Fritz Machlup, The Economics of Preparedness for War: Discussion (1949)

Fritz Machlup’s published conference discussion contribution examines the economic choices concealed within proposals for national-security mobilization. Responding to Professors Smithies and Grether, he asks when taxation and market prices should give way to direct controls, then challenges the assumption that military expenditure itself must be treated as fixed. His central argument is comparative: neither rising prices nor the invocation of preparedness establishes the necessity of administrative allocation. Policies must be judged against their alternatives, including the productive capacity sacrificed by immediate armament.

Machlup begins by contrasting fears of recession elsewhere at the meetings with the resource demands anticipated by the session’s two speakers. For economists administering large security programs, weaker civilian demand could release labor and materials and ease mobilization. This provocative reversal does not amount to a general recommendation for depression; it exposes the conflict between substantial government programs and continuing private demand under conditions of scarce resources. Since a sufficiently rapid contraction seems unlikely, the problem is how to manage competing claims with the least harm.

Smithies and Grether agree on monetary and fiscal restraint, including increased taxation to meet increased expenditure. Their disagreement concerns supplementary direct controls. Smithies favors using prices to redirect resources, while Grether proposes investment restrictions, priorities, allocations, and potentially comprehensive controls. Machlup finds their qualifications—avoiding controls if possible, adopting them if necessary—analytically inadequate:

What are their criteria for this “possibility” and this “necessity”?

The question establishes the contribution’s governing demand: an explicit theory of the point at which reliance on markets becomes impossible or socially intolerable. Machlup does not demonstrate that this point can never be reached. He argues that its location cannot be established through intuition or the mere observation that mobilization would raise particular prices.

His first conceptual distinction separates income transfers from resource transfers. Taxing civilians and spending the proceeds on defense will reduce civilian expenditure, but the goods forgone may contain little of the steel, copper, or aluminum demanded by the military. Aggregate purchasing power can change hands without releasing the required physical inputs. Relative prices must therefore help alter the composition of demand. Machlup nevertheless recognizes the objection grounded in derived demand: when a material accounts for only a small share of a finished product’s cost, its price may have to rise sharply before civilian purchasers release much of it.

To conclude that price and allocation controls are needed whenever prices would rise without these controls is a non sequitur unless we accept the dogma that price increases must be avoided at all cost.

The relevant comparison is between the costs of price adjustment and those of administration. Where a material has hundreds or thousands of civilian uses, suppressing its price requires officials to rank those uses and distribute supplies among regions and producers. The apparent avoidance of a price increase thus entails an extensive apparatus of discretionary decisions.

Machlup supports an intermediate arrangement: government set-aside orders could guarantee defense deliveries while leaving remaining supplies to market competition. But the preferred recipients should pay the competitive price, since preferential prices would encourage others to seek favored status.

The set-aside should merely serve as assurance of preferred delivery.

This distinction between delivery priority and price privilege makes his position more specific than a blanket rejection of intervention. The government can secure essential supplies without replacing the entire allocation mechanism.

He similarly endorses special excise taxes where industries hold prices below market-clearing levels and distribute goods through private allocation. Such practices shift scarcity profits toward dealers and gray or black markets. Excise taxation could capture those profits publicly, reduce excess demand, counter discriminatory distribution, and restore price competition. His explicit distinction between excise taxes and excess-profits taxes matters: the proposal addresses the pricing and allocation of scarce products, rather than simply penalizing profitable producers.

Machlup also distinguishes sectoral price increases from inflation caused by excessive aggregate spending. Heavy taxation could create deficient demand elsewhere even as defense-related prices rise. A net increase in the price level might then reflect differences in supply elasticities between contracting and expanding industries. This clarification reinforces his argument that effective restraint of total expenditure does not eliminate the need for relative-price adjustment. He suspects that the threshold justifying direct controls lies farther away than their advocates assume, while emphasizing that full employment, firms’ experience of controls, and peacetime conditions distinguish 1949 from 1941–42.

The final section widens the inquiry from instruments of mobilization to the scale and timing of preparedness. Security spending is not unalterably given; it must be assessed through foregone opportunities. The decisive alternative is not simply civilian luxury against national safety:

The choice before us is between building up the productive capacity of the nation or building immediately a stock of military equipment whose obsolescence is enormous.

Immediate armament can improve readiness for a near-term war while weakening readiness for a later one by diverting resources from productive capacity. Machlup closes with his childhood recollection of Vienna’s War Department and its maxim about preparing for war to secure peace. Against successive prescriptions for gold reserves, tariffs, subsidies, trade restrictions, and now investment and price controls, his continuing doubt challenges the automatic identification of economic restriction with security. The contribution’s lasting relevance lies in demanding that preparedness policy compare administrative costs, resource-allocation effects, and competing time horizons rather than treating military urgency as sufficient economic justification.