Chapter 16 of 26 · Capitalism: A Treatise on Economics by George Reisman
Chapter 13. Productionism, Say's Law, and Unemployment
CHAPTER 13
PRODUCTIONISM, SAY’S LAW, AND UNEMPLOYMENT
PART A
PRODUCTIONISM
T he identification that the fundamental problem of economic life is how steadily to increase the ability to produce in the face of a limitless need and desire for wealth, is one of the great achievements of the British classical economists. 1 This identification, together with its implications for the understanding of the effects of such phenomena as the use of machinery, advertising, a rise in the birthrate, foreign trade, imperialism, war, and government spending, I term productionism. 2
Productionism is intimately bound up with a series of further propositions which the classical economists advanced, or which are clearly implied in their teachings. We have already examined a number of these propositions, among them: the central importance of the division of labor in raising the productivity of labor; the law of comparative advantage, which, together with the limitless need for wealth, guarantees a place for everyone in the division of labor, provided only that the freedom of competition exists; and the quantity theory of money. We have seen the clear implication of the quantity theory of money that depressions are caused by government sponsorship of a fractional-reserve banking system, which increases the quantity of money unduly, thereby artificially reducing the demand for money and raising its velocity of circulation, thus setting the stage for a subsequent financial contraction, deflation of the money supply, and depression. In Part B of this chapter, we shall see how production and supply, and only production and supply, create purchasing power and thus demand in its real sense—i.e., in the sense of the goods and services a monetary demand can actually buy. This is the classical economists’ proposition that has come to be known as Say’s Law of Markets. 3 In close connection with Say’s Law, we shall come to understand the corollary proposition that the existence of a general overproduction—i.e., of an excess of aggregate supply over aggregate demand—is an impossibility. In Part C of this chapter, we shall also see how mass unemployment is the result of government intervention, not the workings of a capitalist economy itself.
While the present chapter shows how the productive process generates an aggregate real demand that is equal to aggregate supply and grows precisely as aggregate supply grows, subsequent chapters will show how the productive process also generates an aggregate monetary demand that in the absence of government interference is sufficient to buy the aggregate supply at a profit—that is, how the productive process itself inherently operates to make production financially profitable to the businessman of average skill and ability. Along the way, we shall see how, as the classical economists put it, “what is saved is spent,” indeed, is the source of most spending in the economic system, and more, underlies both a growing aggregate real demand for goods and services and a growing aggregate monetary demand for them. All of these doctrines of classical economics are closely related to productionism in the sense both of supporting it and being supported by it.
PRODUCTIONISM, SAY’S LAW, AND UNEMPLOYMENT 543
The one proposition connected with productionism which will be advanced and which may appear as a significant departure from the central ideas of the classical economists, but which actually is entirely consistent with them at the most fundamental level, is that real wages and thus the average worker’s standard of living are determined by the productivity of labor. This proposition, indeed, is actually nothing more than the idea behind Say’s Law applied to wages: real wages are determined by production, just as the real demand for goods is determined by production. Thus throughout, productionism and its related propositions are integrally connected to classical economics.
Productionism Versus the AntiEconomics of Consumptionism
In the twentieth century, there has been a growing influence of irrationalist philosophy, which denies the reliability and efficacy of human reason and which disregards the profound influence that the possession of reason exerts on every aspect of human life. According to such philosophy, there is little to distinguish man from the lower animals. Indeed, as we have seen, man is depicted as “the trousered ape”; porpoises, it is asserted, may possess intelligence comparable to man’s; snail darters, we are told, have equal rights with man. 4 Thus, at bottom, man, it is held, is just another animal. On such a view of man, it follows that man’s needs and desires must be as limited as those of an animal and thus fundamentally incapable of extending beyond the range of minimum necessities. The fact that man’s desires obviously do extend beyond the range of an animal’s is held to be the result of “social and cultural conditioning” and the work of advertisers; at the same time, the desires are denounced as “unnatural,” “artificial,” and “created.” Thus, the basic economic premise is advanced that the need and desire to consume are essentially fixed and given, and that the ability to produce threatens constantly to outrun them.
This premise, together with its leading implications, I call consumptionism. It is the doctrine that the fundamental problem of economic life is how to increase the need and desire to consume in the face of an ability to produce that exceeds them. Consumptionism proceeds as though the problem of economic life were not the production of wealth, but the production of consumption.
The consumptionist premise must be characterized as nothing less than the premise of antieconomics. This is because, as we shall see, point by point, it leads to a total inversion of the conclusions of sound, rational economic science.
While directly implied by irrationalist philosophy, the consumptionist premise also results from the error of considering the effects of things only on those most directly concerned, and neglecting the effects on the rest of the economic system. 5 Very importantly, among the leading practitioners of this error are businessmen who are in the habit of being concerned exclusively with the effects of things on their own industry.
In the context of an individual industry, the emergence of a need or desire for the product of the industry that is strong enough to outrank the need or desire for the products of other industries will channel spending to this industry from other industries. For example, if people developed a greater desire for automobiles, say, to the point that they were willing to cut back on their expenditures for housing or clothing, say, the demand for automobiles would increase. Conversely, if they developed a greater desire for housing or clothing, to the point that they were willing to cut back on their expenditure for automobiles, the demand for housing or clothing would increase. To unthinking businessmen in the industry experiencing the increase in demand—businessmen who do not stop to consider the accompanying offsetting decrease in the demand for the products of other industries—it appears simply that an increase in the need or desire for their product has increased the demand for their product. Because they are unaware of the offsetting effects on the demand for the products of other industries, such businessmen then come to the conclusion that what is required to increase the aggregate, economy-wide demand for products is an increase in the overall, economy-wide need for products, and that what is responsible for the slack demand for products in a depression is a lack of need for products. Thus, such businessmen are led to the same conclusion that is arrived at on the foundation of irrationalist philosophy, namely, that the ability to produce exceeds the need and desire to consume and that the problem of economic life is not the production of wealth but of the consumption of wealth.
Of course, what is overlooked by all such observers, whether businessmen or others, is that every increase in the demand for the product of a particular industry that is based on the need or desire for its product intensifying and thus pushing ahead of the needs and desires for the products of other industries and coming to the forefront, must be accompanied by an equivalent decrease in the demand for the products of other industries.
When this is borne in mind, it becomes clear that the need and desire for goods count in demand only insofar as they operate to determine to which of various possible competing alternatives demand is directed. Yet to those myopically concerned only with a particular industry, it mistakenly appears that because any given industry, at one time or another, could experience an increase in
demand by virtue of the need or desire for its product gaining in priority relative to the need and desire for the products of other industries, that all industries might gain in this way at the same time. This is a case of adding up as additional demands what are in fact a series of mutually exclusive alternatives, each of whose individual existence is predicated on an equivalent decline in demand in the rest of the economic system. This is a glaring example of what logicians call “the fallacy of composition,” that is, invalidly generalizing from what occurs in part of a system to the system as a whole.
When the actual nature of the relationship of the need and desire for goods to demand is kept in mind, it also becomes clear that any increase in the overall volume of mere need and desire—unaccompanied by an increase in the production and supply of goods—is irrelevant to the economy-wide, aggregate demand for goods. The mere need and desire for goods are always vastly in excess of demand in the economy as a whole, as was shown at length in Chapter 2. For example, I have a desire for luxurious houses or apartments in Paris, Rome, and Palm Beach, but I can barely make a demand for the one relatively modest home that I do occupy. If demand in fact depended merely on the need and desire for goods, and greater demand followed from the existence of a greater need and desire for goods, then the proportion of the world’s demand for goods that emanates from India and China would far exceed the proportion that emanates from the United States and Japan. Nevertheless, despite the fact that the populations of India and China far exceed those of the United States and Japan, and the unmet needs and desires of the average Indian and Chinese exceed those of the average American or Japanese by the magnitude of the formers’ lower standard of living, the demand for goods in the United States and Japan enormously exceeds the demand for goods in India and China. The explanation of this difference in demand is the difference in the ability to produce and supply goods, which, as we shall see in Part B of this chapter, is the cause of corresponding differences in purchasing power, which must be joined to need and desire in order to create demand. The United States and Japan are greater demanders of goods because they are greater producers, therefore, possess greater purchasing power, and can satisfy their needs and desires to a correspondingly greater extent. 6
Thus consumptionism flourishes both because of the growing prevalence of an irrationalist view of man and his needs and desires and because of the widely practiced fallacy of looking at the effects of things only on those who are most directly concerned.
In this environment, economists, largely under the influence of Lord Keynes, and, still more, the hordes of intellectuals who have no familiarity with economics, have returned to the view of economic life that was advanced by the predecessors of the classical economists, the mercantilists. Instead of taking the need and desire to consume for granted and focusing on the ways and means by which production might be increased, the problem of economic life is now often believed to be how to expand the need and desire to consume so that consumption may be made adequate to production. Much of what passes for economic thinking in the twentieth century takes production for granted and focuses on the ways and means by which consumption can be increased. It proceeds, as I have said, as though the problem of economic life were not the production of wealth, but the production of consumption. It was in this spirit that Keynes declared: “Pyramid-building, earthquakes, even wars may serve to increase wealth . . . .” 7
Because of the prevailing influence of consumptionism and the major economic errors inspired by it, my procedure here will be to present those errors, one after another, accompanied by the answers of sound economics, based on the philosophy of productionism.
1. Depressions and Alleged “Overproduction”
According to the “overproduction” doctrine, it is possible for the aggregate supply of goods produced in the economic system to exceed the aggregate demand for them, that is, to exceed the need and desire for goods— which is the sense in which the concept “demand” is understood by the doctrine’s supporters. The demand for goods, it is claimed, may simply not be adequate to the rising level of production made possible by economic progress. According to the overproduction doctrine, the need or the desire for the growing volume of goods is simply lacking. People allegedly need and desire only so much, and not an ever increasing amount. Thus when production increases, producers are allegedly put in the position of producing more than the buyers are willing to buy, with the consequence that a depression results.
(Sometimes the supporters of the overproduction doctrine offer a variant of the doctrine. They claim that while the need and desire to buy the growing volume of goods may be present, the ability to buy them is lacking because people do not possess a correspondingly larger quantity of money. Here, instead of confusing demand with need, they confuse the ability to buy goods with the ability to spend money. As we shall see, the ability to buy goods— purchasing power—does not depend on the quantity of money and the ability to spend money, but on the volume of production and supply. 8 )
The overproduction doctrine can be understood graphically, in terms of Figure 13–1, which is titled “The
PRODUCTIONISM, SAY’S
Consumptionist View of the Economic World.” There, in the upper portion of the figure, the consumptionists’ notion of a fixed aggregate demand is depicted by the vertical line DD, which claims that buyers are unwilling or unable to purchase a quantity of output greater than corresponds to point A on the horizontal axis. No matter how low prices go, the buyers allegedly will not buy more than an amount equal to A. Yet at the point of full employment, the economic system is capable of producing the larger quantity of output indicated by point B on the horizontal axis. The vertical line SS, drawn directly up from point B, shows aggregate supply at full employment. The extent to which B exceeds A, in other words the horizontal distance AB, is the measure of the alleged excess of supply over demand—the measure of alleged “overproduction.”
In sharpest contrast to consumptionism, productionism posits an aggregate demand curve for output that has no limit, that is capable of buying all that could ever be produced. This aggregate demand curve is shown in Figure 13–2. It is derived not only from the proposition that man’s need and desire for wealth have no fixed limit, but also from the quantity theory of money. In Figure 13–2, the demand curve DD represents a given total expenditure of money to buy products, corresponding to
LAW, AND UNEMPLOYMENT 545 a given total quantity of money in the economic system. The curve shows that the same expenditure of money can buy any volume of goods, depending only on the price level. At half the price level, it can buy twice the quantity of goods; at a fourth, eighth, or tenth of the price level, it can respectively buy four, eight, or ten times the quantity of goods; and so on, without limit. The curve is asymptotic—that is, it never crosses the horizontal or vertical axis. It is also unit elastic. 9 (Of course, under a system of commodity money, to the extent that an aspect of increases in the production and supply of goods is an increase in the quantity of the commodity serving as money, the productionist aggregate demand curve shifts up and to the right. This diminishes the extent to which prices need to fall.)
While I will expand on the critique of the overproduction doctrine at considerable length in Part B of this chapter, it should already be obvious, in the very nature of the productionist aggregate demand curve and its foundations, that a general overproduction—an overproduction in the economic system as a whole—is an impossibility. It is also appropriate to note at this point the inherent absurdity of the overproduction doctrine. In blaming depressions and their accompanying impoverishment on overproduction, the doctrine implies that people
Figure 13–1
The Consumptionist View of the Economic World
Price
Level
D
D
0 A -
Quantity of -
-
Labor -
-Employed - -- --
H - - - - - - - - - - - - - - - - -
-
Full -
S
S
Output B -
- - B - - -
--
Employ-F - - - - - - - - - A - - - - - - - - - - - B - - - - ment
G - - - - - - - - - -
0
A
Output B
cannot afford homes or apartments because they have nomicstextbooksisratherpompouslycalleda“produc-built too many of them, that they cannot buy food be-tion function,” is such that at the point of full employ-causetheyhavegrowntoomuch,thattheycannotpur-ment—point F on the vertical axis—the output of the chasecarsorappliancesbecausetheyhavemanufactured economic system is A, as indicated by the dashed line toomany,inaword,thattheyarepoorbecausetheyare runningfromFtoA.Lookingupward,alongthevertical rich. dashedlinerunningfromAtotheupperdiagram,whose horizontal axis is exactly the same as that of the lower diagram,oneseesthatwithanoutputofA,theaggregate 2. MachineryandUnemployment supply initially does not exceed the allegedly fixed ag—
Ifonebeginswiththeassumptionthatthebuyerswill gregatedemandDDthatisshownintheupperdiagram. buyjustsomuch,thenitfollowsthatifnowthatgiven TheaggregatesupplySScorrespondingtofullemploy-quantity of goods can be produced with less labor, be-ment under these conditions would supposedly lie di-cause of the adoption of labor-saving machinery, then rectlybeneaththeaggregatedemandDD,beingperfectly there will be correspondingly less work available for concealedbyit.Thusinitiallythereisnoallegedproblem peopletodo,andthusthatimprovementsinmachinery of“overproduction.”
causeunemployment.Thisistheessentialnatureofthe Now,however,comesanimprovementinmachinery, beliefthatmachinerycausesunemployment—theproc-as the result of which any given quantity of labor can essbywhichtheconclusionisreached. produce a larger output than before. The effect of the
Figure 13–1 describes the consumptionist’s thought improvedmachineryisdescribedbyanew“production processintermsofdiagrams.Thelowerdiagramshows function,”whichislowerandfurthertotherightthanthe therelationshipbetweenthequantityoflaboremployed original one, showing that any given quantity of labor (andperformed),whichismeasuredontheverticalaxis, nowproducesmorethanbefore,or,equivalently,thatany andthequantityofoutputproduced,whichismeasured givenoutputcannowbeproducedbylesslabor.Atthe onthehorizontalaxis.Giventhestateoftechnologyand pointoffullemploymentspecifically,thesamequantity the quantity and quality of machinery and other means of labor now produces the outputBrather than A.This ofproductionavailableperworker,thegreaterthequan-allegedly causes supply to exceeddemandintheupper tityoflaborthatisemployed,thegreateristhequantity diagram,creatingexactlythesituationofalleged“over-ofoutputproduced.Hence,therelationshipisdescribed production” that we saw earlier. Acontinuation of the byalinethatslopesupwardtotheright. dashed line from FA to FB, and then a new vertical
Initially,thisrelationship,whichincontemporaryeco-dashedlinerunningupwardsfrompointB,tracethenew
Figure13-2
TheProductionistAggregateDemandCurve
Price
Level
1.000
D
.500
.250
.125 D
.100
Output
0
1.0 2.0 4.0 8.0 10.0
PRODUCTIONISM, SAY’S LAW, AND UNEMPLOYMENT 547 relationship between full employment and output.
Since businessmen will not continue to produce in excess of the demand, it is argued that production will fall back from B to the initial level of A. But now, because of the use of improved machinery and the consequent movement of the “production function” down and to the right, the output A is produced with a smaller quantity of labor than F. It is produced with quantity G of labor, which is the point found by locating A of output on the new, lower production function and then reading across to the vertical axis, as indicated by the dashed lines. FG is the measure of the unemployment supposedly caused by the use of improved machinery.
In just this way, the effect of improved machinery is allegedly to reduce the supply of work available for people to do. In effect, according to the consumptionists, because there is a need and desire for just so much output, there is a need for just so much work to produce that output, and to the extent that machinery can perform more of that work, there is correspondingly less work for people to do. Thus, supposedly, machinery causes unemployment by virtue of consuming part of the allegedly fixed amount of work to be done in the world corresponding to the allegedly fixed quantity of output that is demanded.
Now the actual effect of the adoption of labor-saving machinery, of course, is to cause not unemployment but a higher standard of living. In the economy as a whole, the effect of the adoption of labor-saving improvements is that the same number of workers end up producing a vastly increased quantity of goods and obtain the benefit of those goods in their capacity as consumers. Improvements in machinery of the labor-saving variety are an essential prerequisite of labor becoming available for increasing the production of goods previously considered luxuries and for working with improvements in machinery of the kind that make possible altogether new products.
