7.4 Economy in the Interwar Period

Following the devastation of World War I, the global economy entered a period of instability and transformation. Governments began to play a more active role in managing economic crises and experimenting with new approaches to production and consumption. The Treaty of Versailles, war debts, and an increasingly interconnected economy set the stage for the Great Depression and the rise of authoritarian economic responses.

The Treaty of Versailles and Postwar Economy

The armistice on November 11, 1918, brought an end to the fighting, but not to the economic consequences of the war. At the Treaty of Versailles (1919), the victorious Allied powers imposed harsh penalties on Germany:

• Reparations: Germany was required to pay 132 billion gold marks to the Allies, a figure later reduced but still burdensome.
• Territorial Losses: Germany lost all its colonies, as well as Alsace-Lorraine, the Polish Corridor, and the Sudetenland.
• Demilitarization: The German military was limited to 100,000 men. Tanks, submarines, and an air force were prohibited.
• War Guilt Clause (Article 231): Germany was forced to accept sole responsibility for the war, justifying the reparations.

These measures weakened Germany’s economy, angered its population, and fueled a growing sense of national humiliation. Other European countries also suffered financially due to wartime borrowing, inflation, and disrupted global trade.

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The Global Impact of the Great Depression

Though the 1920s saw some recovery, structural weaknesses remained. The Great Depression, beginning in 1929, would reveal just how fragile the global economy had become.

Interconnected Debt and Financial Collapse

Europe was caught in a cycle of debt. Former Allies owed money to each other and the United States. But to pay back these debts, they relied on reparation payments from Germany and Austria—who themselves needed U.S. loans to do so.

When the U.S. economy collapsed in 1929, the ripple effect was global:

• Foreign investors pulled out of Europe.
• Credit dried up, making repayment impossible.
• Industrial output slowed, leading to mass unemployment and economic instability.

Overproduction and Falling Prices

Industrialization led to mass production of goods, but demand could not keep up:

• Agricultural exports from colonies and rural economies were hit hardest.
• Surpluses in manufactured goods caused a drop in prices.
• Factories shut down, further worsening unemployment.

By the early 1930s, unemployment rates soared across industrialized countries, and the effects were deeply felt in both capitalist and colonial economies.

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Government Responses to the Depression

With laissez-faire capitalism in crisis, many governments turned to interventionist economic policies to try to revive their economies.

Keynesian Economics and the New Deal

British economist John Maynard Keynes argued that governments must actively stimulate demand in times of economic crisis. His theories became the foundation of Keynesian economics.

In the United States, President Franklin D. Roosevelt applied these ideas in his New Deal:

• Created public works programs to provide jobs.
• Introduced social welfare programs and protections for labor.
• Aimed to restore confidence in banks and the financial system.

Though the New Deal didn’t fully end the Depression, it laid the foundation for modern welfare states and increased the role of government in the economy.

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Command Economies and Authoritarian Alternatives

Other countries pursued more radical forms of economic control, especially in Soviet Russia and Fascist Italy.

Soviet Union: Five-Year Plans and Collectivization

Under Joseph Stalin, the Soviet Union launched a series of Five-Year Plans (starting in 1928) to industrialize rapidly and catch up with the West.

• Focused on heavy industry (steel, coal, machinery) rather than consumer goods.
• Collectivized agriculture by merging private farms into state-run collectives.
• Farmers were required to meet production quotas; failure to do so resulted in punishment, imprisonment, or death.
• The policy led to famine (notably in Ukraine) and widespread suffering, but rapid industrial growth.

Italy: Fascist Corporatist Economy

In Fascist Italy, Benito Mussolini developed a corporatist economic system:

• The government oversaw corporations and labor groups to manage production and resolve disputes.
• In theory, this system aligned the interests of the state, workers, and employers, though in practice it suppressed labor rights and promoted state control.
• Economic growth was limited, and Italy still struggled with debt and underdevelopment.

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In depth: Solutions to the Great Depression

U.S. New Deal – Reform Through Democracy

Goals:

• Alleviate effects of the Great Depression
• Stabilize capitalism through regulation, not replacement
• Provide relief, recovery, and reform (3 R’s)

Key Programs:

• Civilian Conservation Corps (CCC) and Works Progress Administration (WPA) created jobs in public works
• Social Security Act introduced pensions and unemployment insurance
• Glass-Steagall Act regulated banking; separated commercial from investment banks
• Agricultural Adjustment Act (AAA) paid farmers to reduce production and stabilize prices

Outcomes:

• Did not fully end the Depression, but restored faith in government and avoided revolution
• Increased federal responsibility for economic well-being
• Created a lasting welfare state model used worldwide

Limitations:

• African Americans and women were often excluded
• Southern Democrats maintained segregationist policies

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Stalin’s Five-Year Plans – Command Through Repression

Goals:

• Catch up industrially with the West
• Turn the USSR into a self-sufficient, modern state
• Enforce state socialism and eliminate capitalist structures

Key Features:

• First plan (1928–1932): Emphasis on coal, steel, oil, and infrastructure (dams, railways)
• Collectivization of farms: forcibly consolidated millions of peasants into state-run farms
• Use of production quotas and state-run factories

Outcomes:

• Rapid industrial growth: USSR became the world’s second-largest industrial power by 1940
• Severe human cost: 5-8 million deaths in famines (especially Ukraine’s Holodomor)
• Millions sent to gulags (forced labor camps)

Long-Term Impact:

• Proved that state planning could industrialize a country quickly—but at a devastating price
• Set precedent for other planned economies (e.g., Mao’s China)

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Mussolini’s Corporatism – Control Through Collaboration

Goals:

• Solve class conflict and economic stagnation without communism
• Promote nationalism, autarky (economic self-sufficiency), and state unity

Key Institutions:

• National Council of Corporations: divided economy into sectors like agriculture, industry, and commerce
• Workers and employers represented by state-controlled syndicates
• State decided labor conditions, wages, and production goals

Outcomes:

• Suppressed labor unions and strikes
• Growth in some industries, but Italy remained economically weak
• Major projects like "Battle for Grain" and infrastructure development had mixed results

Long-Term Impact:

• Corporatism failed to deliver prosperity or full employment
• Economic mobilization improved slightly during WWII, but Italy remained behind Britain, Germany, and France
• Mussolini’s model influenced fascist economies in Spain and Portugal, but lacked sustainability

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Comparative Summary: What Made Each Unique?

• The New Deal used democratic institutions and Keynesian economics to preserve capitalism.
• The Five-Year Plans created a totalitarian economy focused on industrial might, with little regard for human rights.
• Mussolini’s system sought a middle ground between socialism and capitalism, but centralized control without the effectiveness of Stalin’s model or the freedom of FDR’s.

Each system was a response to crisis—but their methods, goals, and results reflect the broader ideologies shaping the 20th century's political economy: liberalism, socialism, and fascism.

Conclusion

The interwar period revealed the fragility of the global economy and forced governments to confront the failures of laissez-faire capitalism. The responses to the crisis varied widely:

• Liberal democracies leaned toward state intervention and welfare.
• Authoritarian regimes pursued total control of economic life.
• Colonial economies suffered disproportionately, deepening global inequality.

The economic challenges of this era, combined with the lingering grievances from World War I, laid the foundation for political extremism, militarization, and ultimately, World War II.

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