.

Ordinary citizens understand that spending drives employment and investment although politicians for centuries have scared them with myths about the dangers of government borrowing and unbalanced budgets. Illiterate boatman ferrying passengers across the Thames in London in the 1700s knew that wars with Holland (there were four) would make the king's navy hire them. The boatmen were grossly under-employed like many Americans today, until the king's government borrowed to employ them.

Farmers during the Viet Nam War also produced in response to war-related demand. The airbase outside of Soc Trang in the Mekong Delta needed carrots and other vegetables. The town and the base were surrounded by flooded rice paddies and there was no dry arable land. The Americans at the base were willing to pay for vegetables, however, so farmers invested labor to dig soil out of the paddies, create patches of dry land, and "teaspoon" fertilizer around the plants. The result was 3 or 4 crops a year of gorgeous carrots and legumes to meet the demand at the base. Labor and resources were plentiful. What it took was money/demand to make the farmers create the land and grow what the base would buy.

American history is full of periods when shortages of credit/money prevented idle labor and resources from being put to work. Alexander Hamilton understood and created a government regulated bank that provided solid and ample credit and money in the 1790s, and prosperity followed. Unfortunately leaders who oppose his insights have often prevailed over the next 225 years. Disruptions of credit/money creation driven by destructive anti-Hamiltonian ideas about gold, banks and deficits cost the U.S. dearly before and after the Civil War. The Civil War itself and the expansionary spending it engendered, on the other hand, led to a great surge in industrial activity financed by borrowing and the printing of "Greenbacks" by the government. Economic disaster followed when politicians without understanding enacted policies that dried up bank credit and sound lending.

Government spending on the Works Progress Administration (WPA) and the Civil Conservation Corps (CCC) put millions of people to work during the Great Depression and could have employed millions more if politicians, including Hoover, FDR, and many in Congress had not been wedded to anti-spending ideas. We know this because massive spending to fight the war greatly exceeded spending by the WPA and CCC after 1940 and put everyone to work. Government spending for war paid for whole new industries like aluminum, financed the building of more than 50,000 planes, thousands of ships, and millions of trucks, tanks and other equipment. The result of this spending was real full employment and double digit growth for the all the war years.

I well remember those discussions with Arthur Smithies in Viet Nam about this economic history.