There is no problem of a lack of demand for these additional goods. As we know from Chapter 2, the need and desire for goods always far outstrips the ability to produce goods and increases further as that ability increases. We also know that the productionist aggregate demand curve shows that even any given quantity of money and volume of spending is potentially capable of buying an unlimited quantity of goods at lower prices. If one visualizes the productionist aggregate demand curve being superimposed on the upper diagram in Figure 13–1, and taking the place of the consumptionist aggregate demand curve, then it is obvious that no matter how great the output becomes at the point of full employment, it will be demanded. At the same time, the standard of living of the average worker rises as the result of the adoption of labor-saving machinery, because the effect of such machinery is always to increase the supply of goods relative to the supply of labor and thus to reduce prices relative to wage rates. This increases the buying power of wages and in this way the standard of living of the average wage earner. 10
All of these propositions are confirmed by the leading facts of modern economic history. Since the beginning of the Industrial Revolution, the productivity of labor has increased by an order of magnitude of at least one hundred times. The unemployment rate is not on the order of 99 percent, as the argument that machinery causes unemployment implies, but is essentially no higher now than it was in the eighteenth century. In essence what has happened is simply that the same number of workers produces vastly more and enjoys a correspondingly higher standard of living. Indeed, not only do the same number of workers find employment, but an enormously larger number. Thanks to the rise in the productivity of labor, and thus the standard of living, achieved by the Industrial Revolution and its machinery, population figures have greatly increased. And essentially the same proportion of this much larger population finds employment as was the case before the start of the Industrial Revolution.
The basic effect of the adoption of machinery, or better machinery, on employment is simply that the pattern of employment is changed, in accordance with the change in the relative size of the various industries that results. Thus, insofar as labor-saving improvements are adopted in industries producing necessities, or any other goods of which relatively little more is wanted, employment in those industries falls. The leading example is agriculture. But in the very nature of the case, because less labor is needed in those industries and the funds which paid the wages of that labor can now be spared, funds are released for the employment of additional labor in industries producing other goods, previously beyond people’s reach. Moreover, the fall in prices of the goods produced with less labor releases funds for a larger volume of consumer spending elsewhere in the economic system.
In cases in which the introduction of labor-saving machinery takes place in the production of goods previously considered luxuries and makes it possible for such goods to come within the reach of a large number of buyers with funds to spare from other purchases, the effect is to increase employment in the industry in which the labor-saving improvement is introduced. As previously pointed out, a good example of this kind is the automobile industry earlier in this century. In 1900, automobiles were as expensive as yachts are today, and only a handful of people could afford them. However, after productive geniuses such as Henry Ford and Alfred Sloan succeeded in radically reducing the quantity of labor required to produce an automobile, and thus brought
the automobile within reach of millions of buyers, the automobile industry became the largest employer of labor in the United States. 11 On a lesser scale, the same pattern occurred in the radio and television set industries and throughout the appliance industry. The video-tape recorder and personal computer industries provide more recent examples.
Because labor-saving machinery raises real wages, it places people in a position in which they can afford to choose additional leisure. Only in this, strictly voluntary sense, can it be said to reduce the total amount of employment. On the other hand, as I have indicated, it also enables a larger population to survive, whose members must work. In this sense, it can be said to increase the total amount of employment. Apart from the voluntary choice of additional leisure that it makes possible, and the increase in number of people alive and needing to work that it causes, machinery has no effect on the overall volume of employment, but only on the pattern in which the same total volume of employment is distributed among the different branches of industry. Its overwhelmingly outstanding effect is to raise the productivity of labor and the average standard of living. 12
3. Alleged Inherent Group Conflicts Over
Employment
As we have already seen in the argument against machinery, the notion of a fixed demand for goods implies the notion of a correspondingly fixed demand for the labor to produce them. If it were true that people desired to buy just so many goods, or could afford to buy just so many, then there would exist in the world just so much work that employers could offer—namely, the amount of work required to produce that limited quantity of goods, and nothing more. As we have seen, it is precisely on this basis that it is believed that machinery causes unemployment: it allegedly appropriates part of the limited stock of work to be done from people and transfers it to machines.
The notion of a limited demand for goods and a correspondingly limited amount of work to be done in producing them also shows up in the belief that there is an inherent conflict between men and women when both seek employment, and between whites and blacks, immigrants and natives, Protestants and Catholics, and all other such groups. Such statements as “married women shouldn’t work because they take away jobs from men,” or “immigration needs to be restricted so that native Americans can have jobs,” rest on the idea that there are only so many “jobs” to go around and that to the extent that more of them are held by the members of any one group, there are that many fewer of them remaining for the members of other groups.
Figure 13–1 serves to depict the process of reaching such conclusions in much the same way as it depicts the process of reaching the conclusion that the use of machinery causes unemployment. Starting with the assumption that point F on the vertical axis in the lower diagram represents full employment and results in an output of A on the prevailing “production function,” it is now only necessary to assume that because of the entry of additional people into the labor market, the point at which full employment exists rises from F to H. If H marked the actual level of employment, then output would once again be B, this time on the original “production function.” (This becomes apparent if one follows the dashes from point H on the vertical axis over to the original production function. The corresponding output will lie at the same point as in the case when improvements in machinery moved the production function to the right.) In the upper diagram of Figure 13–1, this would once again mean an alleged overproduction measured by the excess of B over A. Once again, production would supposedly have to return to A so that supply ceased to exceed demand. Thus, the volume of employment would supposedly return to F, the old full employment point. With employment once again at F, the inescapable implication is that for everyone in the group of new workers, FH, who has gained employment, someone else in the original group, 0F, has lost employment.
(Exactly the same analysis, it should be noted, applies to the case of workers seeking to increase their hours of work. They too allegedly deprive others of work. They allegedly appropriate more than their “fair share” of that allegedly scarce commodity “work.”)
The existence of a limitless need and desire for wealth obviously precludes the existence of any fundamental conflict among groups for limited job opportunities. Just as in the case of machinery, if the productionist aggregate demand curve is substituted for the consumptionist aggregate demand curve, then once again it is clear that the market can accommodate all the additional output that can be produced by any additional number of workers. And this too is confirmed by the leading facts of modern economic history. Just as the hundredfold or more increase in the productivity of labor has not resulted in 99 percent unemployment, or any increase in the unemployment rate whatever, consumptionism to the contrary notwithstanding, so the vast increase in the number of people seeking employment that the Industrial Revolution and its machinery have made possible has not resulted in any displacement of workers. Far more people are alive. Far more people seek work. And far more people work. It is that simple because there is need and desire for all the output that any number of workers can
PRODUCTIONISM, SAY’S LAW, AND UNEMPLOYMENT 549 produce, and any given quantity of money and volume of spending is capable of buying that output, however large. 13 The same principles, of course, apply to any increase in the hours of work that individuals might wish to perform, though as a rule individuals choose to work less as the result of a rising productivity of labor and the consequent rise in living standards.
Furthermore, as we have seen, under capitalism the effect of the employment of a larger number of workers is to raise the real income of the average worker by virtue of extending the division of labor and enabling the occupations concerned with the discovery and application of new knowledge to be carried on, on a larger scale, thereby raising the productivity of labor. 14 In Part C of this chapter, we will see that even though the achievement of full employment may entail a fall in the average level of money wage rates, the effect is still to raise the average level of real wage rates (that is, what the money wage rates can actually buy) and thus the actual standard of living of the average worker. In the next chapter, we will see that the effect of married women working is simply to raise the real income of their families. 15
While there is no foundation for group conflicts over employment under capitalism and a free labor market, it is important to realize that such conflicts can be artificially created by means of government interference that sets wage rates too high and thereby creates a problem of permanent mass unemployment. 16 In conditions in which the overall total number of jobs is artificially limited by making it impossible for wage rates to fall and thus increase the quantity of labor demanded, it is true that the members of any one group can gain employment only at the expense of the employment of members of other groups. The obvious solution, of course, is not to try to prevent the competition of members of other groups but to abolish the government’s interference with wage rates.
4. Make-Work Schemes and Spread-the-Work Schemes
The belief in a scarcity of work to be done in the world leads to the belief that what it is necessary to make is not more goods (that, it is claimed, only causes unemployment) but more work. According to the supporters of this idea, while scientists and inventors and greedy businessmen are off plundering the community’s precious stock of work to be done, with their ceaseless striving for improvements in efficiency, union leaders, government officials, and every good union man must perform the vital function of making work—by, for example, respectively requiring the employment of electricians whose full time jobs consist of nothing more than turning the lights on and off once a day, by employing people in public works projects, and by doing things more slowly and less efficiently whenever possible.
The effect of “making work” is obviously to hold down the standard of living by reducing output per worker. Indeed, the effect of make-work projects is likely to be not that the same output is produced by a larger number of workers, but that a smaller output is produced by the same number of workers. For there is nothing present in any make-work scheme that increases the overall quantity of labor demanded. That would require lower wage rates—given the quantity of money and volume of spending in the economic system. Thus, the effect of make-work schemes is that for every extra useless worker who is employed and adds little or nothing to output, some other, far more productive worker is forced into unemployment. In other words, the effect of make-work schemes is that less-efficient workers take the place of more-efficient workers, less is produced, and the standard of living is reduced. (It should be realized, of course, that the reduction in employment can be shifted to other industries. Thus if a plumbing repair is made to use the services of an unnecessary tile setter, say, the effect is not that the tile setter takes the place of the plumber. He may take the place of an auto worker, a travel agent, a farmer—a worker anywhere in the economic system where demand is now less because funds have been tied up in paying the wages of the tile setter and in buying the artificially more expensive product that is the result of his employment.)
Somewhat similar to make-work schemes, and put forward in response to the same alleged problem of a scarcity of work to be done in the world, are spread-the-work schemes. Here the existence of a given amount of work to be done is taken for granted and the attempt is made to “spread it around”—“fairly.” Thus if the average work week were forty hours and at the same time one worker in four were unemployed, the advocates of spread-the-work would call for a reduction in the work week to thirty hours, in the belief that then everyone could be employed at three-quarters time, rather than three-fourths of the workers at full time.
While the effect of make-work schemes is to shift the burden of unemployment to workers who are presently employed in an efficient manner, in order to make way for workers who will be employed inefficiently, the effect of spread-the-work schemes is not only likely to be very similar, but also very likely to increase the overall amount of unemployment as well, depending on what happens to wage rates. 17
If no attempt is made to raise hourly wage rates, then those who already have full-time jobs must suffer a reduction in their weekly wages to whatever extent their
hours are reduced as the result of spreading the work. More likely than not, at the same time some decline in production will occur and some rise in unit costs and prices will take place, even though the hours worked in the economic system as a whole are the same as before. This result is likely because the workers who were without jobs were likely to have been less efficient than the workers with jobs, inasmuch as employers, as far as they have any choice in the matter, prefer to let go of their poorer workers before their better ones. Thus, by and large, it is the better workers who were able to retain their jobs and the poorer workers who were unemployed. To this extent, “spreading the work” entails substituting hours worked by less efficient workers for hours worked by more efficient workers. In this way, it reduces overall output and raises production costs and prices, even if it leaves the total hours worked the same.
However, the total number of hours worked is unlikely to remain the same. This is because in an effort to compensate the workers who already have jobs and now must accept shorter hours as a result of spreading the work, the attempt will almost certainly be made to raise hourly wage rates. To the extent the attempt succeeds, the total number of hours of labor demanded falls. Indeed, in the face of a fixed aggregate monetary demand for labor—fixed total payrolls in the economic system—(which it is reasonable to assume as a central case if the quantity of money and volume of spending are fixed), the decrease in hours demanded is in inverse proportion to the rise in hourly wage rates. Thus, in the case of a reduction in the work week from forty hours to thirty hours, accompanied by a fully compensating rise in average hourly wage rates in the ratio of four to three, the effect would be that total hours demanded and worked in the economic system would fall in the ratio of three to four, that is, by an additional 25 percent!
This would mean that to whatever extent some of the previously unemployed obtained jobs, the effect would be that those who already had jobs would lose them outright. The latter would not merely work thirty hours instead of forty: in order to make room for the unemployed, they themselves would be thrown into unemployment. Indeed, in these circumstances, the previously unemployed could find employment only to the extent that those who had jobs lost them or at least reduced their hours below thirty per week. This is because the rise in hourly pay to compensate for the shortening of hours totally nullifies any ability of shorter hours to serve as the basis for spreading the work. Thus any employment gained by the previously unemployed must come at the expense of a further reduction in the employment of those who presently are employed.
5. War and Government Spending
According to consumptionism, war has a variety of economically beneficial consequences that promote employment. It creates an enormous additional need for wealth during the war—in the form of tanks, planes, ammunition, and so on. In addition, the destruction it entails creates the need for replacing what is destroyed. And, finally, the cutback in normal civilian production that takes place during the war supposedly operates to create a kind of bank account for postwar demand: the limited need and desire for goods that people would normally have, and which cannot be satisfied during the war, supposedly accumulates and is available after the war to help prolong the alleged prosperity the war brings, by providing for the release of “pent-up” demand. In all these ways, according to consumptionism, war serves to move the allegedly fixed aggregate demand curve of Figure 13–1 to the right, and thus makes possible greater employment.
An aspect of these absurdities that is worth pointing out is that the consumptionist values the absence of wealth rather than wealth. For example, after World War II, he believed that the relative absence of houses, automobiles, and refrigerators in Europe was an asset of the European economy because it represented a large supply of unused consumer desire, thereby supposedly ensuring a strong consumer demand. By the same token, he believed that the relative abundance of these goods in the United States was a liability of the American economy because it represented a depleted supply of consumer desire, thereby supposedly ensuring only a weak consumer demand. Prosperity depends on the absence of wealth, and poverty follows from its abundance, the consumptionist concludes, because that priceless commodity, consumer desire, more limited in supply than diamonds, is produced by the absence and consumed by the presence of wealth.
In contrast to all such absurdities, productionism recognizes that the need for wealth is always superabundant and thus that the last thing in the world that is necessary is to create more need for wealth by destroying existing wealth. It is wealth, not the need for wealth, that must be created, and this is what war wastes and destroys. The actual economic effect of war is to divert production from civilian goods to war goods, which have no economic benefit. It is also to cause people to work longer and harder, and people who otherwise would not have found it necessary to work, such as many housewives and teenagers, to go to work—all in an effort to offset the drop in the standard of living that the diversion of output to the war effort causes. Similarly, the postwar replacement of wealth needlessly destroyed in war is at the
expense of new and additional wealth that otherwise could have been enjoyed in addition to the wealth needlessly destroyed, and at the expense of leisure that people could otherwise have afforded to choose. The same is true of the wartime need to postpone the production of civilian goods. Had the production of those goods not had to be postponed, new and additional wealth could have been produced and enjoyed in subsequent years, and people could also have afforded to choose more leisure.
Nor does war promote prosperity by means of the postwar application of scientific or technological advances made in connection with the war effort. Like the output of war goods, which are at the expense of the output of civilian goods, the scientific and technological advances made in connection with war are at the expense of the advances that would have taken place had the labor of scientists and engineers not had to be diverted from peacetime pursuits to the war effort. While the most that is gained from the war effort are some derivative peacetime applications—mere by-products of the war effort— what is lost are the kinds of advances that would have resulted from the full, focused application of scientific and engineering talent to peacetime advances. In the nature of the case, the loss is greater than the gain, and thus, on net balance, war detracts from scientific and technological progress. Indeed, as we have already seen, so far from it being the case that a focus on the technology of war can serve as the foundation for technology of value to the lives of human beings, that the reverse is true. Those countries which have been free to devote their efforts to improving human life and wellbeing, such as the United States (at least for most of its history), have, as a by-product of their peaceful, civilian scientific and technological pursuits, developed the foundation for far more powerful military technology than countries bent on war and aggression. 18
Finally, war does not promote prosperity by making possible the replacement of factories and machines that have been destroyed, with more advanced factories and machines. 19 The physical foundation for the construction of new factories and machines is existing factories and machines. The destruction of factories and machines destroys the physical ability to produce newer, more advanced factories and machines.
These propositions are in no way contradicted by the postwar experience of Germany and Japan. The physical ability of postwar Germany and Japan to rebuild was enormously facilitated by the fact that the factories and machines of the United States had escaped physical destruction. Had the United States been bombed to the extent that Germany and Japan had been bombed, the rebuilding would have taken many more years, if, indeed, it would have been possible at all. The ability of these countries to recover was also facilitated to the extent that their existing factories and machines had escaped damage and thus were available to serve in production, including not only the production of more advanced factories and machines but also goods to exchange for more advanced factories and machines.
The fact that in the years since World War II, Germany and Japan have in many cases built factories that are more modern than those used in the United States does not at all prove how fortunate they were to have been the scene of massive bombing raids and how unfortunate we were to have escaped bombing. Their success is the result of the fact that starting with whatever capital goods were available to them, they produced substantially as much as they could, and devoted a proportion of their productive efforts to the production of capital goods that was more than sufficient to replace the capital goods used up in production. This increased the capital goods at their disposal and enabled them to increase their production further. And out of the larger production, they again devoted a proportion sufficient more than to replace the capital goods consumed in production, and by a wide margin. Repeating this process over decades is the essential explanation of their great economic success.
