The economics of neutral countries during World War 2

Neutrality has long been viewed as impartiality in war. This column, part of the Vox debate on World War II, asserts that neutral states in the war were realist in approaching their defence to ensure their survival. Neutrals such as Portugal, Spain, Sweden, and Switzerland maintained independence by offering economic concessions to the belligerents to make up for their relative military weakness. Economic concessions took the form of merchandise trade, services, labour, and capital flows. Depending on their position and the changing fortunes of war, neutral countries could also extract concessions from the belligerents, if their situation permitted.

Dozens of European states adopted neutrality at the beginning of WWII, but by 1945 only Ireland, Portugal, Spain, Sweden, Switzerland, and Turkey remained independent or unaligned. Before the war, the traditionally neutral countries put their faith in collective security and did not rearm, despite the increasing militarisation in Europe after 1933. They believed that the League of Nations had removed the need for war by substituting a system of conflict prevention. This belief failed with the Munich Agreement in 1938 (Wylie 2002).

Geography still protected some countries such as Ireland and Turkey, for whom large bodies of water made direct invasion difficult. But Portugal, Spain, Sweden, and Switzerland were unable to provide a military defence against encirclement. They would surely have put up a significant fight but would still have lost if invaded by Britain or Germany. Like other neutral countries, they could not build armies capable of resisting a powerful attacking force.

While each case is different, the problem of maintaining neutrality in WWII had some general features. In order to remain independent, the neutrals had to combine military defence with making themselves economically useful to the belligerent. The economic concessions given by small states included trade in goods and materials, labour provision, and capital. These concessions proved sufficiently valuable for the belligerents to continue to respect the neutral’s independence, despite continued threats of invasion (Wylie 2002).

Merchandise trade and services

Each of the countries which remained neutral after June 1940 was able to assuage the belligerents’ political intransigence and maintain friendly relations by exporting various material goods to each of the belligerent groups: from Sweden, iron ore and ball-bearings; from Switzerland, watches, metal goods, and machinery; from Spain, food, iron ore, and wolfram; from Portugal, leather hides and wolfram (Golson 2011).

Swedish trade was particularly beneficial for the resource-strapped German Reich in military terms: iron ore, ball-bearings, and machine tools were used in the manufacture of German guns, tanks, and aircraft (Golson 2016). These goods were also needed by the Allies, particularly Britain, for the continued manufacture of aero-engines and machines. Despite its geographic location within the German sphere, the Swedish government allowed much-needed war materials to reach Britain illicitly (Golson 2012).

Beyond merchandise, the European neutrals provided a variety of services to the belligerent powers: Portugal provided the British with shipping services (Golson 2019); Sweden provided the Allies and Axis powers with diplomatic, shipping, and insurance services; the Swiss provided diplomatic, protecting-power, banking, and insurance services; and, although Spain was generally less service-oriented, it was still paid for providing shipping to the Allies and diplomatic representation to the Germans. The belligerents were ultimately net payers to the neutrals in most of these relationships, buying millions of pounds of neutral services they could not obtain from any other source (Golson 2011).

The economist Mancur Olson (1963) suggested that in wartime no one good would hold more value than another at the margin, the reason being the scope for belligerents to find substitutes for missing products. It is clear, however, that substitutes were not in fact easily available for all the neutral goods and services. Despite the efforts made in particular industries, substitutes were often more expensive or of lower quality.

This is shown by the case of Swedish steel for ball-bearings. In both the UK and Germany, ball-bearings made from domestic materials had much higher failure rates; this led to the grounding of many Royal Air Force planes when they were desperately needed (Golson 2012). In services, there was no easy substitute for Swiss diplomatic and protecting-power work during the war. It was efficient for the belligerents to obtain the goods and services available from the neutral countries through trade.

Of course, the engagement between the neutral and belligerent economies led to much controversy, including accusations that the Swedes and the Swiss were working for the German war effort.

