The Third National Policy


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The Third National Policy was elaborated in a White Paper on Employment and Income, issued by the federal government, in 1944, and in an accompanying Green Book on social welfare policy. It called for a free enterprise economy in a Keynesian framework of compensatory fiscal and monetary policy, and for redistribution of wealth on positive liberal principles, through a progressive income tax and a comprehensive social welfare system. It called for freer external trade and a functionally flexible exchange rate. The historical significance of this policy becomes evident when it is placed in the context of very long run economic factors in the disintegration of Canada.

By focusing on long run disintegrating factors, we can avoid the Staple Theory, the Keynesian, and the Neoconservative interpretations of the `Great Depression' and the policy consequences of that experience.

The Staple Theory interpretation, most popular in the late 1930s, was the natural heir of the Second National Policy. The latter envisioned a transcontinental economy built in forward and backward linkages from a wheat export. When the wheat economy failed, because of over expansion, drought, and declining world demand, the whole transcontinental economy, so the interpretation goes, linked to it experienced deep decline. The difficulty with this interpretation is that the whole economy was not linked to wheat, or even to primary product exports.

The Keynesian interpretation, appearing in the 1960s, was a product of an attempt to theoretically interpret and correct the problems of the 1930's in Britain and the United States. It assumed a degree of autarchy and homogeneity that was inappropriate in the Canadian case. Canada was not substantially reliant on the export of wheat, or other staples, but some parts of the nation were. Hence the nation , as a whole, was relatively dependent on external markets for staples, and for capital. Whatever may have been true of, or aspired to, in the Montreal-Ontario economy of the third quarter of the nineteen century, transcontinentalization had made independent, balanced growth an impossible goal. Moreover, dependence on staple exports aside, the central Canadian economy was an extension of the economy of the United States Midwest, and becoming increasingly integrated into it in every respect. To the extent that Canada was integrated into the North American economy, independent exercise of Keynesian compensatory fiscal and monetary policy would entail external leakages that would render it ineffective. To the extent that Canada was a set of distinct regional economies a single, integrated economic policy was inappropriate. Nonetheless, there were commentators who suggested a simple Keynesian explanation of what happened in Canada in the 1930s, and simple Keynesian solutions to prevent it from happening again. Any one of these three theoretical interpretations, taken by itself, would provide the basis for a simple and appealing story. In fact, the forces of history generating the economic conditions of Canada in the 1930's were more complex and opaque, and less suggestive of solutions freighting great moral satisfaction.

The Historical Context

Very long run integrating economic factors were dominant in the Canadian case, until the 1930s. The forces of history supported one country: Canada, politically independent in North America. Geography and technology; that is, west to east flowing rivers, the canoe, resources with markets in Europe, the steam locomotive, and the telegraph; all of these made an integrated transcontinental economy possible. Values and institutions; that is, the British parliamentary system of government and, especially, the evolving power of the British Empire, made a transcontinental nation state possible. The forces of history actualized these possibilities.

In the 1930s, when the steam locomotive and the telegraph had been rendered obsolescent, and the western wheat economy they had supported was in a state of collapse, the Statute of Westminster formalized the retreat of the British Empire from America. Then it fell to the Federal Government to maintain the economic and political integrity of the country, in the absence of those very long run factors that had brought it into existence.

Adjustments were made both to accommodate and to thwart long run continentalizing and regionalizing factors, but they were made, in the context of a [fairly long] short run economic depression, and a wartime command economy. Accordingly, legislative action taken by the central government was reactionary and in some respects supportive of obsolescent activities and institutions. When the Depression and the War passed, and very long run forces of technological advance and economic growth reasserted themselves, the short run policies of the depression became inappropriate. Like the First National Policy, the Third National Policy was virtually stillborn, a victim of the forces of history.

The Depression and the Staple Theory

In a general way, the causes of economic depressions are known. How these causes interact in particular cases is not so well known. Viewed in the context of the Staple Theory of Canadian economic development, the depression of the 1930s was transmitted to Canada through a particular sequence of events in its international trade. It cannot be said that the historical existence of this sequence of events has been proven beyond doubt.

