The Rise of the Rate of Profit During World War II

Author(s): Gérard Duménil, Mark Glick and Dominique Lévy

Source: The Review of Economics and Statistics, Vol. 75, No. 2 (May, 1993), pp. 315-320
Published by: The MIT Press
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 NOTES

THE RISE OF THE RATE OF PROFIT

DURING WORLDWAR II

GerardDumenil,MarkGlick,and DominiqueLevy*
Abstract-This study analyzesthe importantincrease in the to 1929, and the postwartrend, from 1946 to 1989, is
rate of profit which occurred in the United States during estimated as a shift of 15.8%in absolute terms (com-
WorldWarII. The gap betweenthe predepressiontrendline,
from 1900to 1929,and the postwarline, from 1946to 1989,is paredwith an averageof 29.0%over the whole period).
estimatedas a shift of 15.8%in absolute terms (to be com- While any use of historicaldata must be careful and
paredwith an averageof 29.0%over the whole period).Using qualified,the restorationof the profit rate is evident
a production function analysis, we demonstrate that this even when limited to the 1929-1989 period for which
transformation can be explainedby an accelerationin the rate
more reliabledata fromthe Bureauof EconomicAnal-
of "autonomousprogress"between 1930 and 1945.We iden-
tify a sudden and nonneutraldiscontinuityin the process ofysis (BEA) are availableand more satisfactorydefini-
technicalchange, characterizedby an autonomoussubstitu- tions of output,compensation,and capitalcan be used.
tion of equipmentfor structures. We denote this extraordinaryshift in the rate of profit
as the "leap forward."
Introduction In this study, we critically evaluate a number of
competingexplanations(such as a reductionin labor
Much ink has been spilled by economists attempting cost, a rise in the utilizationof capacity,or increased
to analyze the decline in the rate of profit (or rate taxes) and argue that the rise of the profit rate during
of return on invested capital) in the United States World War II was associated with a sudden shift in
since the mid-1960s (see, e.g., Okun and Perry (1970), technology.In particular,(1) the growthof the Capi-
Nordhaus (1974), Feldstein and Summers (1977), and tal/Labor ratio was interruptedfor a numberof years
Lovell (1978)). This literature implicitly assumed that and resumed from considerably diminished levels,
the point of departure of most data series in the late (2) the decline of the Structures/Equipment ratio (the
1940s, which is used as reference to argue that prof- two componentsof the capitalstock)suddenlyacceler-
itability has fallen, was not exceptional. Using time ated, and (3) the productivityof capital increased.
series data stretching over ninety years, we show that Using a conventionalproductionfunctionanalysis,the
this is clearly not the case: When pretax profit mea- existence of accelerated "autonomous" technical
sures are considered, the levels of profitability reached progressduringthis period can be demonstrated.1Be-
just after World War II are extraordinary in compari- tween 1929 and 1946,the averagegrowthrate of multi-
son to both the 1920s and the early 20th century. factorproductivity(as measuredby the shift factorof a
The existence of this sudden recovery of profitability C.E.S. productionfunction) was approximatelyequal
during World War II has not gone totally unnoticed. to three times its averagevalue prior to 1929 or after
For example, in the 1960s, a debate focused on this 1946. In addition, it is shown that this autonomous
issue for Manufacturing industries (Krzyzaniak and progresswas nonneutral,primarilyaffectingthe mix of
Musgrave (1963) and Gordon (1967)) and, more re- equipmentand structures.
cently, one can find reference to the transformations One critical methodologicalissue in this investiga-
which occurred during World War II in Blanchard and tion concerns how to measure the breaks in the time
Fisher (1989) (figure 1.3, p. 4, and note 6, p. 30). series of a numberof variables.Our approachinvolves
Nevertheless, this exceptional episode in U.S. eco- regressingeach variableconsidered,x, on time, with a
nomic history has remained unduly neglected. dummyvariable,D, equal to 0 prior to the transition
We show that a sudden recovery of the rate of profit years and 1 after:
occurred during World War II, interrupting its other-
wise slightly downward trend from 1900 to 1989. The xt = a + bt + cDt + 71t. (1)
gap between the predepression trend line, from 1900
The size of the breakis measuredby the value of c. If
Receivedfor publicationApril 17, 1990. Revisionaccepted
1 The issue of the actual "explanation"of this acceleration
for publicationDecember2, 1991.
* CNRS/LAREA-CEDRA, University of Utah, and will not be addressedin this paper (see Dumenil and Levy
CNRS/CEPREMAP,respectively. (1993),partsV and VI).