Starting with far more capital goods, the United States was in a much better position to add further to its supply of capital goods than Germany or Japan. But the destructive policies of its government prevented it from doing so. Government policies such as confiscatory taxation (especially of profits and interest), chronic budget deficits, inflation of the money supply, prolabor legislation, and ever growing regulation in general, have stood in the way of saving and capital accumulation to a much greater extent in the postwar United States than in postwar Germany or Japan. This is the essential reason for their much more rapid rate of economic progress since World War II. 20
It is true that World War II was accompanied by the elimination of mass unemployment in the United States. Part C of this chapter will explain why this was the case, in a way that is perfectly consistent with the philosophy of productionism. It will show that it was not the war as such that brought about full employment, nor any increase in the need for wealth that is associated with war, but a change in the relationship between wage rates and prices on the one side and the quantity of money and volume of spending in the economic system, on the other. It will show how the necessary change in this relationship, and thus full employment, could have been achieved without the war, and how government intervention in the labor market prevented its achievement. It will also show that despite the existence of full employment, and the
illusion of prosperity, the war was actually a period of impoverishment far worse than the worst years of the depression of the 1930s. It will show that full employment with prosperity was achieved only after the war ended, and the labor and capital that had been devoted to the war effort once again became available for the production of peacetime, civilian goods.
The fact that war is economically destructive does not mean, of course, that there is no legitimate basis for war. When war is necessary for the defense of individual freedom, it is justified. What must never be forgotten is simply that even when it is justified, war is always a great expense, not a source of prosperity.
Consumptionists see additional peacetime government spending, whether for public works or for social welfare, as a source of prosperity comparable to war, but without entailing loss of human life. Such spending, they believe, is as beneficial to employment as would be a policy of calling in the artillery or airforce to destroy buildings after they had been evacuated. For it too allegedly increases the demand for goods and thus the need for labor, by virtue of the government performing the supposedly valuable service of exchanging its consumption for the people’s products. In view of the fact that until recently, the enemy in any war we were likely to become involved in would directly or indirectly have been the Soviet Union, whose social system even now still evokes substantial support among intellectuals, this alleged method of promoting prosperity has become much more favored than war.
Of course, since there is in fact no lack of demand for goods or need for labor, the actual effect of government spending to promote employment is to divert production from the goods and services that people voluntarily choose to buy, to goods and services that they do not value sufficiently to buy. In the process, it also reduces their overall ability to produce. This last occurs as the result both of reducing their incentive to work and produce, through higher taxes to pay for the additional spending, and their freedom to produce, through a growing array of regulations enforced by many of those added to the government’s payroll. Thus, production is diverted away from goods and services of value to taxpayers to such things as the production of goods and services for welfare recipients, the provision of “education” to other people’s children, and the production of farm products to rot or to be given away. In addition, it is diverted to providing for the wants of millions of government employees whose function is nothing other than to restrict the freedom of the taxpayers.
In the nature of the case, all government spending inspired by consumptionism must be highly wasteful.
This follows from the fact that its essential purpose is not the achievement of any positive value in exchange for the expenditure, but merely to promote employment. If the government desires something as a positive value, such as a new courthouse or police station, then, just like any other buyer, it would want to obtain the best product it could for as little money as possible. In such a case, the government would implicitly want its product to be produced as efficiently as possible, as the basis for obtaining it for as little money as possible. For all practical purposes, this would mean that it would want its product produced with as little labor as possible, inasmuch as that is the essential nature of efficient production. However, if the government’s goal is to increase spending and employment, then what it wants is not the most and best product for the least money, produced with the least amount of labor possible, but a product for the most money, produced with the greatest amount of labor possible. In fact, the product itself altogether ceases to matter. It can be no product at all or the most absurd product, such as pyramids—as Keynes would be among the first to admit. For the value, according to consumptionism, is not the product gained but the expenditure made and the employment that is allegedly created. 21
Of course, all of the wasteful and destructive economic consequences of war and government spending can be reversed by the coming of peace and by the dismantling of the government programs. (The dismantling of the civilian programs, of course, can be undertaken at any time.) The effect would be a reduction in the labor and capital devoted to producing for the government’s purposes, or for the purposes of those to whom the government gives or pays money, and an equivalent increase in the labor and capital devoted to producing for the purposes of private citizens. Indeed, insofar as the reduction in government spending took the form of a reduction in welfare payments to the able bodied, the effect would be an increase in the number of people working and an increase in the total volume of goods produced. This is because the former welfare recipients would now have to support themselves instead of being supported by others. An increase in the total volume of goods produced would also be the effect insofar as military personnel and other government employees rejoined the private, civilian labor force and thus the ranks of producers’ labor, in contrast to their present status of consumers’ labor. 22 In addition, in the case of the firing of government personnel who presently carry out the regulations hampering productive activity, the further effect would be that the efforts of the citizens would be made correspondingly more productive.
Ironically, it follows from these facts that, given some time to adjust, the effect would be that even the former
welfare recipients and government employees would come out far ahead of where they were when they were on welfare or working for the government. For once they learned the habit of working, or of working in the far more efficient, competitive conditions of private business rather than in the sheltered environment of the government, and doing so, moreover, in the face of a reduced burden of taxation and regulation, they would produce and enjoy far more than they can presently wring from others by force.
6. Population Growth and Demand
In addition to war and government spending, consumptionism claims that a larger number of people, each with his or her limited quota of needs and desires, increases the total demand for goods and thus helps to eliminate the alleged excess of the ability to produce over the need and desire to consume. The existence of a larger number of people, the consumptionist tells businessmen, makes it possible for business to find someone upon whom to unload its otherwise superfluous goods. Business will prosper because its supply of goods will find a counterpart in an adequate supply of desire for goods. These beliefs are the foundation for the talk about “baby booms” and the additional demand for goods of all kinds that is automatically supposed to result from them.
Of course, when these alleged economic benefits of the larger population are put forward, there is no discussion of the additional people entering the labor market and seeking employment. The consumptionist premise, which leads to the larger population being viewed favorably from the perspective of its effects on demand, must lead to it being viewed unfavorably from the perspective of its effects on the supply of labor. For, as we have seen, it follows on the consumptionist premise, that to the extent that the larger population’s members gain jobs, correspondingly fewer additional jobs are available for others. Thus, what is supposed to be the cause of prosperity here, according to consumptionism, is that the additional people exist only as consumers, not as producers—that is, that they exist as parasites. That will be their alleged contribution to employment and prosperity. In that way, they will supply the need for goods, which is allegedly scarce, but not goods, which are allegedly superabundant.
In opposition to these absurdities, the productionist recognizes that the birth and upbringing of children always constitutes an expense to the parents. In raising children, the parents must spend money on them which they otherwise would have spent on themselves. Of course, the parents may, and hopefully will, consider the money better and more enjoyably spent on their children;
but still, it is an expense. And if they have a large enough number of children, they will be reduced to poverty. This is a fact that anyone can observe in any large family that does not possess a correspondingly large income. The presence of children does not make the parents spend more than they otherwise would have, but only spend differently than they otherwise would have. They buy baby food, toys, and bicycles instead of more restaurant meals, a better car, or costlier vacations. There is no stimulus given to production. Production is merely differently directed, to the different distribution of demand.
In reality, the only increase in production that could take place would be as the result of the parents working longer or harder to be able to support their children while still maintaining their own previous standard of living. Furthermore, when the children grow up, the additional market that they are supposed to constitute for houses and automobiles and the like will materialize only to the extent that they themselves are able to produce the equivalent of these things and thereby earn the money with which to purchase them. Thus it will only be by virtue of their production, and not by virtue of their desire to consume, that they will be able to constitute an additional market.
7. Imperialism and Foreign Trade
The same considerations that make the consumptionist believe that a larger population at home is desirable, by virtue of its possession of a larger stock of needs and desires for goods, make him believe that it is desirable to secure the needs and desires of the vast, impoverished populations of backward foreign countries. To the consumptionist, such countries appear as virtual treasure houses of unused consumer desires. He counts the numbers of their inhabitants and the lack of goods of each person, and arrives at what he considers to be staggering sources of demand.
Such ideas undoubtedly influenced the economically ignorant politicians of many European countries before World War I, particularly those of Germany, in embarking upon policies of imperialism and colonial conquest. 23 Instead of denouncing the economic ignorance of those politicians, many historians accept exactly the same false premises of consumptionism, and thus routinely explain World War I as having been caused by conflicts among the advanced countries of Western Europe for socalled markets in the backward nations. According to such historians, each of the European powers allegedly had a problem of overproduction at home and was thus in need of foreign markets as an outlet for its allegedly surplus goods. So valuable were these alleged foreign markets supposed to be to the European countries, that, according
to such historians, it is understandable that they were considered worth fighting for. More recently, the same logic was applied to the United States’ involvement in Vietnam. It was claimed that we were there in order to be sure of having access to the vast “markets” of Southeast Asia.
Contrary to consumptionism and the ignorant politicians and historians that it influences, hordes of impoverished beggars do not constitute markets. Countries, and individuals, constitute markets not to the extent that they have needs and desires for goods, but to the extent that they produce and supply goods. Only to this extent are they in a position to earn the wherewithal to purchase goods and thus to constitute markets. It is for this reason that the United States and Japan are vastly greater markets than India and China, as I previously pointed out, and that Beverly Hills is a vastly greater market than Watts.
It should be realized that the same problem arises for the consumptionist in connection with the policy of imperialism, and foreign trade in general, as arises in connection with a larger population at home. Namely, the consumptionist (and imperialist) values foreign countries only as sources of alleged demand, by which, of course, he means needs and desires. At the same time, he fears them as sources of supply. To the extent that they become sources of supply, such as Hong Kong, Taiwan, South Korea, and Japan, he fears them as depriving domestic producers of markets and thus workers at home of jobs. The consumptionist believes that the gains from foreign trade are in the exports, not the imports. His view of a beneficial relationship with foreign countries is that they should provide us with their needs and desires, so as to provide an outlet for our allegedly excess goods, not that they should provide us with goods. He believes that the object of foreign trade should be to have the maximum possible excess of exports over imports. His ideal is that his country should only export and not import at all, or import only to the extent that doing so is vitally necessary or contributes to the production of a more than compensating quantity of additional exports. 24 Obviously, the notion that an excess of exports over imports constitutes a “favorable balance of trade” is entirely consistent with consumptionism and draws much of its support from it. 25
Thus, the idea of the consumptionist and the imperialist is that a country benefits by virtue of actually giving its goods away for free—by working and sending them out and by receiving back as little as possible. And more, that this privilege is worth fighting for. Indeed, so perverse is the consumptionist view of things that it leads to absurdity heaped upon absurdity. By the logic of those who hold it, the military presence of the United States in Vietnam was to be explained on the grounds that the people of Southeast Asia were too clever to be willing to accept our goods for free. We allegedly had to use force to make them accept such an arrangement, allegedly so harmful to them and so beneficial to ourselves. According to the consumptionist, the privilege of supplying impoverished beggars—that is, of working for nothing-—is so valuable that if it is not actually worth dying for, it is at least understandable why it should appear to be so, to those not restrained from the pursuit of material self-interest by the possession of more noble sensibilities. This is what consumptionist historians and moralists believe.
It needs to be pointed out that the actual benefit of international trade is in the imports, not the exports. The citizens of a country gain in the conduct of international trade by virtue of the fact that the goods and services brought in by international trade surpass the goods and services that the labor and capital employed in producing exports could produce for the domestic market. Thus, to recall the example of automobiles and coffee from Chapter 9, the United States gains in its trade with Brazil by virtue of obtaining more coffee through the production of automobiles for export than it could by using the same amount of labor to produce coffee. At the same time, Brazil gains by virtue of obtaining automobiles and other manufactured goods in far greater quantity through the export of coffee than it could obtain by attempting to use the same amount of labor to produce such goods in Brazil. Or, equivalently, the countries gain by obtaining the same amount of goods with the use of less labor, and thus have labor left over to produce more of other things. 26
International trade does not cause unemployment but, like machinery, a higher productivity of labor and standard of living. As in the case of machinery, the effect on employment is merely a change in the pattern of employment. Fewer workers are employed in the industries in which foreigners enjoy a comparative advantage and hence in which the country imports, and more workers are employed in the industries in which the given country enjoys a comparative advantage and hence in which it exports. 27 Overall, the effect is the same volume of employment but more goods.
8. Parasitism as an Alleged Source of Gain to Its Victims
The consumptionist’s views on the allegedly beneficial effects of war, government spending, population growth, and imperialism rest on the idea that one benefits producers by the mere fact of consuming their products. This gives the producers the work to do of making possible one’s consumption. Such an idea is obviously
absurd. Only the use of money lends it the least semblance of plausibility. If it were true, then every slave who ever lived should have cherished his master’s every whim the satisfaction of which required of him more work. A slave should have been grateful if his master desired a larger house, an improved road, more food, more parties, and so on; for the provision of the means of satisfying these desires would have given him correspondingly more work to do.
The belief that the consumption of the government, or of private nonproducing consumers at home or abroad, benefits and helps to support the economic system is on precisely the same footing as the belief that the consumption of the master benefits and supports the slave. It is a belief the absurdity of which is matched only by the injustice it makes possible. It is the means by which parasitical pressure groups, employing the government as an agent of plunder, seek to delude their victims into believing that they are benefitted and supported by those who take their products and give them nothing in return.
The only economic benefit that one can give to producers consists in the exchange of one’s own products or services for their products or services. It is by means of what one produces and offers in exchange that one benefits producers, not by means of what one consumes. To the extent that one consumes the products or services of others without offering products or services in exchange, one consumes at their expense.
The use of money makes this point somewhat less obvious but no less true. Where money is employed, producers do not exchange goods and services directly, but indirectly. The buyer exchanges money for the goods of a seller. The seller then exchanges the money for the goods of other sellers, and so on. But every buyer in the series must either himself have offered goods and services for sale equivalent to those he purchases, or have obtained his funds from someone else who has done so.
The fact that in a monetary economy everyone measures his benefit by the amount of money he obtains in exchange for his goods or services is interpreted by the consumptionist to imply that the mere spending of money is a virtue and that economic prosperity is to be found through the creation and spending of new and additional money—i.e., by a policy of inflation.
The fact is that for everyone who spends newly created money and thus obtains goods and services without having produced equivalent goods and services, there must be others who suffer a corresponding loss. Their loss takes the form either of a depletion of their capital, a diminution of their consumption, or a lack of reward for the added labor they perform—a loss precisely equal to the goods and services obtained by the buyers who do not produce.
The consumptionist’s advocacy of consumption by those who do not produce, to ensure the prosperity of those who do, is a pathological response to an economic world which the consumptionist imagines to be ruled by pathology. The consumptionist has always before him the pathology of the miser. His reasoning is dominated by the thought of cash hoarding. He believes that one part of mankind is driven by a purposeless passion for work without reward, which requires for its fulfillment the existence of another part of mankind eager to accept reward without work. This is the meaning of the belief that one set of men desire only to produce and sell, but not to buy and consume, and the inference that what is required is another set of men who will buy and consume, but who will not produce and sell. In the consumptionist’s world, the producers are imagined to produce merely for the sake of obtaining money. The consumptionist stands ready to supply them with money in exchange for their goods—he proposes either to take from them the money he believes they would not spend, and then have someone else spend it, or to print more money and allow them to accumulate paper as others acquire their goods.
Hoarding is not the only phenomenon upon which the consumptionist seizes. Where nothing in reality will serve, the consumptionist is highly adept at bringing forth totally imaginary causes of economic catastrophe. Invariably, the solution advanced is consumption by those who have not produced, for the sake of those who have. Always, the goal is to demonstrate the necessity and beneficial effect of parasitism—to present parasitism as a source of prosperity to its victims. This is the meaning of his beliefs about the allegedly beneficial effects of make-work schemes, war and government spending, a growth in the population of idle consumers, and fighting for the privilege of supplying beggars around the world. 28
9. Advertising as Allegedly Fraudulent but
Economically Beneficial
The consumptionist views advertising as attempting to induce people to buy goods for which they have no real need. At the same time, precisely on the basis of this belief, he regards advertising as a method of stimulating demand in the economic system and thus helping to overcome the alleged deficiency of demand.
The fact is that advertising does not create consumer desire where no desire for additional goods would otherwise have existed. It is not the case that, in the absence of advertising, people would be at a loss as to how to spend their money. Advertising is not required, and would not be sufficient, to rouse vegetables into men. What
advertising does, by making people more aware of the alternatives available to them, is lead them to consume differently and in a better way than they otherwise would have. Advertising is a tool of competition, and, as such, for every competing product whose sale is increased by it, there is another competing product whose sale is decreased by it. The only exceptions are insofar as advertising contributes to the increase in production—for example, by making people aware of the existence of products which they judge to be important enough to be worth expending extra effort to earn the money to purchase. Such cases are a further illustration of the fact that it is only the increase in aggregate supply that increases aggregate demand.
The consumptionist’s attitude toward advertising brings into clear relief some further corollaries and implications of his basic premise. His estimate of advertising, like that of war and destruction, is ambivalent, and necessarily so. On the one hand, he approves of it, on the grounds that by creating consumer desires, it creates the work required to satisfy those desires. However, this very belief, that advertising creates desires where absolutely no desires would otherwise exist, also makes him condemn advertising. For if it were true that, in the absence of advertising, men would be perfectly content with very little, the desires created by advertising must appear to be only superficial and basically unnecessary and unnatural.