The hypothesized sequence of events is thought to have occurred in the interaction of Canada's primary product producing frontier with a manufacturing, capital rich, developed economy (metropolitan Britain and/or the United States). The sequence begins with the metropolitan economy investing in frontier industries, importing the products of those industries, and exporting manufactured goods to the frontier economy. Putting aside the question of why things go wrong in the metropolitan economy, the sequence of events in the downturn starts there with a decline in investment leading to a general downturn in economic activity. This causes a decline in imports of goods from, and exports of capital to, the frontier area; where profits fall and investment stops. In this way, the decline in the general level of activity in the metropolitan country is transmitted to the frontier in Canada. Accordingly, the actual decline was alleged to have occurred first in the metropolitan economy (Britain and/or the United States), then in Canada. In Canada, the decline in exports should have preceded the decline in imports, and, by symmetry, in the metropolitan economy, the decline in exports should have followed the decline in imports. In both economies, the decline in investment should have preceded the decline in trade. This is the sequence of events proposed in the context of the Staple Theory.

In fact, general data on trade show that in all three countries, Canada, Britain, and the United States, the decline in exports, coming at the end of 1928, preceded the decline in imports, coming at the end of 1929. In Canada, capital inflows peaked in 1930, a year or two after the trade declines had set in.

It is possible to postulate a set of relationships between the events in question that would fit them into a Staple Theory of Canadian economic development (actions taking place in anticipation of other things happening in the future, and the like). To make such postulates, however, is to construe events to fit a theory, and not to use events to develop or test a theory. Seeing the events of the Depression through the template of the Staple Theory is not a proof of the Theory. It is a mere assertion of the Theory.

The Nature and Causes of the Depression

There were both very long run and short run causes of the depression.

The depression marked the passing of the Railway Epoch; that is, it was contemporary with the definitive downturn of activities characteristic of that period, and with disinvestment consequent upon over expansion of those activities. The timing of the depression was determined by the timing of a short run business cycle. The severity of the depression was determined, in part, by the extent of over expansion, and, in part, by the severity of the short run cycle with which it was associated. The severity of the short run cycle was determined by the general capital intensivity of the economy.

The intractability of the depression had two principal causes: it reflected the need to restructure instruments of support and integration, following a period in which a much wider range of economic activities were drawn into the market system; and, in Canada it reflected the circumstances of a frontier economy.

With respect to the first of these causes, the preceding shift of economic activity from agriculture to manufacturing and services, and the attendant shift of population from rural to urban locations, exposed a larger portion of economic activity to the risks of unprotected markets. The initial shift was an immediate response to very long run factors. Secondary adjustments, making new positions viable, took longer. For example, in the period of expansion it was relatively easy to transfer population from the country side to the cities. It was another thing to ensure an acceptable quality of life in the cities in either expansionary or contractionary times.

Numerical description of the Depression indicates its severity and intractability. National Income fell from $4.3 billion, in 1929, to $2.3 billion, in 1933. The greatest decline came in that sector which was declining relatively before the depression, that is in agriculture. Income from agriculture on the Prairies, where Railway Epoch expansion had been the greatest, fell from $600 million, in 1928, to $200 million in 1932. From 1930 to 1933, cash income of Prairie farms was less than total operating expenses. For all of Canada, real GNP fell in the range of 30% to 40%, between 1929 and 1933. This was about ten times the percentage decline of the 1982 depression, which, when it came, was the most severe downturn since the 1930s. Real Gross Domestic Product did not return to 1928--29 levels until 1938--39.

Canadian exports turned down in 1928. Imports turned down in 1929. Interest and dividend payments abroad did not turn down until 1930. Increasing expenditures on imports and interest and dividend payments were met out of decreasing receipts. Canada's current account credits turned down with the decline in incomes in other countries, only if grains and farinaceous products are excluded from consideration. That is to say, the decline in Canada's principal staple export was not part of the short run circumstances constituting the Depression. Incomes on the Prairies turned down first, for reasons other than general world depression, and fell farthest in percentage decline, though the fall in British Columbia and Ontario was almost as bad. Incomes in Quebec and, especially, in the Maritimes did not fall to the same extent. These regionally distinctive characteristics reflected the regionally differentiated character of the preceding expansion. Quebec and the Maritimes, not having participated to the same degree in the expansive forces of the Internal Combustion and Electric Dynamo Period, had lower incomes and lower relative declines in income than Ontario and British Columbia, where expansion had been most pronounced. Where the entire economy was substantially a product of the forces of the Railway Epoch, on the Prairies, the depression was most severe.