CopyrightC 1993 [ 315 ]

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316 THE REVIEWOF ECONOMICSAND STATISTICS
FIGURE 1.-THREE MEASURES OF THE RATE OF PROFIT
(1900-1989)
Note: * is an estimateof the rate of profitbetween 1900 and
1989 for the total privateeconomy,in whichprofitsare gross
of all taxes. 0 and * present two measuresof the rate of
profitfor the Corporatesector,between1929and 1989,with a
narrowerdefinition of profits, and a broader definition of
capital includingresidentialcapital. Profits are gross of all
taxes in 0 and net in *.
xt is the logarithmof a variable,b is the growthrate of
the variable, and exp(c) measures the break. If the
estimation is performed with ordinaryleast-squares,
the Durbin-Watson(DW) test revealsstrongautocorre-
lation. To eliminatethis problem,we first add a proxy
for the capacityutilizationrate, denoted u (cf. Dumenil
and L6vy (1991), section 4.2) to the exogenous vari-
ables and, second, assumethat the randomterm, 7q,is
autoregressive:-q,= v, + PqTh-1in which vt is an inde-
pendentlyand identicallydistributeddisturbance.2
In the first section, we will explore the features of
the leap forwardin profitabilityand demonstrateits
exceptionalcharacter.Two subsequentsectionsinvesti-
2
The period 1930-1945 poses some specific technical dif-
ficulties.This period combinesthe recoveryof the profitrate
investigatedin this paper and a broad oscillation of the
generallevel of activitycorrespondingto the successionof the
Great Depression and World War II. This fluctuation is
reflected in the decline of the profit rate below its trend
duringthe depressionand the bulge duringthe war. Correc-
tion usinga proxycapacityutilizationrate does not resolveall
technicalproblems,and it is preferableto ignore the period
1930-1945 in the estimations.With this method, it becomes
unfortunatelyimpossibleto locate preciselythe transforma-
tion observedduringthe period and to determine its exact
duration.(Unless otherwise specified, the results presented
belowwere obtainedwith the MaximumLikelihoodmethod.)
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gate the transformationof technologyunderlyingthis
leap. In section II the aggregatecapital stock is con-
sidered, whereas its two components,equipment and
structures,are distinguishedin section III.
I. A Leap in the Historical Trend of the Rate
of Profit
The rate of profit, r, for the period 1900-1989 is
presented in figure 1 (0). The stock of fixed capital is
net of depreciationand restricted to equipment and
structures, and GovernmentOwned Privately Oper-
ated capitalis included.Profitsare calculatedas Gross
NationalProductfor total economyminus:(1) depreci-
ation, (2) income created by the government, and
(3) the total remunerationto labor includinga correc-
tion for the wage-equivalentof self-employedpersons
(estimatedby multiplyinigtotalprivateemploymentby
annualcompensationper employee).
Time series on fixed capital and depreciationfrom
the BEA are available since 1925. The National In-
come and Product Accounts provide data on GNP,
employment,and compensationsince 1929. Prior to
these dates, one must borrow from various historical
studies:Balke and Gordon(1989)for GNP, Goldsmith
(1952) for the capital stock, Kendrick(1961) for em-
ployment, and Lebergott (1964) for compensation.A
detailed accountof the sourcesand constructionof the
series can be found in Dumenil and Levy (1991).3
Obviously, the accuracy and reliability of the data
greatlydepend on the period considered.
In orderto providea measureof the leap forwardin
profitability,we applythe methodologyoutlined in the
introduction,and obtain the followingequationcorre-
spondingto the two trend lines in figure 1:
rt= 0.249 - 0.00125t + 0.366 ut
(t = 16-7) (t = 2.1) (t = 6.4)
+ 0.158 Dt
(t = 4.4)
p = 0.768(t = 9.7) R2 = 0.906 DW = 1.80
1930-1945 excluded
A leap of 15.8%is observedcomparedwith an average
value of 29.0% for the entire period. When viewed
from the long-run perspectiveof figure 1, the World
War II leap forward appears as an obvious exceptional
3The data series can be obtained upon request from
I?. Levy, CEPREMAP,142, rue du Chevaleret,75013 Paris,=
France.
 NOTES 317