And this, of course, as previously explained, is precisely how the consumptionist regards such desires. In his eyes, all desires men have for goods, beyond what is necessary to make possible bare physical survival and a vegetative existence, represent an unnatural taste for “luxuries.” These desires the consumptionist considers to be inherently unimportant. Their only justification is the creation of work. The consumptionist’s conception of the greater part of economic activity, therefore, is that it represents senseless motion, with deceit and deception required to make people desire goods for which they have no need, in order to enable them to pass their lives in the production of those very same goods. 29
In reality, of course, people’s desire for “luxuries” is necessary and natural, for it is nothing but the desire to satisfy their inherent needs (including the need for aesthetic satisfaction) in an ever more improved way. It is from the importance that attaches to the satisfaction of the desire for “luxuries” that the importance of the work required to produce them is derived, and not vice versa. Indeed, however paradoxical it may appear, it is only from the perspective of productionism that one can understand the actual importance of consumer desires— namely, as the ever-present end and purpose of all production, not as a means serving production absurdly regarded as an end in itself.
10. Misconception of the Value of Technological Progress
Just as he believes in the need to create uses for an expanding supply of consumers’ goods, so the consumptionist believes there is a problem of finding “investment outlets” for an expanding supply of capital goods. Here he looks to technological progress as providing a possible solution to this alleged problem. Its contribution is supposed to be the enlargement of the “supply of investment outlets” or “investment opportunities.”
The fact is that the value of technological progress does not lie in the creation of “investment outlets” or “investment opportunities” for an expanding supply of capital goods. If the concept of capital goods is properly understood, as denoting all goods that the buyer employs for the purpose of producing goods that are to be sold, then, as has already been shown in Chapter 2, it is clear that there is no such thing as a lack of “investment outlets” or “investment opportunities” for capital goods. So long as more or improved consumers’ goods are desired, there is need of a larger supply of capital goods. As shown, capital goods are scarce both in their horizontal and vertical dimensions. 30
For example, ten million automobiles of a given quality require the employment of twice the quantity of capital goods—twice the quantity of steel, glass, tires, paint, engines, and machinery—in their production as do five million such automobiles. If the quality of the automobiles is to be improved, or if the efficiency of their production is to be increased by the adoption of more capital-intensive methods of production, then a larger quantity of capital goods is required for the production of the same number of automobiles. For example, a given number of cars of Chevrolet quality, with their greater number of accessories and larger size and greater need for materials, require a larger quantity of capital goods in their production than the same number of cars of Volkswagen quality; the same number of cars of Cadillac quality require still a larger supply of capital goods; and the same number of cars of Rolls-Royce quality require yet an even more enlarged supply. Greater capital intensiveness is entailed not only in shifting from such lower-quality models to such higher-quality models, but also insofar as more capital-intensive methods of production are to replace less capital-intensive methods of production in the manufacture of any of these given models. To this extent, too, a larger supply of capital goods is required.
The identical principle applies to houses of different size and quality. A given quantity of eight-room houses of a given quality requires the employment of a larger supply of capital goods than the same number of seven—
room houses of the same quality. A given number of brick houses requires a larger supply of capital goods than the same number of wooden houses of the same size; the bricks or any more expensive material constitute a larger supply of capital goods because a larger quantity of labor is required to produce them. The principle applies to food and clothing, to furniture and appliances, to every good. So long as more of any consumers’ good is desired, so long as not every consumers’ good that is produced is of the very best-known quality, and produced by the most capital-intensive methods, there is a need for a larger supply of capital goods.
It is not the case that in the absence of technological progress, the supply of capital goods would continue to expand but find no “investment outlets.” It is not the case that what we have to fear from a lack of technological progress is a flood of capital goods surpassing every possible use for capital goods, and that then we will be at a loss as to how to employ our expanding supply of capital goods. Before such a situation could exist, every car produced would have to be the equivalent of the finest-known-model Rolls Royce; every house would have to be a palatial mansion; every suit of clothes would have to be fit for the Prince of Wales. This is because so long as any such possibilities remained unmet, there would be a need for the additional capital goods that would enable them to be met. Before such a situation could exist, capital intensiveness would have to be carried to its utmost limits in terms of reducing costs and improving the quality of goods in every respect. Among other things, this would mean that every known machine that can save labor would be in use in every possible case, that bridges and tunnels would eliminate every major detour across land or around water, that the roads and railroads would be straight and level, and that all major inland cities technologically capable of having access to the sea would have it. Clearly, whatever problems the world may face, such a situation is not one of them. Clearly, whatever our worries may be, such a situation deserves no place among them. On the contrary, what we have to fear from a lack of technological progress is not that we will be overrun with a supply of capital goods that surpasses all worthwhile uses for capital goods and that we shall then be at a loss for what to do with our still expanding supply of capital goods, but that we will not have an increase in the supply of capital goods, that we will not be able to exploit any considerable portion of the virtually limitless “investment outlets” that already exist, within the framework of known technology.
The value of technological progress consists in the fact that it enables us to obtain a larger supply of capital goods, and not that it solves the problem of what to do with a larger supply. 31 The technological advances that
made possible the canal building and railroad building of the nineteenth century and the development of the steel industry were valuable, not because they absorbed capital goods, as the consumptionist believes, but because they made possible the accumulation of capital goods. The consumptionist does not realize that capital goods can be increased in supply only by means of an increase in their production, and that precisely this is what technological progress makes possible. Had the technological advances that made possible the first railroads in the 1830s not taken place, the supply of capital goods required for the expanded and improved railroad building of the 1840s would not have been obtainable; or, if obtainable, only at the price of the expansion of some other industry. Had no technological advances been made in railroading in the 1840s, the supply of capital goods in the 1850s would have been less, both for railroads and for all other industries. And so it would have been decade by decade, had the technological advances made in railroading or in any other industry not taken place.
For capital accumulation to continue for any period of time, technological progress is indispensable. Only it can make possible continued increases in production, and only continued increases in production can make possible continued capital accumulation. The consumptionist is not aware that the very thing that he considers to be the solution to his imagined problem is the source of what he imagines to be the problem. The absurd implication of his belief is that somehow, in the absence of technological progress, a supply of capital goods could have been accumulated out of the level of production of a preindustrial economy that would have been sufficient to build the railroads and steel mills of the nineteenth-century United States, but, thank heaven, the technology of railroad building and steel-mill construction came along in the nick of time to find uses for those capital goods. It is on this basis, under the name of the doctrine of “secular stagnation,” that the consumptionist explains why largescale capital accumulation did not depress the rate of profit in the nineteenth century, but allegedly did in this century. 32
Nor is the consumptionist aware that when he advances technological progress as the solution to the problem of what to do with more capital goods, he is confronting himself with the problem of what to do with the larger supply of consumers’ goods, that even he admits results from technological progress. The consumptionist is faced, in addition to other quandaries, with the dilemma of explaining how it is that technological progress can raise the rate of profit by, as he puts it, “increasing the demand for capital,” while at the same time, as he admits, it increases the production of consumers’ goods, which, he maintains, lowers the rate of profit by causing “overpro—
duction,” falling prices, and “deflation.”
The textbook of Samuelson and Nordhaus provides a typical instance of this contradiction on the part of the consumptionists. In one place it declares:
But what happens as society invests in more and more capital goods? As a nation transfers more and more of its consumption toward capital accumulation? As production becomes more and more roundabout or indirect?
The answer is that we would expect the law of diminishing returns to set in. As we add more fishing boats and nets or power plants or steel mills or chemical factories or computers or trucks, the extra product or return on even more roundabout production begins to fall. The first few fishing boats or nets yield many fish, but too many fishing boats simply deplete the fish stock. Eventually, as capital is accumulated, the rate of return on the investments would fall from, say, 20 percent per annum to 10 percent or even to 2 percent.
Unless offset by technological change, therefore, rapid investment would produce diminishing returns, which would drive down the rate of return on investment. But then, why have rates of return on capital not fallen markedly over the course of the last 150 years, even though our capital stocks have grown manyfold? Because innovation and technological change have created profitable new opportunities as rapidly as past investment has annihilated them. 33
Yet while here they claim that technological progress raises the rate of return, elsewhere in their book, they say: “The opposite of inflation is deflation, which occurs when the general level of prices is falling. . . . Sustained deflations, where prices fall steadily over a period of several years, are associated with periods of deep depression, such as the 1930s or the 1890s.” 34
It is obvious that on this definition, technological progress must cause “deflation,” for clearly it operates to increase production and supply and therefore to reduce prices. Deflation, of course, entails a reduction in the rate of profit, or rate of return. Thus, Samuelson and Nordhaus are in the position of alleging that technological progress both raises and lowers the rate of return.
This unfortunate dilemma of the consumptionists is resolved by realizing that technological progress does not increase “the demand for capital” or the rate of profit. Rather, as already indicated, it increases the supply of capital goods, which reduces their prices and thus the costs of production. In increasing the productivity of labor, it also reduces costs of production. Thus the fall in prices of consumers’ goods is preceded by a fall in costs of production, which prevents it from resulting in a fall in the rate of profit. 35
Finally, it must be observed that the notion that technological progress raises the rate of profit is as mistaken as the notion that it causes deflation and thus reduces the rate of profit. Fundamentally, technological progress is neutral with respect to the general or average rate of profit. It raises the rate of profit of those firms that introduce appropriate technological advances or are relatively early in their adoption. But at the same time, it reduces the rate of profit of those firms that fail to introduce such advances and suffer from the greater competition of the firms that have introduced them. If, for example, a pharmaceutical company could offer an affordable pill that would prevent cancer, it would make enormous profits. At the same time, however, various other firms, probably in a wide variety of different industries, would suffer an equivalent reduction in sales revenues and profits, at least in comparison with what they would otherwise have been. And then, if some other pharmaceutical company were to be able to offer a pill at a comparable price that not only prevented cancer but also heart disease, the pill that prevented only cancer would almost certainly incur losses. The belief that technological progress raises the general or average rate of profit is simply another instance of the fallacy of composition, based on the failure to consider the effects of things on all parties in the economic system. 36 The only way in which technological progress can contribute to raising the general or average rate of profit is under a system of commodity money, such as a gold standard. In that case, as I will show, it raises the rate of profit insofar as its by-product is a more rapid rate of increase in the quantity of money and volume of spending. 37
11. Increases in Production and Alleged Deflation
The preceding leads to the final point that must be considered here, which is not a manifestation of the consumptionist premise exclusively, but which is closely allied to it in that it implies that increases in production are responsible for depressions. This is the belief that increases in production cause deflation unless they are accompanied by equivalent increases in the quantity of money and volume of spending in the economic system.
As evidenced by the quotation from Samuelson and Nordhaus in the text above, the consumptionists, and many people who in other respects are not consumptionists, believe that falling prices in and of themselves, irrespective of their cause, represent deflation. Just as “inflation” is used as a synonym for rising prices, “deflation” is used as a synonym for falling prices. But deflation, of course, is also used as a synonym for depression. Thus, increases in production are regarded as inherently tending to produce depressions, unless, either by accident, or by virtue of the plan of the government, the quantity of money and volume of spending in the economic system grow as rapidly, and thus prevent prices from falling.
In this way, what comes to be feared is both the increase in the supply of goods and the lack of increase in the quantity of money. And what comes to be advocated, at least implicitly, is both the destruction of wealth and the inflation of the money supply—as the means of preventing “deflation.”
It should be obvious that anyone who holds these ideas must be fearful of allowing the quantity of money in the economic system to be governed by the quantity of gold. For he has no guarantee that under a gold standard, the quantity of money will increase as rapidly as the supply of ordinary goods. 38
Part B of this chapter shows why falling prices caused by increased production are of a radically different character than falling prices caused by a decrease in the quantity of money and volume of spending, and thus do not deserve to be stigmatized as “deflation.” It shows that none of the negative consequences associated with genuine deflation, such as a generally greater difficulty of repaying debt or a wiping out of general business profitability, accompany falling prices caused by increased production.
12. Consumptionism and Socialism
The consumptionist premise is influential not only in all the ways I have described, which are certainly important enough in their own right, but also in an important indirect way. By this I mean that while most people who hold the consumptionist premise are content to live with its paradoxical implications to the extent that they are aware of them, many are not. The latter accept all of the absurd implications of consumptionism as applying only to the capitalist economic system in which they live. Their view is that it is under capitalism that improvements in production cause impoverishment; that war, destruction, parasitism, and fraud cause prosperity; and that conflicts exist within and between nations. Such an absurd and discordant system, they believe, deserves to be overthrown, and replaced with an allegedly more rational system. To them, socialism appears, or at least did appear, as a system of reason and order, in which these paradoxes and conflicts can be harmoniously resolved.
The contribution of the collapse of socialism to the spread of irrationalism, which I have referred to in connection with the rise of such doctrines as environmentalism, can be understood in part in the light of the influence of consumptionism. To consumptionists the collapse of socialism means that reason simply does not apply to the economic organization of mankind. They had been convinced of the absurdity and evil of capitalism, but had looked to socialism as the solution. Now, after almost three generations, they are coming to see that socialism means slavery and poverty. And thus, they conclude, the economic world is inherently and inescapably riddled with paradox and evil.
Some major loose ends remain to be tied up in connection with consumptionism. Above all, there is the bundle of fallacies known as Keynesianism, which represents a convoluted variant of consumptionism. I will deal with Keynesianism in Chapter 18. Of lesser prominence, but still quite significant, is the widespread fallacy that depressions are caused by too much wealth in the form of inventories. I will deal with this fallacy in an appendix following the end of this chapter.
PART B
SAY’S (JAMES MILL’S) LAW
1. Monetary Demand and Real Demand
While productionism shows that the need and desire for goods, and for the labor to produce them, have no limit, Say’s Law shows that under the freedom of competition the process of production itself creates purchasing power equal to what is produced—that, in the typical formulation of Say’s Law, “supply creates its own demand.”
There are two senses in which the word demand can properly be used in the context of the present discussion. One, is the mere expenditure of money. We may call this “monetary demand.” The other, is “real demand”—that is, the quantity of goods and services that the monetary demand, whatever it is, is capable of actually buying. Real demand is the monetary demand adjusted for the wage and price level. It should be observed that, depending on wages and prices, a smaller monetary demand can represent a larger real demand than does a larger monetary demand. For example, a monetary demand of 100 at one time can buy more than a monetary demand of 200 at another time, if, when the monetary demand is 200, prices are more than double what they are when the monetary demand is 100.
Real demand can be thought of also as the classical economists frequently described demand, namely, as the will combined with the power of purchasing. We have seen that the will to purchase can be taken for granted. All that is required to enlarge demand is the power of purchasing. And all that is required to enlarge the power of purchasing, as we shall see, is an increase in production. In the words of Ricardo, the desire to consume “is implanted in every man’s breast; nothing is required but
the means, and nothing can afford the means but an increase in production.” 39
Increases in production and supply create purchasing power and real demand. They do so by virtue of reducing prices. This enables any given monetary demand to buy correspondingly more—to buy all that is produced and offered for sale. 40
Indeed, increases in production and supply are, as the classical economists held, the only thing that can increase real demand. In the words of James Mill, “The production of commodities creates, and is the one and universal cause which creates a market for the commodities produced.” 41 This proposition becomes obvious as soon as we realize that increases in monetary demand that take place without increases in supply operate only to raise prices. The only way that increases in monetary demand can possibly represent increases in real demand is insofar as they are accompanied by increases in supply. Thus, increases in monetary demand alone are not sufficient to constitute increases in real demand. But increases in supply, unaccompanied by any increase in monetary demand, are fully sufficient to increase real demand.
To confirm these results, let us consider the price level formula developed in the previous chapter, namely, that the general consumer price level P is equal to D C , the monetary demand for consumers’ goods, divided by S C , the supply of consumers’ goods produced and sold. Thus:
P = D C .
S C
Observe. On the basis of this formula, if all that happens is that monetary demand rises, then the numerator in the formula increases while the denominator stays fixed. The effect is a corresponding rise in prices. If, for example, the monetary demand doubles, and that is all that happens, then the price level doubles. At the doubled price level, the doubled monetary demand buys no more than the original monetary demand. It is not the least bit larger as a real demand. The larger monetary demand is fully dissipated in the payment of higher prices and thus represents no increase in real demand whatever.
The only way that a larger monetary demand can represent a larger real demand, is, as stated, insofar as it is accompanied by an increase in supply. If, for example, when the monetary demand for consumers’ goods doubled, the supply of consumers’ goods produced and sold also doubled, then the doubled monetary demand would represent a doubled real demand. For the doubled supply would prevent prices from rising and thus enable the doubled monetary demand actually to purchase twice as much. An increase in supply is an absolutely indispensable condition of a larger monetary demand representing a larger real demand.
Further, the increase in supply, if any, determines to precisely what extent a larger monetary demand represents a larger real demand. If, for example, while the monetary demand doubled, supply increased only in the ratio of three to two, then real demand instead of doubling would increase only in the ratio of three to two. Our price level formula shows that in this case prices would be four-thirds as great (the doubled monetary demand divided by three-halves the supply). At four-thirds the price level, the doubled monetary demand buys only three-halves as much. All increases in monetary demand in excess of the increase in supply are dissipated in higher prices and thus do not represent increases in real demand.