The depression was deeper and lasted longer in Canada than in Britain or the United States. This was a consequence of Canada's extreme exposure to international trade in recently developed primary products. Frontier developments in primary products experience the boom and collapse pattern of modern economic activity more than other types of economic activity, because they involve a build up of infra structure as well as of immediate production facilities. Canada had participated in two such frontiers of international development, one in wheat, and one in forest products and minerals. At the end of the boom, in 1929, private and public investment in durable assets was 24.6% in Canada, compared to 18.7% in the United States. Further, to a large extent, the investment boom in Canada had been financed by fixed payment bonds, and 47% of this debt was foreign owned. Fully one fifth of all private debt was bonded and subject to fixed payments. The rigidity of this circumstance added to the length of the Depression by inhibiting adjustment of costs in the face of declining prices.

Long Run Adjustment: Institutional Change

Some of the institutional changes that were accelerated to meet the demands of the Depression were a response to very long run factors, and were present in some embryonic form before the depression. Industrialization and urbanization had increased the demands placed on the provinces as a result of their jurisdiction over health, education, and welfare (Sections 92, #7, and Sec. 93 of the British North America Act). Accordingly, the services of the welfare state took shape in the provinces, prior to the short run pressures of the Depression and the War. For example, British Columbia's Workmen's Compensation Act was first passed in 1902. Its Mother's Pension, Superannuation, and Old Age Pension Acts came in 1920, 1921, and 1927. In all provinces, social services outgrew the dispensation of 1867, long before relative regional incapacities appeared in the Maritimes and on the Prairies, in 1920 and 1929, respectively. Between 1871 and 1937, British Columbia's Per Capita Grant for social services was $14 million. Its expenditure on social services, between 1919 and 1937 alone, was $193 million.

Government ownership and regulation of industry, which became associated with interferences to cope with the Depression, were also associated with very long run forces that were at work long before the Depression set in. In 1901, the Union of Canadian Municipalities for Municipal Ownership of Utilities conducted its campaign on the grounds that private ownership of natural monopolies was both inefficient and exploitative. The Movement was not successful in Montreal, where it was attacked for promoting `water and gas socialism'. Elsewhere it did succeed, but not as socialism. In the hands of newly formed `Boards of Control' and newly appointed `City Managers' public utilities became an instrument for `bonusing' industrial development in the private sector.

The Dominion Trade and Industry Commission Act of 1935 was a short run response to the depression that accentuated long run changes predating the Depression. The Act was designed to prevent destructive competition during a period of numerous business failures. It was declared ultra vires of the Dominion government's considerably narrowed powers, but what it would have done was just what private industry had done in response to very long run factors during the merger movement over the turn of the century. It was not depressed conditions that elicited federal anti-combines legislation in 1889, 1910 and 1919. That the federal government was against combinations before the depression, at least in its anti-combines legislation, and that it fostered combinations during the depression, is beside the point. The point is that very long run factors were bringing about certain institutional changes long before they received support as a result of the short run pressures of the depression.

The most telling evidence of the influence of very long run factors on the character of the Third National Policy, came in two judgements of the Judicial Committee of the Privy Council. Having virtually provincialized political power in Canada, between 1881 and 1931, the Committee reversed itself with respect to jurisdiction over two new areas of economic activity. The Aeronautics Reference [1932, AC 54] and the Radio Reference [1932, AC 304] empowered the federal government under Section 92, #10, and Section 132 of the British North America Act, dealing with inter provincial communications and the treaty making power. Activities related to these technological innovations were clearly within the judicially narrowed powers of the Dominion.

The Third National Policy was empowering for the federal government. In the case of the immediate adjustment to radio and aircraft communications, very long run factors worked in that direction. On the whole, however, very long run factors were empowering for provincial governments.

The Third National Policy, insofar as it was a reaction to new technologies, embodied adjustments that were, perhaps, overdue, and which would survive the test of time. Insofar as it was an attempt to ward off inevitable consequences of new technologies, it would not survive the test of time. For example, the Third National Policy translated the need for a social welfare net into `equalization payments' to provinces to maintain national standards in welfare services. This was not an adjustment to change, but an attempt to maintain an obsolescent structure that had been elaborated in response to eighteenth and nineteenth century technological and political factors. Eventually, the cost of these transfers would be an unbearable drag on economic advance. The same was true of all activities mitigating the costs of adjustment by supporting declining sectors of the economy. It was particularly true of tax support for railways.