event, a restoration of major historical significance. In- and using the MaximumLikehoodmethod):
dependentlyof the leap, a slight trend downwardof r
is observedamountingto an averageof -0.125% per Productivityof Labor,PL 0.168 (1.8)
year.4 Productivityof Capital,PK 0.536 (10.3)
Beginning in 1929, the rate of profit can be com- Capital/Labor,K/L - 0.498 (4.9)
puted on the basis of BEA data alone. A difficultyin LaborCost (Nominal Wage/ 0.134 (1.8)
the use of these data is, however,that only one year, GNP Deflator), w
1929,is availableto assess the prewar"normal"levels. Priceof Capital 0.240 (7.6)
Abstractingfrom the effects of taxation,the leap for- (Deflator of Fixed Capital/
ward survivesany change in rate of profit definition. GNP Deflator), PK
Variousmeasuresof the stock of capital(grosscapital,
net capital,net capitalplus inventories),and changing Obviously,the leap in the rate of profitdid not occur
definitionsof profits(withoutcorrectingfor ,the wage- in isolation.A numberof economicvariableswere also
equivalent,or withoutinterest)yield a similarresult. It affected,in particularPK, K/L, and PK. In additionto
is also possibleto eliminatethe dubiouscomponentsof this observation,the above table suggests that high
income (such as rental income of persons) and restrict profitsare not the resultof shiftsin relativeprices.The
the unit of analysisto the sum of the Corporatesector profitrate did not rise in responseto a decreasein the
and Sole Proprietorshipsand Partnerships,or to the price of inputs. (Both the labor cost and price of
Corporatesector alone, without affectingthe results. capital increased.) Paradoxically,the small increase
One importantaspect of the leap forwardin prof- observedin the laborcost coincideswith a reductionof
itabilityis that it was completelyabsorbedby the state the Capital/Labor ratio.
through taxation. In order to investigate this phe- The rise of the tax burden stands out as another
nomenon,the unit of analysismust be restrictedto the possible explanation. For the Corporate sector, the
Corporatesector (now 66% of the total privateecon- ratio Indirect Business Taxes plus Profits Taxes/Gross
omy),for whichboth IndirectBusinessTaxes and Cor- Domestic Product was increased 2.11 times between
porateProfitsTaxes are available.Figure1 displaysthe 1929 and 1946-1955. However,when taxes are propor-
rate of profit for the Corporatesector gross of taxes tional to profits they do not affect the optimal factor
(0) and net of all taxes (*). (A description of the combination(cf. Stiglitz(1986), p. 443) and, therefore,
constructionof the series can be found in Dumenil, largertax rates cannotaccountfor higherprofits.It has
Glick, and L6vy(1989).) In the first measure(0), the also been contendedthat the supplycurveof capitalis
rate of profitis equal to 15.8%in 1929 and soars to an horizontaland taxes are fully shifted by enterprisesto
averageof 27.1%for the period 1946-1955, yieldinga consumers,by raisingprices, or to salariedworkers,by
ratio of 1.71. In the second measure,the leap is totally diminishingwages. Unfortunately,this hypothesis is
offset, and the series actuallydisplaysa decline. Com- contradicted by the movement of the labor cost
paring the period 1946-1955 with 1929, the ratio is (Wages/Prices) which actuallyrose duringthe period.5
now equal to 0.90. The above observationssuggest that the rise of the
rate of profit reflects the effect of an "autonomous"
II. Factor Prices and Technological Change wave of technicalprogress.To investigatethis hypothe-
sis, we considera C.E.S.functionwith constantreturns
This-sectioninvestigatesthe historicalshift in tech- to scale: Q = A(t)(a L- + (1 - a)K-Y)- 1/ in which
nology and distributionwhich accountsfor the leap in the shift factorA(t) accountsfor technicalprogress.As
profitability. is well known,when w -> 0 the Cobb-Douglasfunction
Using the methodologypresented in the introduc- is recovered, and w -> oo correspondsto the case of
tion, it is possible to providemeasuresof the break in complementaryfactors. The optimal combinationof
the trend of the variables.The table below displaysthe factorsis given by
value of parameterc, as in equation(1), for the loga-
rithmof the variable,and its t value within the paren- w
W A1/1 +W9) (
theses (still assumingthat the residualis autoregressive