Finally, an increase in supply increases real demand without an increase in monetary demand. The price level formula shows that an increase in supply makes the same monetary demand into a larger real demand—by virtue of reducing prices. For example, a doubling of production and supply in the face of an unchanged monetary demand, causes prices to halve. At the halved price level, the unchanged monetary demand buys twice as much. Thus, the increase in supply is not only necessary to the increase in real demand, it is also sufficient for the increase in real demand.
The principle is that under the freedom of competition, more supply is the necessary and sufficient condition for an increase in real demand. Its presence is what holds down prices in the face of a rising monetary demand, and reduces prices in the face of an unchanged monetary demand. In either case, it is what enables the monetary demand actually to buy more—that is, to become a larger real demand. In other words, more monetary demand without more supply just means higher prices and thus no additional real demand—it is not sufficient to create additional real demand. It takes more supply to make a larger monetary demand into a larger real demand. Thus, more supply is necessary for the creation of more real demand. But more monetary demand is not necessary to create a larger real demand. More supply will do it with the same monetary demand, by way of reducing prices (and, if it’s a larger supply of labor that is in question, wages). Thus, more supply is both necessary and sufficient to the creation of more real demand. Supply, not more money, is what counts for real demand. More money is neither sufficient nor even necessary for more real demand. Again, only more supply creates more real demand.
Figure 13–3 presents not only the productionist aggregate demand curve, which we have already seen in Figure 13–2, but also the relationship between aggregate real demand and aggregate supply. It shows that while the quantity of goods demanded with a fixed quantity of money and volume of spending is potentially unlimited,
PRODUCTIONISM,SAY'SLAW,ANDUNEMPLOYMENT 561 the quantity of goods actually purchased—that is, the andthemonetarydemand—thatis,thevolumeofspend-aggregaterealdemandthatthevolumeofspendingrep- ing—the price level will drop correspondingly and the resents—isdeterminedbysupply.Inthefaceofagiven real demand will be increased correspondingly. In this total expenditure of money to buy goods, under the sense,theformulationofSay’sLawthat“supplycreates freedomof competitionitissupplythatdeterminesthe itsowndemand”isabsolutelycorrect.
price level and thus how much the given expenditure Ofcourse,asIpreviouslypointedout,moreproduc-actually buys. For example, in the face of the same tionandsupplydonothavetooperateinthecontextof quantityofmoneyandvolumeofspending,adoubling afixedquantityofmoneyandvolumeofspending,that ofproductionandsupplyfromSStoS’S’iswhatresults is,inthecontextofaninvariablemoney.Indeed,undera in a halving of prices and thus in a doubling of the commodity money, any substantial increase in produc-quantity of goods thatthe same quantity of money and tion and supplyin the economy as awholewillalmost volume of spending can buy. In the same way, a four, certainlyincludeanincreaseintheproductionandsupply eight,ortenfoldincreaseinproductionandsupplyinthe ofthemonetarycommodity.Itwillthusalmostcertainly faceofagivenquantityofmoneyandvolumeofspend-beaccompaniedbyanincreaseinthevolumeofspending ing is what would result in prices falling to a fourth, intheeconomicsystem,thatis,byanincreaseinmone-eighth, or tenth of their initial level and thus in corre-tarydemandaswellasinrealdemand.Inotherwords, spondingincreasesinthequantityofgoodsthatthesame as supply in Figure 13–3 moves out to the right, it is quantity of money and volume of spending could buy. reasonabletoexpectthatovertimetheaggregatemone-(ThisisshownbythevarioussupplylinesS’’S’’,S’’’S’’’, tary demand curve DD would also shift upward and to and S’’’’S’’’’.)Thus,underthefreedomofcompetition the right. Thus, we might associate with the various and theabilityofpricestofall,thelargeristhesupply, highersupplylinesrespectivelyhighermonetarydemand the larger is the quantity of goods demanded for any curves.However,whilethisalmostcertainlywouldhap-given total expenditure of money. In this way, more pen,itisnotessentialthatithappen.For,aswehaveseen, supply creates more purchasing power, more real de-theincreaseinproductionandsupplyissufficientforthe mand—thatis,moredemandinthesenseofthewilling-increaseinaggregaterealdemand.
nesscombinedwiththeabilitytopurchasegoods.
Thereisnoinherentlimittoaggregaterealdemand.It
2. TheReferentsofSay’sLawandItsConfirma-dependsonlyonthewillingnessandabilityofpeopleto produce. If they are willing and able to produce more, tionbyCasesApparentlyContradictingIt and freeto compete,then,giventhequantity ofmoney ThemajormisunderstandingsofSay’sLawarisebe—
Figure13-3
ProductionismandSay’sLaw:
DeterminationofAggregateRealDemandbySupply
Price
Level D AggregateSupplyCurves
1.000
S S´ S´´ S´´´ S´´´´
.500
Productionist
Aggregate
DemandCurve
.250 S´´´ S´´´´
.125
.100 S S´ S´´ D
Output
0 1.0 2.0 4.0 8.0 10.0
cause of a failure to keep in mind that it refers both to real demand and to aggregate demand—that is, to real demand in the economy as a whole, not to the expenditure of money to buy goods and certainly not to the expenditure of money to buy the goods of any particular industry. When these referents are forgotten, it is easy to think that Say’s Law is contradicted by everyday experience. Because then one interprets Say’s Law as claiming that any time anyone has an additional supply of something, he will automatically be confronted with an additional expenditure of money by his customers to buy it. One then holds this interpretation up to the light of experience and finds repeated examples in which the ruin of producers can clearly be traced to an increase in the supply of the goods they bring to the market. And one concludes on this basis that Say’s Law is not only false but absurd.
In order to overcome such misunderstandings, let us consider a typical case that on the surface flatly appears to contradict Say’s Law, at least when it is misinterpreted in this way. I will show how such cases not only do not contradict Say’s Law, but actually confirm it.
Thus, let us consider a kind of good with which people in every industrial country are already very well supplied and want little or no more of. Potatoes are a good example. Let us imagine that because of improved methods of production, the average potato grower is able to double his output, and thus that twice the supply of potatoes is brought to the market.
Just for the moment, let us put aside the use of money, and, adopting a procedure often used by the classical economists, imagine that our potato growers live in a barter economy. Thus, when they bring their potatoes to the market, they do not exchange them for money, but directly for the various other goods they require.
Even in a barter economy, our potato growers will fare very badly. A doubling of the supply of potatoes will lead to a very sharp drop in the amounts of other goods that a bushel of potatoes can be exchanged for. If a bushel of potatoes exchanges for any amount of goods less than half of what it used to exchange for, the potato growers as a group will actually be worse off than they were before they increased their production. Because in such a case the total quantity of goods they receive in exchange for their doubled supply of potatoes will be less than it was before. In other words, the doubled supply of potatoes will result in a reduction in the real demand for potatoes in such a case.
For ease of arithmetic, let us assume that the doubled supply of potatoes results in a fall of the price of potatoes expressed in terms of other goods—that is, the barter ratios of other goods to potatoes—to one-third of what it was initially. Of course, nothing essential would be changed if we assumed a price of a fourth or a fifth, or any other price less than one-half of the initial price. The essential thing is that we have a case in which an increase in supply makes the producers of the commodity concerned collectively worse off than they were before the increase in their supply. At one-third the price per bushel, a doubled supply of potatoes brings in only two-thirds as much in terms of other goods as did the smaller, initial supply. 42
Thus, here we have a case which as much as any provides a seeming refutation of Say’s Law. As part of it, we can imagine the complaints of the potato growers to the effect that here is their larger supply but where is the larger demand that Say’s Law claims the larger supply must bring?
Well, let us find the larger demand, because it really does exist. Only it is not a larger demand for potatoes. We can find it by starting with the reduction in demand for potatoes. The producers of goods other than potatoes—goods such as shoes, shirts, houses, hardware, and whatever—turn over to the potato growers only two-thirds the shoes, shirts, etc., that they used to turn over to them. (That is, they pay one-third the price of potatoes times twice the quantity of potatoes.)
But now, we must ask, what do the producers of goods other than potatoes do with the portion of their goods that they no longer exchange for potatoes? The answer is, they exchange them among themselves. The producers of shoes are able to devote one-third of the shoes they previously exchanged for potatoes, to the purchase of shirts, houses, hardware, and so on. Likewise, the producers of shirts are able to devote one-third of the shirts they previously exchanged for potatoes, to the purchase of shoes, houses, hardware, and so on. And it is the same for all other producers of goods other than potatoes.
In other words, while the “othergoods” demand for potatoes does fall (that is, the demand for potatoes in terms of goods other than potatoes), the “othergoods” demand for other goods equivalently rises. There is less demand for potatoes in terms of other goods but equivalently more demand for other goods in terms of other goods. When both changes in demand are added together, we see that there is no reduction in aggregate demand in the economic system, despite the reduction in the demand for potatoes.
Say’s Law, of course, promises an increase in aggregate demand, not an unchanged aggregate demand. Where is the increase?
The increase in aggregate demand is constituted precisely by the increase in the supply of potatoes. In a barter economy, potatoes are, in effect, the currency used by potato growers to purchase other goods. A doubling of the supply of potatoes brought to market constitutes a doubling of the demand for other goods in terms of
Table 13–1
How an Increase in Aggregate Supply Creates a
Precisely Equal Increase in Aggregate Real Demand
1. The “othergoods” demand for potatoes is down by one-third.
2. The “othergoods” demand for other goods is up by an equivalent amount, as the customers of the potato growers use their savings from the purchase of potatoes in exchange with one another.
3. The potato demand for other goods is increased by potatoes brought to the market.
potatoes. And the producers of goods other than potatoes experience this doubled potato demand in the form of doubled potato receipts.
Thus, if we add together all the changes in demand accompanying an increase in supply, we find that there is indeed an increase in demand precisely equal to the increase in supply—even though it may very well be the case that there is a decrease in the demand for the particular good whose supply has increased. There is an increase in aggregate, economy-wide demand precisely equal to the increase in supply. These facts are shown in Table 13–1, which summarizes our example of the potato growers.
It is obvious from the table that aggregate demand increases precisely to the same extent as the increase in the supply of potatoes. For the first two items—the fall in the othergoods demand for potatoes and the equivalent rise in the othergoods demand for other goods— precisely offset one another. This leaves item three, the increase in the potato demand for other goods, as representing a net increase in aggregate demand to the same extent. Of course, the increase in the potato demand for other goods is nothing but the increase in the supply of potatoes that is brought to market. Thus, the increase in aggregate real demand in this case is precisely equal to the increase in the supply of potatoes.
Obviously the same conclusion applies to any other case that might be imagined. In a barter economy, when the supply of a given good increases, it does not matter if, as a result, the quantity of other goods offered in exchange for it decreases. Real demand in the economy as a whole still increases precisely to the same extent as the increase in the supply of this good. For the decline in the othergoods demand for it is offset by an equivalent rise in the othergoods demand for other goods, while the increase in its supply that is brought to market constitutes a further increase in the demand for other goods. Thus, when all three elements of the change in aggregate demand are added up, the result is necessarily equal to an amount precisely equal to the increase in supply of the increase in the supply of the given good that is brought to market. 43
It should be clear, moreover, that even though the producers of a particular good may suffer as the result of the supply of their good being increased, the total gains in wealth in the economic system outweigh the losses precisely to the extent of the greater production of wealth. For example, while the potato growers are worse off, the producers of goods other than potatoes are better off in doubled measure. They receive not only the goods no longer received by the potato growers, but the additional supply of potatoes as well. The increase in the supply of potatoes represents the amount by which their gain exceeds the potato growers’ loss.
If we return now to the conditions of a monetary economy, we will soon see how the potato growers are able to deal with their situation and to share in the benefits of the higher productivity of labor in potato growing.
We can assume that in a monetary economy, the doubled supply of potatoes results in the money price of potatoes falling to one-third of its initial level. The effect of this, of course, is that the average potato grower takes in only two-thirds as much money as before. Just as in the case of barter, he is clearly worse off than he was before the increase in potato production.
But now we must ask what people do with the money they no longer spend for potatoes. The answer, of course, is that they spend it for other things—shoes, shirts, etc. The producers of these other goods thus enjoy larger money revenues and incomes than before.
There is no increase in aggregate monetary demand in this case; just a decrease in the monetary demand for potatoes matched by an equivalent increase in the monetary demand for goods other than potatoes. But there is nevertheless an increase in aggregate real demand. And, again, it is precisely equal to the increase in the supply of potatoes.
For the same aggregate monetary demand now buys
all that it used to buy, plus the additional supply of potatoes. It is a larger aggregate real demand to precisely the same extent that the larger supply of potatoes represents a greater aggregate supply. If, for example, (allowing for the relatively small size of the potato industry in the economic system as a whole) the doubled supply of potatoes represents a 1 percent increase in aggregate supply, then the increase in aggregate real demand is also 1 percent, because the monetary demand buys 1 percent more goods in all than it did before.
Thus, Say’s Law does not claim in any sense that an increase in the supply of a good means that its producers can be assured of a greater demand for that good and thus of greater immediate prosperity for themselves. It claims that an increase in supply is the source—the only source— of an increase in aggregate, real demand, that is (it cannot be repeated too often or stressed too strongly), of real demand in the economic system as a whole.
3. Partial, Relative Overproduction
It is necessary to show how the potato growers, too, ultimately come out ahead as the result of the increase in the ability to produce. In the course of this discussion, I will also show why the only kind of overproduction that can exist is a partial, relative overproduction—that is, overproduction in some industries counterbalanced by precisely equivalent underproduction in other industries— never a general, absolute overproduction in which the economic system as a whole overproduces.
Before economic theory can be brought to the rescue of the potato growers, it may be necessary to point out once more that this sort of case has been chosen deliberately, in order to present the opposition to Say’s Law in the strongest possible light. For it is certainly not true as a general proposition, and I had no intention of implying that it is, that in every instance in which an industry succeeds in increasing its production, its producers suffer. In many cases, the producers in such an industry gain from the very outset, and gain more at first than they do later on from the improved ability to produce. If, for example, we had been dealing with a kind of good whose price would fall less than in proportion to the increase in its supply, then its producers would have been immediately better off as the result of increasing their production. But in that case, producers in other industries would have been placed in a temporarily worsened position. For example, early in this century, when the automobile was still a luxury good that only very few could afford, every improvement in the productivity of labor in producing automobiles so expanded the market for automobiles that the sales revenues and income of the automobile industry steadily grew as it increased its production and reduced its prices. But in this case, there were short-run losses suffered by blacksmiths and horsebreeders and the like.
I would also like to point out that the fact that an industry as a whole may lose when its output is increased does not necessarily mean that everyone in that industry loses. For example, even in our case of the potato growers, if the doubling of production were the result, say, of one-fifth of the potato growers finding a way to increase their production by a factor of six, while the other four-fifths of the potato growers went on producing an unchanged amount of potatoes, this innovative one-fifth of the industry would earn doubled revenues at the one-third price, while the industry as a whole earned diminished revenues. Of course, in this event, the reduction in revenues would be all the more severe for the four-fifths of the industry that did not improve its ability to produce. 44
But let us focus on the case as initially laid out, in which all the potato growers become twice as efficient and all lose as the result of it. This is the case that most strongly seems to contradict Say’s Law.
Let us begin with the respective situations of the potato growers and producers in the rest of the economic system following the doubling of the supply of potatoes. The revenues and incomes of the potato growers are badly depressed—they are only two-thirds of what they originally were. At the same time, however, the revenues and incomes of producers in the rest of the economy are somewhat elevated, thanks to the spending of funds no longer spent in buying potatoes. (Since the funds no longer spent to buy potatoes are now spread over the whole rest of the economic system, which, of course, is vastly larger than the potato industry, the percentage increase in revenue and income outside the potato industry is far less than the percentage decrease in revenue and income in the potato industry.)
The effect of the resulting sharp disparity in income between potato growers and people elsewhere in the economic system will be that some of the potato growers, observing the higher incomes to be made elsewhere, will give up potato growing and move into other lines. As they do so, the supply of potatoes is reduced—it falls to something less than double. It is still larger than it was initially, but it is less than twice as large as it was initially. At the same time, of course, the supply of goods other than potatoes is increased as former potato growers now add their efforts to the production of other goods.
The consequence of these developments is that the price of potatoes rises above one-third of its initial price, while the prices of other goods fall somewhat. As a further consequence, the incomes of the remaining potato growers begin to recover, while the incomes of
producers in the rest of the economic system begin to recede from their elevated levels.
Because the average remaining potato grower is able to grow two bushels with the same ease that he was originally able to grow only one, he will be just as well off in his capacity as an income earner as he originally was, when the price of potatoes rises to one-half of its initial height. Producing and selling twice the bushels at half the price will give him the same revenue and income that he had initially, when he had only his original number of bushels to sell.
Let us assume that the rise in the price of potatoes from one-third of its initial level to one-half of its initial level is accomplished when potato production is cut back from double its original amount to three-halves of its initial amount. (Obviously, we could assume any figure for potato production that was less than double and more than the initial amount. There is some intermediate amount of potato production that gets the price up to one-half and thus restores the incomes of the remaining potato growers. Three-halves is simply a convenient number to work with as representing this amount.)