Long Run Adjustment: The Central Bank

Confusion of long run and short run forces in the formation of the Third National Policy was most clearly evident in circumstances surrounding the establishment of the Bank of Canada. When the Policy was articulated in the White Paper of 1944, the Bank of Canada was ascribed the short run, counter cyclical task of interest rate and price stabilization. At the time of its establishment, however, it was given the task of maintaining a stable external value of the Canadian dollar in the face of contrary demands for internal price and interest rate `stabilization'; that is, demands for devaluation and lower interest rates.

Founding the Bank of Canada was a response to the end of the Gold Standard Era of the international payments system. Growing weakness of the Gold Standard system had long been evident in increasing central-bank-like interferences in the payments system. Just prior to the First World War, its weakness was the cause of special arrangements for unbacked currency issues, in the United States and Canada, to meet the demands of western agriculture during the crop moving season. Canada suspended redemption in gold, as did the other belligerents, during the First World War, The Department of Finance, on certain conditions, to issued unbacked paper reserves to the commercial banks. After the war, Canada officially returned to the gold standard, but it also renewed the Finance Act. This allowed the private banks to increase the money supply in Canada despite net exports of gold. Increases in the money supply, in turn, fueled the speculative expansion that preceded the onset of the Depression.

Long run and short run elements interacted. Just as the gold standard system came to an end, the Canadian government faced serious political pressure from western wheat producers to establish a fiat currency and expand the money supply. This over expanded, debtor sector of the economy pleaded for short run support for prices and interest rates. To head off this possibility, which was thought to be prejudicial to Canada's position in international capital markets, and to its substantial recovery from the depression, control over the currency was given to a central bank. The expectation was that the Bank of Canada would do for the currency what the Gold Standard had done, that is, stabilize its value in terms of the currencies of Canada's major trading partners, Britain and the United States. And, indeed, that is what it did.

That the function of the central bank was subsequently said to be implementation of short run counter cyclical monetary policy is evidence of the force of the short run considerations of the Depression and the War in shaping the Third National Policy. That the central bank never fulfilled expectations with respect to counter cyclical policy is evidence that short run factors leading to a return to centralization, during the Depression and the War, lost their strength, when very long run factors reasserted themselves in the period of growth that followed.

Fiscal Policy

Declared fiscal policy was unbending in the face of short run demands. From 1930 to 1937, official policy was a balanced budget. A National Employment Commission was struck, in 1936. Those associated with it were Keynesian, and, as a result of their influence, the 1938 national budget embodied a small measure of Keynesian short run counter cyclical fiscal policy. There were `Keynesian considerations' in the first budgets after the War. Still, the reluctance of the federal government to do anything but balance the budget, or to suffer passive deficits in periods of low economic activity, after 1950, is testimony to the evanescence of certain short run considerations once the Depression and War were over.

What did emerge in fiscal policy was the beginning of an explicit attempt on the part of the federal government to counter the long run effects of economic change on the relative wealth of different regions of the country. In this regard, short run supports became long run attempts to mitigate the consequences of very long run forces for change. Under the immediate demands of the Depression, the long abused system of Per Capita Grants was abandoned in favour of grants to maintain income and living standards in economically declining regions. This occurred as intergovernmental grants rose from 4% of GNP, in 1926 and 1929, to 20%, in 1933 and 1936.

A similar, complex system of supports for lower income and disadvantaged groups constituted the social welfare net of the post Second World War period.

Adjustments proposed in Prime Minister Bennett's `New Deal', in 1935, were a mixed bag of responses to long run and short run problems. Proposed unemployment insurance, minimum wage legislation, and old age pensions were not intended to be a response to the Depression, as such. Proposed farm credit arrangements were both an attempt at long run adjustment and a response to short run problems associated with the Depression. The proposals of the 1937 Royal Commission on Price Spreads, and the provisions of the Natural Products Marketing Act were intended to be support for a market structure threatened by both a short run decline in prices, and long run technological advance.