4 Othermethodsthan the MaximumLikelihoodmethodgive S Krzyzaniakand Musgrave(1963), consideringthe Manu-

similarresults. The values of the coefficientof Dt are the
following:0.160 (t = 4.8) for the Yule-Walkermethod, 0.156
(t = 4.1) for the iteratedYule-Walkermethod and uncondi-
tioned least squares.OLS overestimatesthe leap: 0.187 (t =
11.6).
facturingsector, defended this view that the rise of pretax
profitabilityduringWorld War II resultedfrom the increase
in CorporateProfits Taxes during the war. Gordon (1967)
repliedthat the restorationof the rate of profitis explainedby
the rise in the productivityof capital.

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318 THE REVIEWOF ECONOMICSAND STATISTICS
TABLE 1.-THREE MEASURES OF THE BREAK IN THE SHiFT FACTOR In A(t)

Variable Intercept t u D p R2 DW

A(l)(t) 0.567 0.0112 0.575 0.339 0.881 0.998 2.20

(t = 17.3) (t = 9.7) (t = 8.4) (t = 4.9) (t = 15.1)
A(2)(t) 0.805 0.00978 0.647 0.309 0.926 0.999 1.93
(t = 27.5) (t = 10.9) (t = 15.2) (t = 5.8) (t = 22.6)
A()t 0.800 0.00951 0.640 0.349 0.906 0.999 1.97
(t = 31.9) (t = 11.6) (t = 14.7) (t = 7.1) (t = 18.2)

and interpreted as a true revolution in technology. We now

.PK =( CKK ) A(t)@/1@
in which CK is the cost of capital, i.e., rpK= (Q-
wL)/K with Q and K expressedin constantdollars.
Parametersa and X can be determinedby regress-
ing ln PL/PK on ln WICK:
PL W
ln- = - 0.529 + 0.947 ln-
PK (t = 3.5) (t = 20.3) CK
+ 0.703 u
(t = 2.8)
p = 0.547 R2 = 0.969 DW = 1.54
(t = 5.46)
(using the Yule-Walkermethod, since the Maximum
Likelihood method does not converge). One obtains
w = 0.0561and a = 0.636. (The productionfunctionis
close to a Cobb-Douglas.)The shift factor, A(1)(t)=
(aPLj + (1 - a)PZ)l/, can thus be determined. The
results of the regression are presented in table 1. The
coefficient of D is c = 0.339,6 and the break amounts
to a ratio of exp(c) = 1.404.
These results confirmthe fact that the rise of the
profit rate can be explainedby an exceptionallyfast
growthof technical progressbetween 1930 and 1945,
althoughthe exact timingof the phenomenonis diffi-
cult to locate, owing to the succession of the Great
Depression and WorldWar II. The underlyingannual
growthrate of technicalprogressis approximately1%.
The additionalgrowthrepresentedby the dummyvari-
able amountsto more than 40%, representingan an-
nual rate of about 2% (and thus a total of 3%).
This sharp progressof multifactorproductivitycan
be partially explained by the more intensive use of
fixed capital, as documentedby Foss (1984, table 1,
p. 8). Comparing1929 and the 1950s, Foss's figures
account only for a rise of 4% in capital productivity,
and the remaining increase cannot be attributed to
more intensiveuse of capital.
III. Labor, Equipment, and Structures
The analysisconductedin the previoussection sug-
gests that the phenomenon under investigation must be
6 With
the other methods, the coefficientof D varies be-
tween 0.318 and 0.382.
attemptto outline the specificcontoursof this revolu-
tion.
We first direct our inquiry to the composition of
fixed capital.The BEA stock of equipmentseries (for
the period 1925-1989) can be disaggregatedinto 22
components.Structures,in turn, can be disaggregated
into 11 components.An examinationof these series
revealsthat no single componentstandsout as respon-
sible for the dramatic transformationwhich we ob-
served.The main feature of the evolutionof capitalis
the relative decrease of structuresoverall in compari-
son to equipment. In 1900 the ratio of the stock of
structuresto that of equipmentin constantdollarswas
equal to 3.78, whereas in 1989 it is reduced to 0.92.
After a shortincreasein the late 1920s,a steep decline
can be observeduntil the beginningof the 1950s.The
acceleration of the fall from the aftermath of the
depressionto the beginningof the 1950s corresponds
to the historicalbreak under investigation.(Using the
same model as in equation (1) with the Yule-Walker
method, exp(c) = 0.85.) It is easy to infer from the
above observationsthat the profilesof the productivi-
ties of equipment and structures have been signifi-
cantlydifferent.The productivityof equipmentdisplays
a downwardtrend. After World War II, the series
returns to its earlier trend, at a higher level. Con-
versely,the productivityof structuresdisplaysa nearly
horizontaltrend before and after World War II, with
an importantbreakduringthe war, from an averageof
about 0.80 prior to the breakto an averageof 1.73 for
the period followingthe break(exp(c) = 1.90).
In order to analyze the differencebetween equip-
ment and structures,we will use productionfunctions
with three factors:Q = f(L, E, S). Since the deprecia-
tion rates, Ss and 8E' of the two componentsof fixed
capital are significantlydifferent, it is necessary to
measure output gross of depreciation.(The average
values of Ss and SE in the BEA series for 1925-1989
are 0.0519 and 0.123.) With PE and Ps denoting the
prices of equipmentand structureson the commodity
market, the optimal combination of factors can be
determinedfrom the maximizingof the rate of profit:
r = (Q - wL -pPSSS -PE8EE)/(psS + pEE).
(2)
For a C.E.S. function Q = A(tXoaL-w + /SE- +
yS-W/)-w/ with a + 13+ y = 1, the optimal factor

