A fascinating book “Archduke Franz Ferdinand Lives – A World Without World War I” by Richard Ned Lebow (Palgrave Macmillan, 2014) looks at history’s likely trajectory if the Sarajevo assassin Gavrilo Princip had missed and concludes that while much would be changed, we would at best be only modestly better off. However Lebow is not an economist and he misses two enormous economic factors that would almost certainly be different in a world without World War I. His “worst world” scenario might have derailed us, but absent that worst case, 2014 without World War I would probably enjoy much greater prosperity than today’s real world.

Lebow’s book takes its subject seriously; he constructs “Best World” and “Worst World” scenarios in which he explores how the world would have evolved given a century of big power peace, and what might have gone wrong. Franz Ferdinand himself plays an important role, initially in staving off calls for war and, after his accession on Franz Josef’s death in 1916, in reforming Austria-Hungary by turning the Dual Monarchy into a Triple Monarchy including more power for the Slavs, while democratizing Hungary, thus breaking the power of the Hungarian baronage. Austria-Hungary thus remains a stable element in the following century in both scenarios, on average somewhat richer than in real life, playing an especially important cultural, scientific and economic-theory role as its 20th century diaspora doesn’t happen.

The split between “best” and “worst” worlds comes in the Kaiser’s Germany, where a coup around 1920 takes one of two forms, a democratic one in which the Social Democrat and Centre Party parliamentarians’ power increases and Germany is largely democratized and pacified, or an authoritarian one, in which Germany’s semi- democracy is emasculated and the military runs the country behind the scenes. In the latter case there is a “cold war” between the authoritarian powers of Germany and Russia and the democracies, which in one variant turns into a small-scale nuclear war in the 1970s. (In even this pessimistic scenario, Hitler and Stalin remain insignificant, and the lack of a war tradition makes even authoritarian policymakers much more cautious than the 1930s dictatorships; hence full-scale nuclear holocaust is avoided.)

Lebow points out that there are certain disadvantages of even his better world. Some scientific advances, prompted by war, are considerably postponed – he postulates that without wartime code-breaking, the computer would have been delayed and without DARPA we might still not have the Internet. Here I think he may be too pessimistic; most of the intellectual advances that led to computers were undertaken by Alan Turing in the 1930s, while a network of computers exchanging information had obvious scientific potential. As I shall discuss below, economic factors that Lebow does not consider (his strength is strategic analysis; his economics are Keynesian and his social views those of the fashionable center-left) might well have led to more long-term research facilities inside large corporations, similar to the old Bell Laboratories, in which case basic technological advances might well have been accelerated compared with our own timeline.

Lebow also believes that the lack of a world war would have held back social developments, so that we would today be living in a 1950s world, in which the sexual revolution never happened, de-colonization was considerably delayed and, less attractively, where the rights of minorities were less well established. Lebow considers this a “bug” of even his Best World; others may in certain (perhaps not all) respects consider it a positive feature.

While Lebow’s analysis is generally very persuasive, he gets certain things wrong, in my view. For one thing, he assumes that without a Soviet Union supporting China’s Maoist forces there would have been no 1949 takeover, and China would have remained lapsed in warlordism, with no economic takeoff. I think the opposite scenario is more likely: without a strong Mao or a Japanese invasion Chiang Kai-shek would have established overall dominance by 1940, and would then have pursed the same free-market policies in China he was to pursue in Taiwan from the 1950s. That would have brought a Chinese economic takeoff some 35 years earlier than in real life, so that today the world would contain the China of 2050, with an economy far larger than that of the United States and a government that was not held back by nostalgia for the fallacies of Communism and Chairman Mao.

Overall, even Lebow’s Best World is no nirvana for the United States, which is part of a highly multi-polar global system, without strategic or economic dominance as in our world. On the other hand, it represents wish-fulfilment for Europeans, especially those attached to Britain or Austria-Hungary. However his picture is incomplete on the economic front, for he misses two major factors that would have made a huge economic difference over the intervening century.