The Keynesian element in the Third National Policy was a short run response to a supposedly short run phenomenon. Putting aside the fine tuning of alleged Keynesian doctrine that characterized the period from 1950 to 1970, the Keynesian position may be summarized as follows. Perhaps long run forces were at work in generating the circumstances of the depression, but the short run fact was that the economy suffered from underconsumption, or, what amounted to the same thing, excess capacity. Under the circumstances the private sector, motivated by the search for profit, found itself constrained to cut production even more. This, in turn, reduced incomes and consumption even more. There seemed to be no point in increasing the money supply to lower the rate of interest, because depressed expectations would prevent the lower rate of interest from being translated into more investment. Indeed, the only plausible solution, in the Keynesian view, was to have the government enter the field to raise aggregated demand. Once demand, and consequently production, began to rise, it would be profitable for the private sector to join in the recovery.

The more conservative view was that all of this government support would prevent necessary long run adjustment, and, ultimately would make things worse. When anti Keynesian, Monetarist policies were proposed, in the late 1960s, however, they were a set of short run macroeconomic measures of the general Keynesian sort. Neither set of policies focused on the very long run factors in the development of the Canadian economy. Neither even referred to its open (continentalized) and non homogeneous (regionalized) character.

Provincial Reaction to the Depression

Copying the New Deal of President Roosevelt in the United States, Premier Pattulo of British Columbia announced a program to `socialize credit' and to enact all of the social welfare programs, medicare excepted, that were to be realized nationally in Canada in the 1960s. His government established the first economic council in Canada, and charged it with developing a plan to rehabilitate the province. In 1934, Pattulo attempted to rally the western premiers around his demands for better terms in Confederation, a national unemployment insurance scheme, provincial control of the income tax, and what he called `the rational use of national credit'. When the others failed to respond, he had his legislature pass a Special Powers Act, giving the Cabinet in British Columbia all the powers of the Legislative Assembly. When the federal Liberals were elected on a platform of retrenchment, in 1935, Pattulo threatened to separate his province from the federation.

When Pattulo was rebelling, the Maritime Rights Movement was active on the other coast, demanding the return of certain elements of federal jurisdiction to the provinces. The federal government had responded to similar demands, in 1926, with a Royal Commission on Maritime Rights, the report of which had simply said no. In 1934, the Maritimes answered back with the report of the Nova Scotia Royal Commission of Economic Enquiry, which outlined the differential regional effects of national policies, and demanded that the Maritimes be given the support that had been given the economy of the Prairies. To this the federal government responded with a Royal Commission on Financial Arrangements between the Dominion and the Provinces. This led into the more ambitious Royal Commission on Dominion Provincial Relations of 1937--1939, which, in turn, led to the articulation of the Third National Policy.

Neither Ontario or Quebec co-operated with the 1937 Royal Commission. Ontario was governed by Mitchell Hepburn, who found Prime Minister King personally obnoxious. Besides, Ontario was loath to participate in an endeavour that was bound to increase its financial contributions to the other provinces. Quebec, under Duplessis, was just entering the separatist stage of its nationalism. Objecting to the centralization latent in the commission, it, too, refused to co-operate. Alberta felt itself so badly treated that it withdrew.

Given these gaps in its political direction, the Royal Commission came under the control of an emerging anglophone, federal civil service elite. Most of these `Ottawa men' were economists familiar with the doctrines of John Maynard Keynes concerning the causes and cures of the Depression. In large measure, it was the influence of these people that determined the content of the Third National Policy.

Depression, War and Continentalization

The immediate effect of the Depression on international trade was dramatic. During the 1920s, Europe and America returned to the `normalcy' of nineteenth century protectionism. When levels of employment fell, tariffs were raised even more, and `beggar thy neighbour' currency devaluations became the rule. International trade fell off faster than average GNP. In the United States, the 1930 Smoot-Hawley Tariff raised the general level of protection. In Canada, Prime Minister R.B. Bennett announced that he would `blast' his way into foreign markets with higher tariffs. The problem of the Depression, however, was lack of markets, and efforts to reestablish, rather than restrict, trade were not long in coming.