Given the assumption that each potato grower produces double, a drop in potato production from double to three-halves is achieved when one-fourth of the initial number of potato growers leave the industry. The three-fourths of the initial number who remain, each producing double, then account for the three-halves level of potato output.
When this situation is achieved, the remaining potato growers derive the same benefit from the increase in the
productivity of labor in potato growing as producers in the rest of the economic system. And so do the former potato growers, for, by this time, they should have been able to acquire levels of experience and skill in other lines of work sufficient to enable them to earn incomes equal to those they initially earned in potato growing.
In this situation, the average member of each group— the remaining potato growers, the former potato growers, and the group composed of everyone else in the economic system, who has no present or past employment in potato growing—earns the same amount of money revenue and income as he originally earned, and, at the same time, benefits from the lower price of potatoes. Everyone gains from the fact that he now receives three-halves the potatoes for three-fourths the expenditure of money, and thus has one-fourth the money he previously expended on potatoes left over to purchase additional quantities of other goods—goods whose physical production, it must be stressed, is now possible because of the availability of one-fourth of the initial number of potato growers to produce them.
These results are presented in Table 13–2, which is titled “Say’s Law and the Process of Economic Adjustment.” The table assumes that total revenue and income in the economic system as a whole are constant at 500 monetary units, and that initially the potato growers collectively earn a revenue and income of 5 monetary units. (Each such monetary unit could be taken as representing a billion dollars some years back, or ten billion dollars today. It makes no difference which, just so long as the size is held fixed at some definite amount and is
Table 13–2
Say’s Law and the Process of Economic Adjustment
Revenue and Income of Revenue and Income of Revenue and Income of
Potato Growers +
I. Initial Equilibrium 5 + (Price = 1)
II. Doubling of Potatoes 3.33 + (Price = 1/3)
III. New Equilibrium
3.75 + (Quantity = 3/2; Price = 1/2)
Rest of Economy = Economy as a Whole 495 = 500 496.67 = 500 496.25 = 500
large enough so that the example can be understood as referring to the economic system as a whole. Of course, for the sake of simplicity, the example greatly overstates the relative size of the potato industry, which is certainly much less than 1 percent of the economic system.)
Condition I in the table exists before the increase in the supply of potatoes. Condition II exists immediately following the increase in the supply of potatoes. In Condition II, the initial number of growers are each producing on average double the supply, and the price of potatoes is 1 ⁄ 3 . Double the supply times 1 ⁄ 3 the price accounts for the decline in total revenue and income in potato growing to 3.33 from 5—a drop of 1 ⁄ 3 . Revenue and income in the rest of the economic system are up equivalently, from 495 to 496.67. Revenue and income in the economy as a whole remain unchanged.
Condition III comes about after enough potato growers have left the industry to bring the price of potatoes up from 1 ⁄ 3 of its initial level to 1 ⁄ 2 of its initial level. At this point, because the average potato grower is producing double with the same effort that he previously produced his initial quantity, he earns the same revenue and income and is monetarily just as well-off as before the increase in the supply of potatoes.
Condition III further implies that we end up with 3 ⁄ 4 the initial number of potato growers remaining in the industry, inasmuch as 3 ⁄ 4 the growers times twice the output per grower equals 3 ⁄ 2 the output, which is the amount assumed to be required to bring the price of potatoes up from 1 ⁄ 3 to 1 ⁄ 2 of its initial level and so restore the income of the average remaining grower. Three-fourths the initial number of growers, each on average earning the same money revenue and income as he did initially, is what explains why the total revenue and income of the potato industry is now 3.75, that is, is 3 ⁄ 4 of 5.
The 1 ⁄ 4 of the initial growers who leave the industry increase the supply of goods other than potatoes. A further consequence of their change in occupation is that while revenue and income in the potato industry are partially restored in rising to 3.75 from 3.33, the increase in revenue and income in the rest of the economic system is equivalently diminished. Revenue and income in the rest of the economic system come to rest at 496.25, down from the 496.67 of Condition II.
As we have seen, the net upshot of all of this is that the average potato grower, former potato grower, and nonpotato grower from the beginning, now receives 3 ⁄ 2 the potatoes at 1 ⁄ 2 the price, for 3 ⁄ 4 the expenditure of money. And the average person in all groups now has 1 ⁄ 4 the funds he previously expended for potatoes, to purchase other things, which other things can physically be produced with the 1 ⁄ 4 of the labor released from potato growing.
Now let us take this final state of affairs, in which potato production has been cut back to three-halves of its initial level, and the production of other goods correspondingly expanded, and use it as the standard for appraising the earlier situation, in which potato production had been doubled while the production of all other goods remained the same. In other words, we use Condition III as the standard for describing Condition II. From the perspective of this standard, it is clear that a doubling of the production of potatoes constituted an overproduction of potatoes. By the same standard, however, it is equally clear that going on with an unchanged production of other goods represented an underproduction of goods other than potatoes.
An appropriate description of things would be to say that more production in the economic system is always desirable and thus that a doubling of the productivity of labor in potato growing is desirable. However, it is a poor use of such an improvement in productivity if it takes the form merely of doubling the production of potatoes, in view of the fact that labor can be withdrawn from potato growing to increase the production of other things. Such a large increase in the supply of potatoes is much less needed than increases in the supply of other things. If the initial effect of the improvement in productivity is a doubling of the supply of potatoes, a mistake is being made. Losses and lower wages for potato growers, and higher profits and wages for producers of other things, will rectify this mistake and ensure that the effect of the higher productivity of labor in potato growing is an adequate increase in the production of other goods. Until this mistake is rectified, there is an overproduction of potatoes and a corresponding underproduction of other goods.
Thus, a doubling of the supply of potatoes represented a partial overproduction: it was an overproduction in one part of the economic system, while some or all parts of the rest of the economic system were correspondingly underproducing. The doubling of potatoes represented a relative overproduction, in that it made potato production too large in relation to production in the rest of the economic system.
In the case of a good like potatoes, it is possible that there is an absolute limit to the need, just as there appears definitely to be an absolute limit to the need for table salt. However, even if the production of potatoes, or any other good, surpassed its particular absolute limit of need, its overproduction would still be relative in the sense that the particular industry had expanded at the expense of the more necessary expansion of other industries. Its problems would be solved by the movement of capital and labor to other industries, to bring about their expansion. (In this connection, it should always be kept in mind that there is a need for improvements in the productivity
of labor even in the production of goods with which we may actually be sated, such as table salt, because then those particular goods can be produced with less labor and the labor released can be used to expand production elsewhere.)
In the overwhelming majority of cases, and possibly even in the case of potatoes as well, however, production never comes close to absolutely sating the need for the good. In all cases of this kind, the expression “relative overproduction” takes on a further meaning. For the relative overproduction of such a good could be eliminated without any reduction whatever in the absolute amount of its production. It could be eliminated if the production of other goods could be sufficiently increased.
For example, when such things as automobiles or houses are said to be overproduced, the problem is never that the need of the buyers for that kind of product is sated. The problem is that even though the buyers would still like more of this kind of good, they would like more of other goods first. If they could have sufficiently larger quantities of other goods as well, then they would like larger quantities of this good, too.
For example, almost everybody would like, if not a second automobile, then at least the equivalent of a second automobile in the form of a higher quality automobile, and, indeed, the higher-quality equivalent of a third, fourth, and fifth automobile—and, indeed, probably several such automobiles. People would gladly buy more and better automobiles if their purchasing power increased sufficiently. With doubled real incomes they would probably easily absorb a doubled production of automobiles.
Our discussion of Say’s Law implies that the only thing that can give people doubled real incomes is a doubling of production. If production doubles while money incomes remain the same, prices fall in half, and the same money incomes are able to buy double. If people’s money incomes double, the only thing that can keep prices the same and thus enable their doubled money incomes to buy double is a doubling of production. Thus, a general doubling of the ability to produce would create doubled real incomes and thus, in all probability, a demand for a doubling of automobile production.
But, now, suppose that the only improvement in production is a doubled ability to produce automobiles. A doubled ability to produce automobiles does not represent a doubling of real income, but an increase in real income of perhaps only 10 or 15 percent, depending on the portion of their incomes that people presently spend on automobiles. If, for example, people are presently spending 10 percent of their incomes on automobiles, and now a way is found to double automobile production, this would constitute only a 10 percent increase in their real incomes. For the increase that is constituted by a doubling of something that represents 10 percent of people’s real incomes can itself represent no more than a 10 percent increase in their real incomes.
In this context, the automobile industry would fare very badly if it in fact doubled its production. Even though people would like a doubled production of automobiles, they can hardly be expected to devote 100 percent of their additional real incomes to the purchase of automobiles. Yet that is what would be required in this case for the auto industry alone to expand production and for the whole of the increase in production to be desired in the form of additional automobiles.
With the 10 percent higher real incomes generated by the improvement in automobile production people would probably want some increase in automobile production, more or less on the order of 10 percent, but they would almost certainly want to devote the great bulk of their additional purchasing power to the purchase of goods other than automobiles. They would want more and better housing, more and better clothing, to eat out more often, to take more and better vacations, and so on. Before they can reasonably double their consumption of automobiles, they must be able to increase their consumption of all kinds of other goods commensurately. To obtain the purchasing power necessary to do that, there must be improvements in production not only in the automobile industry, but in many other branches of industry as well.
Then, in the same way that people want to spend most of the money they save in the price of an automobile on goods other than automobiles, they will also want to spend some of the money they save in the purchase of housing, food, clothing, entertainment, etc., on automobiles. In this way, the auto industry can find an additional demand equal to a doubled supply of automobiles. For just as its improved ability to produce creates a demand for the products of other industries, so their improved ability to produce creates an additional demand for its product.
If improvements occur on a wide-ranging enough basis, then people will want substantially more of practically everything, or at least improved versions of practically everything. The appearance of a problem of overproduction arises only when and insofar as an increase in the ability to produce is overly concentrated in a particular industry or industries. In that case, an industry’s problem is that its improvement creates a limited amount of additional real income most of which people want to devote to other uses, besides the purchase of its additional output. What this industry needs is more improvements in production elsewhere, so that the growth in real income will be great enough to make
possible the purchase of its additional output. If that does not happen, then what is necessary is the transfer of capital and labor out of this industry and into other industries so that a properly balanced, properly proportioned increase in production can take place throughout the economic system.
People’s behavior here is guided by the law of diminishing marginal utility. They want to use their additional real income in a way that keeps marginal utility in balance in all the various lines of consumption. 45 Insofar as labor and capital can be directly or indirectly transferred from a given industry to other industries, with the result that an improvement in the productivity of labor in that industry can be made to show up as an increase in the output of other industries, failing to readjust the pattern of production to conform to the pattern of relative marginal utilities would constitute a disproportionate and wasteful use of the additional productive ability. It would represent concentrating what in fact is an improvement in the ability to produce in general within the narrow confines of the particular industry in which the improvement originates. So long as such a condition exists, there is a state of partial, relative overproduction, counterbalanced by a state of partial, relative underproduction elsewhere.
As a final, extreme confirmation of the fact that there cannot be a general, absolute overproduction, but only partial, relative overproduction, let us imagine a sudden universal doubling of the ability to produce. Everywhere, in each and every industry, the same labor is suddenly enabled to produce double. If each and every industry in these circumstances in fact began to produce double, it would be found that many industries were overproducing, but that to precisely the same extent many other industries were underproducing. If we had a doubled ability to produce and thus a doubled level of real income, we would not want double of each and every good. In the case of some goods, we would want only the same quantities, or only moderately larger quantities—certainly, much less than double the quantity. In the case of some things, we might actually want smaller quantities, as we gave up the consumption of inexpensive cheap, goods in favor of more expensive, higher-quality goods. But precisely as this last statement suggests, in the case of more expensive, higher-quality goods and in the case of virtually all goods previously considered to be luxuries, we would want more than double the quantity.
Thus, while we would want probably just the same quantity of table salt and matches, and possibly smaller quantities of things like chopped meat and cheap cars, we would want correspondingly more than double of such things as sirloin steak and restaurant meals, higher-quality automobiles, better homes, swimming pools, tennis courts, yachts, and so on. If the doubled ability to produce initially took the form of a doubling of everything, then the first kinds of goods would be overproduced, but the rest would be correspondingly underproduced. And what we would want is a shift of labor and capital from the overproducing industries to the industries that were underproducing. Once that occurred, we would obtain the full benefit of our doubled ability to produce, for then it would be properly proportioned to our wants. Until then, much of the improvement in the ability to produce would be wasted in producing too many more of some goods while the production of other goods was not increased sufficiently. The only overproduction would be an overproduction on the part of some industries, that was fully matched by an equivalent underproduction on the part of other industries. The overall doubling of production as such would certainly not constitute an overproduction.
Say’s Law and Competition
Our discussion of Say’s Law—in particular, the example of the potato growers—confirms an important point established in Chapter 9 in connection with economic competition, where it was argued that there are no genuine longrun losers under the freedom of competition. The example of the potato growers confirms this point, in that it shows how the potato growers end up benefitting even from an improvement in production whose initial effect is to depress their standard of living and take away their jobs. For once the necessary number of potato growers leave the industry and relocate elsewhere, the effect on them is that, along with everyone else, they simply get their potatoes cheaper and have the income left over to buy more of other goods, which physically can be produced because the labor required for their production is no longer tied up in potato growing.
I would like to make a modification in the potato growers example in order to make it illustrate the way in which I think competition normally operates within an industry. In my original example, of course, I assumed simply that every potato grower doubled his production and that, as a consequence, all suffered. This represented a case of competition in which all the competitors are perfectly equal and, in the circumstances of an inelastic demand for the product—that is, a situation in which the price falls more than in proportion to the increase in supply—all temporarily suffer as the result of expanding their production. It is important to realize that in most cases, the competitors are not all equal. At first, only a small number are able to increase their production. Only gradually does the increased ability to produce spread throughout the entire industry. The effect of this is to
enable those who introduce the improvement to gain from doing so, and to force a gradual withdrawal from the industry of those who do not introduce the improvement.
For example, let us imagine that initially only 10 percent of the potato growers are able to double their production. This represents an increase in the total supply of potatoes of only 10 percent. Given the nature of the demand for potatoes, the price will fall more than in proportion to the 10 percent increase in supply. Let us assume that it falls by 20 percent. In that case, the 10 percent of the growers who have doubled their output will greatly prosper. They will sell a doubled quantity at 80 percent of the initial price, and will thus earn 1.6 times their initial revenue and income. The entire burden of the fall in revenue and income that is experienced by the industry as a whole in selling 1.1 times the quantity at 80 percent of the initial price is experienced by the part of the industry that has not increased its production. That part of the industry simply sells its initial quantity at 80 percent of the initial price.
A withdrawal of capital and labor from potato growing will now take place on the part of producers who have not improved their productivity. And as more and more of the remaining growers adopt the more productive method, more and more of those who have not adopted it will withdraw from the industry. It is entirely possible that in this way, almost every producer who adopts the improved method will experience an increase in his individual revenue and income compared to what it was initially, while the industry as a whole continues to suffer a drop in revenue and income, with the entire drop being experienced by the producers who do not adopt the improvement. It is entirely possible that this could go on until the seventy-fifth percentile of growers doubles its output, just as the last of those who have not doubled their output leave the industry. In that case, even the last of those who adopt the improvement will experience a great gain as compared with not adopting it, and will never be worse off in their ability to earn revenue and income with the improvement than they were without it.
I think that this is the usual way in which competition operates. It rewards those who adopt improvements and puts the entire burden of an inelastic demand on those who do not adopt the improvements. The progressive adoption of the improvement finally eliminates the financial gains to be had by adopting it, except in comparison with not adopting it. Meanwhile the relocation of producers who did not adopt it into other lines enables them to restore their incomes. And, as previously explained, everyone ends up benefitting in his capacity as a consumer from the lower price of the product and the ability to obtain more goods for his money.
4. Say’s Law and the Average Rate of Profit
Our discussion of Say’s Law and the impossibility of a general overproduction can be reinforced by introducing alongside the pricelevel formula presented earlier, a second simple arithmetical formula—this time for the determination of the average level of money wage rates. Putting this new formula alongside our previous formula for the general consumer price level will enable us to see how increases in production can depress the profits of particular industries, but never the rate of profit in the economic system as a whole. The conjunction of these two formulas will also enable us later on to understand many other important economic phenomena, such as the cause and cure of mass unemployment and the determination of real wages. 46
The formula for wages is simply this: the average money wage rate earned by those who are employed is equal to the aggregate demand for labor divided by the aggregate supply of labor. The aggregate demand for labor is to be understood as manifested in a definite total expenditure of money to employ labor in the economic system, that is, in total payrolls of a definite size, such as $1 trillion per year. The aggregate supply of labor is to be understood as manifested in a definite total quantity of labor sold, that is, in a definite number of units of labor employed, such as 100 million workers. Thus, for example, with an aggregate demand for labor of $1 trillion per year and an aggregate supply of labor of 100 million workers, the average annual wage rate per worker that results is $10,000. (Typically the period of time in view is a year, and the number of units of labor employed is in terms of number of employees. Thus, the average money wage rate earned is typically described in terms of annual earnings per worker. However, different periods of time than a year could be selected, and the number of units of labor supplied could also be stated in terms of the number of hours or days of labor rather than the number of employees.) Algebraically, the formula is
W = D L
S L where W is the average money wage rate per unit of labor employed, D L is the aggregate demand for labor, as manifested in a definite total expenditure of money to employ labor in the economic system, that is, in total payrolls of a given size, and S L is the aggregate supply of labor, as manifested in a definite total quantity of labor employed.