First, at least in his Best World or those closely related to it, governments would be much smaller. In our world, they were only politically enabled to grow to their present grotesque size through the aggrandizement and political takeovers of two world wars. Without those wars (or the cold war and military build-up of Lebow’s Worst World) governments would probably be larger as a percentage of GDP than in 1914, as the pro-government sentiments of the Edwardian Liberal Party and the Wilson/Roosevelt Democrats would have pushed for expansion. However instead of today’s 40%-50% of GDP, government spending at all levels might total around 25% of GDP, still double that of 1914 Britain and about quadruple that of the 1914 United States.

In that event the social “safety net” would be correspondingly less generous, with pensions and unemployment benefits smaller and disability benefits very restricted. The gigantic regulatory apparatus that has grown up in the U.S. since 1965 and in Britain since World War II would be almost non-existent (there would doubtless be some environmental regulation, but it would be a minimal extension of property rights to include clean air and water.)

Inequality would not be higher than in our world because of the other even more important difference in economic arrangements: without World War I (or the wasteful arms race of Lebow’s Worst World) we would never have needed to leave the Gold Standard. Without being compelled to leave the Gold Standard, it is unlikely we would have done so, in spite of the bleatings of Keynes and his acolytes, because it would cause no obvious instabilities and would have worked well since its inception in 1819.

Keynes himself would not have written “The Economic Consequences of the Peace” and would not have enjoyed the status-boosters of the Great Depression and World War II; consequently he would have remained one of the myriad fringe anti-market economic figures, beloved by cranks and academics but with no great influence in the real world. Conversely the Austrian School, centered in the world’s leading economic-theory powerhouse at the University of Vienna, would be prominent if not dominant in the world’s economic thinking.

A Gold Standard world economy with smaller government would look very different from today’s. Governments would generally run budget surpluses, since persistent deficits in a Gold Standard world would cause unpleasant economic crises. Government debt would be tiny as a percentage of GDP; it would not have been increased by world wars, and without deficits its relative size would have been brought down by economic growth, as it was in 19th Century Britain.

In a Gold Standard world, leverage would be very expensive, instead of being subsidized through the tax and financial system as it is today. Bank and corporate debt would thus be much lower. Smaller governments would not run deposit insurance schemes, and so banks would be capitalized at 20% of assets, while corporations would borrow almost exclusively for working capital purposes. In consequence, there would have been no 1929 or 2008; the world’s financial system, being so underleveraged, would be completely stable. House prices would be much lower and houses would be financed as traditionally in Germany (funny money is apparently changing even German habits, alas) with middle-aged first time buyers and mortgages of no more than 50-60% of the purchase price.

The primary personal investments would be bonds and preferred stock, offering fixed dividends that suffered no inflationary erosion and were secure since they would occupy a senior position in the capital structures of underleveraged corporations. Since retirement investment would thus be very simple, it would almost all be done individually, with few mutual funds or pension funds and only insurance companies allowing people to annuitize some of their savings to avoid longevity risk. Corporations themselves would be much more oriented towards earning high and stable long-term returns, with large research and development operations, modest top management salaries and few takeover deals or bankruptcies.

In a world with leverage expensive and limited, there would be no cheap borrowing subsidy for the rich, and so Thomas Piketty’s inequality nightmare would be mitigated. While there would be a modest “tail” of people who would find it tough to survive with the limited safety net, there would also be far fewer billionaires, with the solid blue-collar and white-collar middle classes immeasurably strengthened.

Average living standards would also be much higher. Without the hugely damaging post-1973 regulatory state, with long-term research and development spending considerably higher and with smaller and less wasteful governments, productivity growth might even exceed the 2.8% achieved in the U.S. in 1948-73 with no post-1973 drop-off. Without the burden of past wars and debt, and with higher productivity growth, the average Gross Private Product in the U.S., Europe and Japan would be perhaps double its level in our world. (GDP would exceed our level by somewhat less, but nobody would use that flawed Keynesian measure!)

Lebow’s book is fascinating, and well worth reading. But by extending its analysis in the economic sphere, we can appreciate more fully just how much we have lost through the activities of the madman Princip, and how much we can regain by returning to the better economic management that pertained worldwide before the Sarajevo shots were fired.

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(The Bear’s Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that the proportion of “sell” recommendations put out by Wall Street houses remains far below that of “buy” recommendations. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)