In the inter bellum period, Canadians still thought of themselves as part of the British Empire, despite increasing continentalization, so trade expansion was sought on two fronts. In 1931, President Hoover of the United States offered to lower agricultural tariffs against Canada in return for co-operation on hydroelectric and canal projects on the upper St Lawrence River. Nothing came of the offer. In 1932, an Imperial Trade Conference agreed to lower tariffs in a system of Imperial preference. With the election of the Democrats to the White House, in 1933, United States trade policy became expansionist. The long period of Railroad Epoch protectionism came to an end in the United States as the imperatives of coming globalization were recognized. Long run forces of continentalization expressed themselves, in 1935, when Canada and the United States granted one another most favoured nation status.

Anticipation of war also made a difference in trade relations. Britain's need for allies in the face of German rearmament, in 1938, led to a mutual lowering of tariffs with the United States. The arrangement was in line with United States policy, and Britain was anxious for United States good will. Canada, which was party to the treaty, was able to wring concessions from both of its principal trading partners. For Britain and Canada the War began in 1939. In 1940, Canada and the United States agreed to a common effort in North American defence. In 1941, they agreed to share defence contracts. The War markedly accelerated the pace of North American continentalization.

War and Centralization

According to the British North America Act, as interpreted by the Judicial Committee of the Privy Council, the powers of the federal government were virtually unlimited `in time of real or apprehended war, invasion, insurrection, or national emergency'. Accordingly, while it lasted, the War accomplished the kind of centralization that was sought by those who felt that that was the answer to Canada's economic problems. The mentality generated by this situation, the sense of what the federal government could do, and what the federal civil service could do in a command economy, had a bearing on the formulation of the Third National Policy.

The immediate effect of the War was to end the Depression, and to accentuate economic regionalization. By the end of the war the total labour force had grown by 12%. The labour force in manufacturing, by 100%. The increase in manufacturing was reflected in Ontario's increased share of Gross National Product, which rose 3.5%. Quebec's share fell 2.5%. Saskatchewan's fell 3.0%.

Political centralization became evident in the size of the federal government which grew absolutely and in relation to the rest of the economy. Federal expenditures rose from $0.5 billion to $5 billion. Tax Revenues rose from $0.5 billion to $2.5 billion. Customs and sales taxes fell from 65% of revenues to 18%. Income taxes rose from 21% to 45%. The federal civil service, apart from the armed services, rose from 45,000 to 115,000 employees. During the war there were wage and price controls, rationing, and employment regulations. Federal Crown corporations were established to do what was thought to be beyond the means of private enterprise: notably in the production of aircraft, synthetic rubber, and uranium.

At the end of the War there existed a strident federal civil service, accustomed to power in what was virtually a command economy in a unitary state. The economy had been restructured toward manufacturing, and regionalization, and had developed even stronger ties to the United States. This was the seed-bed of the Third National Policy, and of its demise.

In 1939, the Royal Commission on Dominion-Provincial Relations recommended that all income taxes go to the federal government; that, for purposes of social welfare, the provinces become virtual districts in a unitary state; and that the federal government take responsibility for unemployment. The British North America Act was amended to give the federal government jurisdiction over unemployment relief. In 1943, Leonard Marsh reported to the federal government that it should become active in health care, old age pensions, and children's allowances, all matters impinging on provincial jurisdiction. The Third National Policy was, in effect, a combination of the Keynesian counter cyclical policies favoured by the authors of the Royal Commission on Dominion Provincial Relations, and the Marsh proposals.

The Third National Policy

The Third National Policy, like the First, was carried off by the forces of history. Provincial government opposition forced the federal government to negotiate, piecemeal, every incursion into provincial jurisdiction. Quebec objected to incursions on the grounds that they threatened the ability of Quebecois to preserve their distinct social character and language. Keynesian fiscal and monetary policies were impossible to implement in a highly regionalized, small open economy governed by federated state. By the mid 1950s, federal governments were showing a partiality to balanced budgets, regardless of the state of the economy, and the Bank of Canada was refusing to implement Keynesian monetary policies. Short run demands for centralization growing out of the depression and the war passed, leaving long run factors of disintegration to continue working at their relentless pace.

The First National Policy, having its roots in the relatively balanced, homogeneous economy of Montreal-Canada West in the Canal Era, was swept away by transcontinentalization and development of a wheat export economy, in the latter half of the Railway Epoch. The Third National Policy, having its roots in an attempt to shore up the transcontinental, national economy of the Railway Epoch, was swept away by continentalization and globalization in the aircraft stage of Internal Combustion and Electric Dynamo Period.

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