Labour

A steady supply of labour is important for any war economy; too few workers or too few soldiers foretell an eventual battlefront defeat. During WWII, imported labour helped to sustain the economies of Germany and Great Britain. Germany used foreign voluntary and forced labour from occupied Europe to replace German workers sent to the fronts.

Neutral countries also contributed but to a smaller extent. Geographical constraints limited Portuguese, Swedish, Swiss, and Spanish labour participation in the war effort (Golson 2013). From beyond the North Sea, no significant numbers of Swedes could work in Germany or Great Britain. The Portuguese were even further away from the Germans, and although some Portuguese worked in the British shipping industry, their numbers were quite small.

Spain promised 100,000 workers to Germany during the early years of the war, but numbers peaked at less than 10,000. Switzerland’s proximity to Germany theoretically allowed more substantial labour transfers, but while the Swiss promised thousands of workers for German industry, only 1,800 were ever allowed to go (Golson 2014). The Swiss could not work in Britain to any large extent because they could not get through the blockade.

So, although Spanish and Swiss labour was initially expected to contribute to the German war effort, the outcome fell short. Promises though were many and the promise was useful in dissuading the Germans from invading.

Capital

Capital is the last key dimension: in two cases the numbers show substantial support of the belligerent by the neutral. Despite considerable transfer restrictions during the war, the neutrals accepted private transfers amounting to substantial flows. All belligerents severely restricted the transfer of funds to neutral countries, to prevent hot money flows and destabilisation.

In most of the neutral–belligerent relationships, these transfers benefitted the belligerents by 0.1% to 0.5% of GDP annually between 1940 and 1944. Exceptions were the larger annual Swedish–UK transfers averaging 0.8% of GDP and Portugal–UK at 1.1% during 1941–1944. Significant increases in transfers from Germany occurred in the last years of the war, as German defeat became more likely (Golson 2011).

The neutrals also allowed the Germans and British to accumulate large unpaid balances in order to placate the belligerents on whom they depended. Some smaller loans were settled with capital transfers. Portugal allowed Britain to run a clearing deficit, later converted into a loan, which at the end of the war amounted to 28.6% of Portuguese GDP (Golson 2019). Generally, Switzerland and Sweden allowed Germany to run clearing deficits; although the Swedish balance was largely paid off by the end of the war, the balance due to Switzerland amounted to nearly 10.7% of Swiss GDP in 1945 (Golson 2011).

Spain also provided clearing loans, on top of Civil-War debts already owed to Germany, but precise figures are not available. Various loans and short-term clearing agreements were provided, but capital account balances were sometimes settled in gold, particularly when the war was not going well for the debtor (Britain before 1941 and Germany after 1942). Thus both the Allied and Axis powers transferred gold to the neutrals to pay deficits (Bower 1997). The acceptance of German gold has become a point of controversy, given how much of it came from plundered central banks and murdered Jews.

Conclusion

No simple formula allows a country to isolate itself from the pressures and problems of the outside world. Neutrality as it existed up to WWII was largely a legal concept, dating back to the early 1600s when the first definition of non-participation in war was provided by Hugo Grotius. He argued: “from those who are at peace nothing should be taken except in case of extreme necessity, and subject to the restoration of its value.” In exchange, neutrals had to “show themselves impartial to either side in permitting transit, in furnishing supplies to his troops, and in not assisting those under siege” (Grotius 1646/1925). But Grotius’ conception of neutrality as impartiality could not withstand the extension of total warfare to all facets of state power.

In order to maintain their independence in WWII, neutrals had to make up for their relative military weakness by offering economic concessions to the belligerents. Despite their different starting points, the concessions by Portugal, Spain, Sweden, and Switzerland were similarly motivated. The media, politicians and lawyers have disparaged the version of neutrality that these states chose as no more than a convenient excuse for self-enrichment. For small states in a world at war, however, the defence of neutrality was complex; survival was everything.