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 NOTES 319

combinationis givenby These results (f82 > 311Y2 < 7yl and a1 = a2) clearly
reveal an autonomoussubstitutionof equipment for
= W 1/(l+ w) structureswithin the stock of capital (and, thus, a
PL=
- A )
largerincreaseof the productivityof structures),which
left the share of labor and labor productivitylargely
PE =
CE 1/(1 @C A /(1+ - . unaffected.
In sum, it appearsthat, in spite of minordifferences,
Cs 1/(1 +) the three estimatesare consistentin the following:
PS A +
y

with CE= pE( r+ '6E) and cs =ps(r + SS). 1. A comparisonof the levels reached in 1929 and
Parametersax, 3, y, and w can be determinedby 1946revealsan exceptionallystrongwave of "au-
estimatingsimultaneously7In PE/PS and In PS/PL tonomous"technologicalchange:a rise of about
40% of multifactorproductivity,i.e., an annual
rate of growthof more than 3% for more than
InPE= 0.319 + 0.761 CE+ 3.74 u 15 years, approximatelythree times the rate
PS (t = 9.8) (t = 34.7) cs (t = 6.0) achievedprior to and subsequentto this period.
(3)
2. This accelerationof technicalprogresswas asso-
In- = 0.287 + 0.761 -c 1.18 u.
ciated with an "autonomous"substitution of
PL (t = 4.2) (t 34.7) w
= (t = 6.0) equipmentfor structureswithinthe capitalstock.
3. This progressaccountsfor the exceptionalrise of
SystemWeightedR2 = 0.871
the profitrate duringthis period,whichsuddenly
From equations (3), we can derive: w = 0.314, a = sprungforth at the beginningof World War II,
0.468, f8 = 0.211, and y = 0.321. Notice that w is because of the fluctuation of output from the
largerthan in the previousestimation,where the capi- depressionto the war.
tal stockwas consideredglobally.The results concern-
ing the shift factor,A(2)(t) = (aPLO+ /3PE + yP5)l/W,
are displayedin table 1. This time, the break amounts
to a ratio 1.362. REFERENCES
As suggestedearlier, equipmentand structuresdid Balke N. S., and R. G. Gordon,"The Estimationof Prewar
not contributeequally to the transformationof tech- Gross National Product:Methodologyand New Evi-
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raises the issue of the nonneutralityof technological 38-92.
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320 THE REVIEW OF ECONOMICS AND STATISTICS
Krzyzaniak M., and R. A. Musgrave, The Shifting of the
Corporation Income Tax (Baltimore: The Johns Hop-
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THE FISHER EFFECT AND THE TERM STRUCTURE OF INTEREST RATES:
TESTS OF COINTEGRATION
Myles S. Wallace and John T. Warner*
Abstract-The literatureon the Fishereffect has ignoredthe
potential relationshipbetween inflationand long-terminter-
est rates. Using an expectationsmodel of the term structure
of interest rates, we establish the conditions under which
innovations in short-term inflation will be transmittedto
long-termas well as short-terminterest rates. Cointegration
tests find supportfor both the FIshereffect and the expecta-
tions theoryof the term structure.
I. Introduction and Summary
Recent studies of the term structure of interest rates
(Campbell and Shiller (1987), Stock and Watson (1988))
find support for a stable relationship between short-
and long-term interest rates, that is, that they are
"cointegrated." At the same time, virtually all Fisher
effect studies have limited themselves to the relation-