Now, under a simplified view of things, total wages paid in the economic system can be taken as total costs of production, while the total spending to buy consumers’ goods can be taken as total sales revenues. The simplified
view of things rests on the assumption that all business firms are vertically integrated over the entire length of the production process—for example, that General Motors owns its own steel mills, iron mines, facilities for producing iron mining equipment, and so on, and that all other companies are in a similar position. On this assumption, the only cost of production that firms would have is wages, for that is the only outlay firms would make to outside parties, since they themselves would supply all of the materials and equipment at all stages of the process leading to the production of their ultimate products. By the same token, the only source of sales revenues that firms would have would be the consumers of the ultimate, final products. As we shall see, making the assumption of the complete vertical integration of business yields results for the theory of profit that are universally applicable, because the omission of spending for capital goods results in an equal understatement of sales revenues and productive expenditure, thereby leaving the difference between them unchanged. 47 (Of course, a full analysis must include the demand for capital goods in order to be able to relate the rate of profit to all the major phenomena in the economic system that depend on that demand. 48 )
As should be apparent, in the circumstances of full vertical integration of business enterprises, total profits in the economic system would equal the aggregate demand for consumers’ goods minus the aggregate demand for labor—that is, the spending to buy consumers’ goods, which would constitute the sales revenues of business firms, minus the total wages business firms paid, which would constitute their total costs of production. For example, if we imagine the aggregate demand for consumers’ goods to be 500 units of money, while the aggregate demand for labor is 400 units of money, then total profits in the economic system would be 100 units of money.
The following formula shows this simple relationship: Aggregate Profits in the Economic System = D C − D L .
Now the use of this formula enables us to understand more fully why any overproduction must be a partial, relative overproduction, accompanied by an equivalent partial, relative underproduction elsewhere. For the first thing that should be clear is that the monetary profitability of the economic system as a whole is absolutely independent of its level of physical production! So long as the demand for consumers’ goods in the economic system is 500 and the demand for labor is 400, profits in the economic system are 100. If twice as much or ten times as much, or any multiple whatever, is produced and sold at one time than at another time, aggregate profits under these conditions are still 100, and the relationship of profits to sales, costs, and, by implication, capital, is still the same. 49
Under these conditions, more production reduces the general consumer price level, but to precisely the same extent it causes a reduction in the level of unit costs. In effect, the larger output is divided into a given amount of consumer spending to produce lower prices, and into a given amount of total wage payments to produce lower unit costs. Total profit in the economic system is still the same because it is the difference merely between the two numerators—the demand for consumers’ goods and the demand for labor—which are unchanged.
What we want to do now is to see how increases in production, while absolutely neutral with regard to profitability in the economic system as a whole, can have very major effects on the profitability of individual industries, accompanied by corresponding opposite effects on profitability in the rest of the economic system. 50
Thus, let us now break up the economy-wide, aggregate demands for consumers’ goods and labor into two portions: that of any particular industry or group of industries, and that of all the rest of the economic system taken together. As before, let us suppose, for example, that there is an individual industry that initially represents 1 percent of the economic system. If we assume that the economy-wide aggregate demands for consumers’ goods and labor are 500 and 400 respectively, then this particular industry can be assumed to spend a total of 4 units of money in paying wages and to take in 5 units of money in sales revenues from consumers. The rest of the economic system combined, of course, then spends 396 units of money in paying wages and takes in 495 units of money in sales revenues from consumers. All this is described in Table 13–3, in the form of a matrix, in the portion headed “Initial State of Affairs.”
It is certainly possible for this one industry to suffer lower profits, or even outright losses, as the result of an expansion of its production. For confirmation of this fact, we need look no further than to the example of the potato growers, the essential features of which are reproduced in the table in the form of a second matrix, which is labeled “Case 1.” The only difference between Case 1 and the potato growers example is the introduction of the assumption that the industry spends 4 units of money in paying wages. The fall in its sales revenues from 5 to 3.33 when it doubles its production is thus responsible for a fall in the industry’s profits from 1 to (.67), that is, for a loss of .67. However, it should certainly come as no surprise that profits in the rest of the economic system are increased to precisely the same extent, as sales revenues there rise from 495 to 496.67 while wage payments remain at 396. (Apart from the introduction of wage payments, the situation is identical with that of Table 13–2, under roman numeral II.) Thus, there is no fall in
the economy-wide, aggregate amount of profit, nor there-the economic system cutting back its expenditure for fore any reason for supposing a fall in the economy-wide labor from 396 units of money to 392 units of money. average rate of profit. The result is that the particular industry doubles its
Case 2 in the table depicts an increase in the given production, while the rest of the economic system corre-industry’s production that is brought about not by a rise spondingly reduces its production. Of course, unfortu-in its productivity but by the investment of additional nately for the industry’s investors, the consumers will capital that is withdrawn from other industries. Thus, as buy the doubled output of this industry only for an the result of the shifting of capital funds, the given expenditure of money that is less than doubled, that is, industry is assumed to increase its expenditure on labor less than 10. This is implied by the fact that its selling from 4 units of money to 8 units of money. In the nature price must fall, at least to some extent, in order to find of the case, however, this is at the expense of the rest of buyers for the doubled quantity of its output. Thus, this
Table 13–3
Production and Profitability in the Individual Industry
and in the Economy as a Whole
Initial State of Affairs
A Given Industry + The Rest of the Economy = The Economy as a Whole Sales
5 + 495 = 500 Costs (Wages)
4 + 396 = 400 Profit
1 + 99 = 100 CASE 1: State of Affairs Following the Expansion of the Given Industry by Means of an Increase in Its Productivity (A Potato-Industry-Type Case)
A Given Industry + The Rest of the Economy = The Economy as a Whole Sales
3.33 + 496.67 = 500 Costs (Wages)
4.00 + 396.00 = 400 Profit
(.67) + 100.67 = 100
CASE 2: State of Affairs Following the Expansion of the Given Industry at the Expense of the Rest of the Economic System
A Given Industry + The Rest of the Economy = The Economy as a Whole Sales
7 + 493 = 500 Costs (Wages)
08 + 392 = 400 Profit
(1) + 101 = 100
CASE 3: State of Affairs Following the Expansion of the Given Industry by Means of an Increase in Its Productivity (A Luxury-Industry-Type Case)
A Given Industry + The Rest of the Economy = The Economy as a Whole Sales
6.67 + 493.33 = 500 Costs (Wages)
4.00 + 396.00 = 400 Profit
2.67 + 97.33 = 100
industry has doubled its total costs, but less than doubled its total revenue and total profits. Its profits, therefore, fall as a percentage of its costs and sales, and of its capital as well, which we may regard as having also doubled. Thus, for this particular industry, profitability declines as it expands its production.
Once again, however, to precisely the same extent, profitability in the rest of the economic system must rise! If, for example, this particular industry now takes in only 7 in revenue, say, which is the specific assumption made in Table 13–3, while it incurs total costs of 8, then the rest of the economic system takes in total sales revenues of 493, while incurring total costs of 392. Thus, the rest of the economic system earns 101 in profits, while this industry suffers a loss of 1. What the table shows is that to the same extent that sales revenues fail to keep pace with total costs in the given industry, they expand relative to total costs in the rest of the economic system. This is mathematically inescapable, so long as total sales revenues and total costs in the economic system as a whole remain constant. Thus, while profits in the given industry fall by 2, from +1 to -1, they rise by 2 in the rest of the economic system, namely, from 99 to 101.
Table 13–3 presents one other case, Case 3, which assumes that a given industry increases its productivity in the face of an elastic demand for its product, rather than an inelastic demand. It is described as “A Luxury-Industry-Type Case,” in contrast to Case 1, which is described as “A Potato-Industry-Type Case.” Just as in Case 1, the industry is assumed to find a way to double its output by virtue of increasing its productivity. In Case 3, however, instead of the doubled output causing the price to fall by two thirds, it is assumed that the doubled output causes the price to fall by only one third. Thus the industry’s expenditure of 4 for labor is now accompanied by sales revenues 6.67. This represents an increase in its profits from 1 to 2.67. But just as the fall in the profit of the given industry in the previous cases did not represent a fall in the economy-wide amount of profit, so now the rise in the profit of the given industry does not represent a rise in the economy-wide amount of profit. The rise in the industry’s profitability is the result of the improvement in its competitive position relative to other industries. By virtue of being able to offer its goods less expensively, it leads large numbers of buyers to shift their expenditures from other industries to it. Its additional products find such favor that the reduction in price attracts additional buyers more than in proportion. The obvious result, which the table shows, is that the increase in the given industry’s profitability is at the expense of an equivalent decrease in the profitability of the rest of the economic system.
Thus, in all cases, the change in sales revenues, costs, and profits of the given industry, whether in the downward or upward direction, is shown to be accompanied by opposite changes in the sales revenues, costs, and profits of the rest of the economic system. This, as I say, is the inescapable implication of the aggregate demands for consumers’ goods and labor remaining the same. The table shows that while profitability in the particular industry can fall as the result of an overexpansion in its production relative to the rest of the economic system, profitability in the rest of the economic system correspondingly rises. It makes clear that the proposition that there can be no fall in general profitability, no matter how great the increase in production, is perfectly consistent with the fact that profitability in any given industry or group of industries can be reduced by an increase in its production. The reconciliation is that profitability in any given industry is determined by its competitive status, which changes in the industry’s production relative to that of other industries can profoundly influence. At the same time, however, as I have said—and it cannot be stressed too strongly—the general profitability of the economic system as a whole is independent of the level of physical production. It is independent of all competitive factors—which, in the nature of the case, are always mutually offsetting. What aggregate profit depends on, basically, is consumption spending minus wages; from the perspective of the economy as a whole, the level of physical production acts only on the general price level and on the buying power of wages, not on profitability.
To say the same thing in different words: the determinants of aggregate profits and the average rate of profit in the economy as a whole are different than the determinants of the amount and rate of profit of any individual industry. The determinants of the former comprise above all the difference between the demand for consumers’ goods (sales revenues) and the demand for labor (costs). Changes in the magnitude of production and in the price and wage level are simply irrelevant, so long as these two aggregate demands are the same. At the level of the economic system as a whole, the phenomenon of competition is not operative. Its effects on profits and losses are mutually offsetting. But at the level of individual companies and industries the effects of competition on the rate of profit are decisive. Insofar as increases in production place the marginal utility of an industry’s product at a competitive disadvantage with the marginal utility of the products of other industries, its profitability is reduced or even wiped out altogether. By the very same token, however, the profitability of the rest of the economic system is equivalently increased. There is no effect on the aggregate amount or average rate of profit in the economic system as a whole.
PRODUCTIONISM, SAY’S LAW, AND UNEMPLOYMENT 573
Production and the Fallacy of Composition
If we keep the preceding discussion in mind, then it is possible to grasp more fully the nature of the mistakes underlying the consumptionist belief in the possibility of a general, absolute overproduction. Apart from the underlying mistaken philosophy that man’s true, legitimate needs do not differ significantly from those of an animal, is, above all, the fact that it is possible for any given industry, at one time or another, to be in the position of incurring losses as the result of overexpanding relative to the rest of the economic system. Absolutely any industry could find itself in the position of our given industry and incur losses as the result of expanding its production.
The actual cause of its losses, of course, would be its relative overproduction, and there would exist at the same time a precisely equivalent relative underproduction in the rest of the economic system. But the businessmen in the industry concerned would be correct in concluding that the cause of their particular problem of low profits or losses was that they had carried their production too far. Not being philosophically inclined or familiar with classical economics, they would be neither aware of nor concerned with the effects of their action on the profitability of other industries. In looking only at their own particular industry, they would conclude, and again and again do conclude, that losses result simply from excessive production. And then, when there is a general business depression, and practically all industries suffer losses, they, and most other observers, conclude that the explanation is that all of the industries are overproducing. Their fallacy is the same as that which leads many businessmen to the mistaken conclusion that need is synonymous with demand and that what is needed for more demand is more needs because an increase in the need for any particular product relative to the need for other products that are currently being purchased can increase the demand for that product. 51
The fallacy, of course, is the fallacy of composition— i.e., the error of assuming that what is true of part of a system is automatically true of the system as a whole. This fallacy is what makes the overproduction doctrine seem plausible. The fallacy of composition arises again and again in economics because of a failure to think out the implications of events in particular industries for the rest of the economic system. It arises because of a failure to realize that every given industry is in a state of competition with the rest of the economic system—either having its sales revenues and profits competed away by the rest of the economic system or itself competing sales revenues and profits away from the rest of the economic system. The fallacy of composition plays a prominent role in the consumptionist belief that a general, absolute overproduction is the cause of depressions insofar as that belief rests on an invalid generalization from the conditions of a particular industry to the economy as a whole. To repeat, any particular industry might at some time or other suffer low profits or losses as the result of a problem of partial, relative overproduction. But when it does, the rest of the economic system earns correspondingly higher profits as the result of a precisely equivalent partial, relative underproduction. It is the fallacy of composition par excellence to conclude that when all industries suffer losses, as is the case in a general business depression, it is the result of a general overproduction.
A general business depression has absolutely nothing to do with the level of production in the economic system. Less production would do nothing to alleviate depressions. It would only reduce the general standard of living. To whatever extent the profits of particular industries might be increased by reduced production in those industries, the profits of other industries would only be further reduced. And, as I say, the general standard of living would be reduced. Depressions are not the result of anything on the side of production or supply. They are a monetary phenomenon. That is, they originate on the side of money and spending—on the side of monetary demand, not production and supply. They are the result of a sudden contraction in aggregate spending for goods and labor, which makes the repayment of debt more difficult, reduces the general profitability of business, and precipitates mass unemployment. As the previous chapter showed, and as Chapter 19 will show more fully, this contraction, in turn, is the result of a preceding artificial monetary expansion caused by government interference in the economic system. In sum, it is the contraction in spending, brought on by a previous inflationary boom, that causes all the leading symptoms of a depression. The cause is not the increase in production.
5. Falling Prices Caused by Increased Production Are Not Deflation
A major implication of the fact that increases in production do not reduce the general rate of profit is the fact that the falling prices caused by increases in production do not represent deflation.
The fact that the falling prices resulting from increasing production are not accompanied by a decline in the general or average rate of profit represents an enormous departure from the conditions of a genuine deflation. In a genuine deflation, business profits are almost universally depressed, if not eliminated altogether. But we have seen that the aggregate profit of the economic system can be represented by the difference between the spending of consumers to buy products and the wages paid by business to produce them, and that so long as those magni—
tudes, and thus the difference between them, remain the same, the aggregate profitability of business is totally unaffected by the physical volume of goods and services produced and sold. Thus, when production increases, prices fall. That is perfectly true. But the general rate of profit does not.
By the same token, when prices fall because of an increase in production, there is nothing present that would cause any general increase in the difficulty of repaying debts, which is the most prominent symptom of a genuine deflation. A fall in prices resulting from more production in the face of constant sales revenues does not mean that there is any greater difficulty of earning any given sum of money. If, over a period of years, an increase in production, let us say a doubling, is achieved by virtue of business firms becoming more efficient, then the conditions of the case imply that the mathematically average business firm produces twice the output just as easily as it previously produced its original output. True enough, a unit of output sells for only half the price. But, by the conditions of the case, the average business firm has twice the units to sell. Its sales revenues in money are, therefore, just as great as they were before, and no more difficult to earn. Whatever money it is obliged to repay, does not come to it with greater difficulty than was originally the case.
It is certainly true that individual firms and whole industries could find it more difficult to repay their debts as prices fell. These would be the firms that did not improve their efficiency while their competitors did, and the industries that were relatively overexpanded. These firms and industries would suffer a decline in sales revenues and profits, and probably incur outright losses. But for every firm and industry in this position, there are other firms and industries that enjoy correspondingly increased sales revenues and profits and a correspondingly enhanced ability to repay their debts. Namely, the firms that introduce improvements ahead of their competitors, and the industries that are relatively underexpanded. There is no overall pressure on debtors here—nothing present that operates against debtors as a class.
Thus, it is simply incorrect to think of falling prices per se as “deflation.” The falling prices caused by more production share only one symptom of deflation—namely, the fall in prices itself. They do not share two further, essential symptoms of deflation—namely, the sudden reduction or total elimination of business profitability and the increased difficulty of repaying debts.
What accounts for the combination of these three symptoms of deflation together is not any increase in production or supply, but a decline in monetary demand—a contraction of spending—which occurs as the result of a drop in the quantity of money or at least a slowing down of its rate of increase. A drop in total spending reduces prices. That is one of its effects. In addition, and totally unlike an increase in production and supply, it also reduces total business sales revenues. This reduces the availability of funds with which to repay debts. It makes it more difficult for the average seller to earn any given sum of money, because there is simply less money to go around. In addition, and again totally unlike an increase in production and supply, a drop in total spending reduces the general rate of profit, because while sales revenues fall immediately as a consequence of a decline in spending in the economic system, total costs of production in the economic system fall only with a time lag. For example, depreciation cost continues to reflect the larger volume of spending on account of plant and equipment that existed in the past.