ship between short-term interest rates and short-tcrm
inflation on the belief that neither current and past
inflation rates nor survey data provide a guide to future
long-term inflation.
The purposes of this paper are twofold. First, we
establish the conditions under which innovations in
inflation affect long-term interest rates as well as short.
We demonstrate that if the one-period inflation rate
has a unit root in its time series process, then expecta-
tions of inflation in future periods will ultimately be
dominated by the current one-period rate. As a conse-
quence, it is possible for the current one-period infla-
tion rate to be cointegrated with long-term interest
rates as well as short.
Second, we apply Johansen's cointegration test
(Johansen (1988), Johansen and Juselius (1990)) to
quarterly data from the period 1948:1-1990:4 to test
for stable long-run relationships between the (annual-
ized) 3-month inflation rate, 3-month Treasury bills
and 10-year government bond rates. Unlike some pre-
Received for publication October 9, 1990. Revision accepted
for publication January 15, 1992.
* Clemson University.
We thank Dennis Placone, Gerald Dwyer, Don Gordon, and
David Dickey, in addition to two anonymous referees for
numerous useful comments. The usual caveats apply.
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All use subject to JSTOR Terms and Conditions
Nordhaus W., "The Falling Share of Profits," Brookings Pa-
pers on Economic Activity (1, 1974), 169-208.
Okun A., and G. Perry, "Notes and Numbers on the Profits
Squeeze," Brookings Papers on Economic Activity (3,
1970).
Stiglitz J. E., Economics of the Public Sector (New York:
W. W. Norton and Company, 1986).
vious studies, we provide support both for the exis-
tence of a Fisher effect on short- and long-term inter-
est rates and for the expectations theory of the term
structure of interest rates. In fact, we are unable to
reject a one-to-one relationship between one-period
inflation and either interest rate.
II. Issues
Let us sketch a simple model of the term structure
of interest rates and study the conditions under which
innovations in inflation will be transmitted to short-
and long-term interest rates. Suppose the government
issues a $1 zero coupon bond of maturity G and an
alternative one-period asset. Let r, be the interest rate
prcvailing at the start of timc t on the one-period
asset, and {E,(r, +), j= 1. ..,- 1) denote the se-
quence of expected future one period yields. Let R, be
the return to maturity on the bond. According to the
expectations theory of the term structure, the interest
rate on the G period assct will be
_ II - I
-G
R, = (1 ? 171(1 ? - 1. (1)
Now consider the effect of expected inflation. Ignor-
ing tax adjustments (Darby (1975)) and other complica-
tions such as risk premiums, according to the Fisher
effect, r, = E,(r*) + E,(7T) + E,(r*)E,(w7,), where
E,(r*) is the expected real rate during period t and
E,(7T,) is thc one-period rate of inflation expected
during period t . Furthermore, E,(r,+.) = E,(r,*+ ) +
E1(7141J) + E,(r,*+ )E,(r,+J), j = 1,...G - 1. Since
1 + r, = (1 + E,(r1*))(I + E,(CT,)) and 1 + E,(r ,.) =
(t ? E,(r* .))(I + E1('n-1j)), the long-term interest ratc
RI is
G_ I l(
R = [(1 + E,(r*+.))(I + EJ(7141))]
(2)
Copyright C) 1993