Thus, deflation is a monetary phenomenon, not a phenomenon originating on the side of production. It should be thought of as a contraction in the volume of spending in the economic system, precipitated by a decrease in the quantity of money or slowing down of its rate of increase. For this is the underlying phenomenon that produces the cluster of symptoms that constitute deflation, not merely the one, isolated symptom, the fall in prices, that deflation shares with increases in production.
It is nothing less than absurd, indeed, vicious, to equate deflation with increases in production on the basis of their sharing this one, isolated symptom of falling prices while being of an absolutely opposite nature in connection with their effect both on the average rate of profit and on the general ability to repay debts. It is the wiping out of profitability and the sudden increase in the difficulty of repaying debts that is the substance of the evil produced by deflation. This has absolutely no connection with increases in production and the fall in prices brought about by increases in production. To view the fall in prices brought about by increased production as the same as deflation and depression is gratuitously to confuse the enormous economic good that is constituted by increases in production with the evil that is constituted by depressions. It is difficult to imagine a more profound or devastating error.
The Anticipation of Falling Prices
The question arises of whether the anticipation of falling prices caused by increases in production could have deflationary effects—i.e., could the prospect of steadily falling prices lead people to increase their demand for money in anticipation of being able to buy more cheaply later on? And, if so, wouldn’t this be equivalent in its effects to a reduction in the quantity of money? And thus, on these grounds, shouldn’t increasing production be
PRODUCTIONISM, SAY’S LAW, AND UNEMPLOYMENT 575 called deflationary after all?
The answer to these questions is no. The prospect of falling prices caused by increases in production, rather than by decreases in the quantity of money and volume of spending, does not operate to increase the demand for money. And thus it does not operate to reduce the velocity of circulation of money and the volume of spending in the economic system.
The first thing that must be pointed out is that even if the prospect of falling prices caused by increases in production did increase the demand for money, which it does not, the increase would be of an essentially one-time nature. Once the increase in the demand for money took place, further increases in production and the falling prices they caused would take place with no further increase in the demand for money.
For example, let us suppose that there is a given, fixed quantity of money in the economic system and that initially the aggregate demand for consumers’ goods is 500 monetary units and the aggregate demand for labor is 400 monetary units, as in our previous example in connection with Say’s Law and the rate of profit. We can assume that initially production and prices are both constant from year to year. And now we assume that production begins to rise and prices to fall from year to year and, for the sake of argument, in response to the fall in prices and the prospect of the fall continuing, the demand for money rises. If it occurred, the rise in the demand for money would have the effect of reducing the monetary demand for consumers’ goods and labor. For the sake of illustration, let us assume that the effect would be to reduce the demand for consumers’ goods and labor by 10 percent, namely, from 500 and 400 respectively to 450 and 360 respectively. From this point on, it is clear, production would increase and prices would fall with no further increase in the demand for money and no further fall in the monetary demands for consumers’ goods and labor.
Under no conditions could the prospect of falling prices be assumed to cause a continuing, endless increase in the demand for money. At most the prospect of some rate of fall in prices could plausibly be argued to result in some defined, delimited rise in the demand for money, which would then result in some delimited drop in expenditures and thus be satisfied. The only reasonable basis for a further rise in the demand for money based on the anticipation of falling prices caused by increases in production would be if the rate of increase in production and fall in prices accelerated. In that case, it might plausibly be argued that there would be a one-time further increase in the demand for money and a one-time further fall in the aggregate demands for consumers’ goods and labor.
Thus, even if the argument alleging deflationary effects were correct, which it is not, it would still be essentially false. For at most, it would apply only to a transition phase. Thereafter, once the additional demand for money was satisfied and the volume of spending in the economic system stabilized at a lower level, production could go on increasing and prices go on falling at any given rate with no further increase in the demand for money, exactly as I have described.
As I say, however, there is no basis for assuming that falling prices caused by increased production bring about a rise in the demand for money. Insofar as the increasing production and falling prices are the result of improvements in the productivity of labor, the falling prices do not lead to a postponement of consumption and thus do not increase saving at the expense of consumption. This is because they are the accompaniment of the average person having a higher real income and thus being better off in the future than in the present, which prospect gives him as much motivation to consume more as the prospective increase in the buying power of money gives him to postpone consumption and save more. 52 Inasmuch as the two incentives are thus mutually offsetting, there is no overall tendency for consumption spending to fall, or saving to increase, as the result of falling prices caused by increases in production—not insofar as the increases in production and fall in prices are the result of a higher productivity of labor.
When increases in saving do occur, the demand for money does not increase, but, if anything, decreases. This is because, as we shall see after we have studied their determinants, the average rate of profit and interest in the economic system is always both positive and sufficiently high—in the absence of monetary contraction—to make it worthwhile to invest savings that are available for any significant period of time rather than hoard them. In such an environment, as we saw in the last chapter, the effect of an increase in saving is actually to reduce the demand for money, both because funds that are saved are normally available for spending sooner than funds that are held for consumption and because savings are the source of credit, the prospective availability of which reduces the need to hold money. 53
Thus, the falling prices brought about by increased production do not result in a rise in the demand for money or have deflationary effects. Indeed, it should be realized that under a system of gold or silver money, an increasing ability to produce on any kind of broad, substantial scale almost certainly means the production of a larger quantity of these metals and, insofar as it represents an increase in a country’s ability to produce relative to the rest of the world, the attraction of a larger proportion of the world’s supply of such precious metal money to its
shores. The larger quantity of money caused in these ways by an increased ability to produce implies a growing volume of spending, not a diminished volume of spending. Indeed, on a commodity money system, only an increasing ability to produce can bring about a growing quantity of money and rising volume of spending in the long run. Thus, under a commodity money system, the falling prices that are caused by increases in production actually take place in a context in which there is almost certainly an increase in the quantity of money and volume of spending.
What this means is that when prices fall because of increases in production, there is almost certainly some increase in the quantity of money and volume of spending taking place at the same time, as part of the increase in production itself, or at least on the foundation of the increase in production itself (the latter as far as matters pertain to international trade and the relative size of a country’s production in the world economy, and hence its ability to garner part of the increase in the world supply of money). Thus, to whatever extent prices fall because of an increase in production, the fall is almost certainly not in full proportion to the increase in production, but only in proportion to the amount by which the increase in production exceeds the rise in monetary demand that takes place at the same time and in connection with it. For example, in conditions in which prices might fall perhaps 2 percent per year because of increasing production, the fall would almost certainly reflect a condition of the kind in which the quantity of money and volume of spending increased on the order of, say, 1 to 3 percent per year while the supply of goods increased on the order of, say, 3 to 5 percent per year.
Thus, falling prices caused by increased production are so far removed from deflation and financial contraction that they are actually part of a process in which the quantity of money and volume of spending grow from year to year. And, as we already have reason to know, this increase in the quantity of money and volume of spending both adds to the rate of profit and interest and, in increasing the sales revenues of the average seller in the economic system, correspondingly reduces the difficulty of earning the money that is required to repay debts. For example, in a context in which prices fall 2 percent per year because production increases 5 percent per year while the quantity of money and volume of spending increase 3 percent per year, the average seller in the economic system enjoys a 3 percent per year increase in his sales revenues. The position of the average seller— that is, a seller who has increased his production in accordance with the economy-wide increase of 5 percent per year—is that the supply of goods he has available to sell at the 2 percent per year lower prices is 5 percent per year greater. Thus his sales revenues are 3 percent per year higher. In this case, the average seller would actually have considerably less difficulty in earning the money with which to repay his debts than when he borrowed the money. This is because, other things being equal, after he borrowed he would be able to earn 3 percent more money per year than the amount he earned at the time he borrowed, with no greater difficulty on his part.
Hopefully, on the basis of all of the foregoing, it is now even clearer than before that the existence of falling prices accompanied by a contraction in spending and the other symptoms of deflation and depression is not the result of increases in production. We have seen that the relationship between the prospect of falling prices and a greater demand for cash holdings pertains to falling prices caused by a decrease in the volume of spending, not to falling prices caused by increases in production. The decrease in the volume of spending in turn is the result either of a decrease in the quantity of money or a reduction in the rate of increase in the quantity of money, the latter in an environment in which the demand for money has first been artificially reduced by virtue of more rapid increases in the quantity of money. 54 In such a situation, the desire to hold cash balances increases and the velocity of circulation of money falls, in accordance with the principles explained in Chapter 12. 55
In sum, the particular nature of the cause of the fall in prices is essential for the effect on the demand for money. Only those price reductions emanating from monetary contraction cause a rise in the demand for money.
Economic Progress and the Prospective Advantage of Future Investments Over Present Investments
Similar to the question of whether the prospect of falling prices resulting from increased production causes a rise in the demand for money is a question pertaining to the effects of prospective improvements in machinery on the profitability of investing in the machinery of today. Thus, to the extent that there is economic progress, the machines of the future will be more efficient than those of the present and therefore today’s machines will be at a competitive disadvantage in comparison with them. The question that arises is whether this circumstance might operate to depress current investment by creating the prospect of losses or, at any rate, lower profits than could be obtained by delaying investment, and whether it might thus operate to cause an increase in the demand for money as well as to inflict losses on the producers of plant and equipment, who would have to cut their prices in the present in order to be competitive with the plant and equipment of the future.
The answer is that if economic progress took place only once, or were just about to take place for the first
PRODUCTIONISM, SAY’S LAW, AND UNEMPLOYMENT 577 time, then it would be true simply that the machines of the present would be at a competitive disadvantage with the machines of the future, with the result that a rise in the demand for money might ensue and the new machines of the present might have to be sold at a loss if their competitive disadvantage were major. Observe, however, that the increase in the demand for money would exist only until the expected more advanced machines arrived on the market, and the loss would be borne only by the machines which did not embody the progress. The arrival of the more advanced machines would put an end to any increase in the demand for money. They would be in demand and would not sell at a loss. More importantly, it should be realized that if improvements in machinery are a repeated occurrence and are expected, there is no increase in the demand for money and no problem of the owners or producers of machinery incurring losses because of the prospective introduction of more efficient machines in the future.
This is because in such conditions, while the machines of next year may be expected to be more efficient and at a competitive advantage over the machines of this year, the machines of this year are, for their part, more efficient and at a competitive advantage over the machines of last year and previous years. Because of their greater efficiency and higher productivity, the machines of this year account for a disproportionately large share of total production, when compared to the machines of last year and previous years.
For example, if the average machine lasts twenty years, and the machines in use at any given time range in age from brand new to twenty years old, the current year’s machines, being relatively more efficient and more productive, will account for more than one-twentieth of the production of the economic system and will earn more than one-twentieth of the total revenues attributable to machinery. If not for the prospective introduction of still more efficient machinery in the years to come, the machines of this year would be extraordinarily profitable. The fact that they, in turn, will be superseded means merely that a part of what would otherwise represent extraordinary profits must be set aside to compensate for the time when they will be of below-average efficiency. In other words, the effect of continuous economic progress is not to make the machinery of the present continuously unprofitable or less profitable, because the machinery of the future will be better, but to require a system of more rapid depreciation in the earlier years of a machine’s life, when it possesses above-average efficiency. Its competitive advantage in the early years of its life compensates for its competitive disadvantage in the later years of its life. 56
Similar observations apply to the case of inventory and the fear that business would always have to sell its inventories at a loss, because of continuously falling costs and prices. The fact is that to the same extent that older inventories must be sold at a loss, newer inventories can be sold at a correspondingly enhanced profit. This proposition can be demonstrated for the case of any given rate of increase in production and any given ratio of inventories to sales. If, for example, production were to double from period to period, and half of current production were always to remain in and constitute inventory, then in any given period sales would represent half of the production of the current period plus half of the production of the previous period, which was half as great. Thus, two-thirds of current revenues would be attributable to half of the production of the current period and one-third of current revenues would be attributable to half of the production of the previous period. To the same extent that the half of the production of the previous period brought in deficient revenues, the half of the production of the present period that is currently sold would bring in additional revenues. Thus, the general rate of profit would not be affected. What is present here is nothing fundamentally different from the fact that businesses are profitable despite the fact that they run clearance sales on which, considered in isolation, they incur a loss; the losses on the clearance sales are compensated for by the profits on regular operations.
I have said that if economic progress took place only once, or were just about to take place for the first time, then it would be true simply that the machines of the present would be at a competitive disadvantage with the machines of the future, with the result that a rise in the demand for money might ensue and the new machines of the present might have to be sold at a loss. This is actually an overstatement of matters, because unless such a situation were pervasive, that is, applied to the greater part of the economic system at the same time, the decline in expenditure to buy the machines even of a fairly substantial number of industries would almost certainly not represent a decline in expenditure in the economy as a whole. The funds not expended for the machines in question would be made available for other purposes and be expended elsewhere. The only way that spending in the economic system as a whole would be reduced is if economic progress throughout the economic system, or at least in the greater part of the economic system, were about to take place for the first time or, what would be very similar, were about to undergo some significant acceleration. Only in such unusual cases, would spending in the economic system as a whole temporarily fall, awaiting the appearance of the improved machines.
While such a case is unlikely in connection with
improvements in machinery, it has important application to the labor market in the context of mass unemployment, as I will show in Part C of this chapter. Specifically, in the conditions of the prospective fall in wage rates and prices, and thus in the costs of investments, that mass unemployment entails, not only does an increase in the demand for money ensue, but government intervention that prevents wage rates and prices from falling lengthens its duration and thus lengthens and deepens the depression. This is because it prevents the restoration of demand that would occur upon the costs of investments made in the present coming down to a level competitive
57 with their prospective cost in the future.
Falling Prices and Accumulated Stocks
The case of goods such as housing and automobiles, that is, goods with substantial accumulated stocks and important markets for such accumulated stocks, may appear to represent a partial exception to the principle I have advanced that falling prices caused by increased production do not reduce the aggregate or average ability to repay debts because the fall in prices is accompanied by an inversely proportionate increase in the supply of goods.
In the case of goods with substantial accumulated stocks, the rate of increase in production and the rate of increase in the quantity of accumulated stock, while always ultimately tending to be equal, can be substantially different for more or less protracted periods of time, whenever the rate of increase in production changes. For example, if after being stationary for many years, the production of new houses should begin to increase at a compound-annual rate of 5 percent, the rate of increase in the accumulated stock of housing will be much less than 5 percent for many years. Indeed, if the accumulated stock of housing is initially 50 times as large as the annual production of new housing, the first 5 percent increase in the production of new housing will constitute an increase in the stock of housing of only .1 percent, that is, 5 percent divided by 50. Only after 50 years of a 5 percent compound-annual rate of increase in new housing construction, would the accumulated stock of housing also increase by 5 percent per year. 58
If, under these conditions, the price of housing fell on the order of 5 percent per year starting as soon as the annual production of housing began to increase at 5 percent per year, the result would be that for 50 years the price of housing would fall more than in proportion to the increase in the accumulated stock of housing. A further implication would be a severe decline in the aggregate monetary value of the housing stock and, of course, in the ability of the average homeowner to repay his mortgage out of the proceeds of the sale of his house.
In answer to the possibility of this kind of argument, it is necessary to point out that in cases in which the accumulated stock is so significant, the price of a good should not be expected to fall in proportion to the rate of increase in its production, so long as the rate of increase in its production is so much larger than the rate of increase in the accumulated stock of the good. A 5 percent annual increase in the production of housing should not be expected to reduce the price of housing on the order of 5 percent, so long as all that it represents is a .1 percent increase in the total accumulated stock of housing. Such a situation would imply an extremely
59 inelastic demand for housing.
A more reasonable estimate for the extent of the fall in the price of housing under such conditions must allow for the fact that alongside the money expended in constituting the demand for new housing is the money expended in constituting the demand for already existing housing. Of course, even under an invariable money, the combined sum of these two demands is capable of undergoing change in the face of a change in the production and accumulated stock of housing. This is because people can shift the expenditure of funds either away from housing to other things, or to housing from other things. For the sake of ease of analysis, however, let us assume that the overall expenditure for housing, newly produced and already existing combined, remains the same. Under these circumstances, if the average homeowner were in the habit of moving every year, the annual expenditure for housing would initially be on the order of 50 times the annual expenditure for new housing, inasmuch as the total quantity of housing sold in a year would be 50 times the production of new housing. In this case, an increase in the housing stock of .1 percent would result in a decrease in the price of housing also on the order of .1 percent. In such circumstances, the fall in the price of housing would be precisely counterbalanced by the increase in the supply of housing, and the aggregate value of the housing stock would remain absolutely unchanged.
In reality, of course, the average homeowner does not move as often as every year. For the sake of argument, let us assume that he moves only once every 5 years (which is probably too conservative an assumption). In this case, if the existing housing stock is initially 50 times as large as the current year’s production of housing, the overall funds expended for housing will be on the order of 10 (i.e., 50 ⁄ 5 ) times the funds expended for new housing, which is still an enormously greater magnitude and, as I say, probably too conservative an estimate. In this case, if the aggregate demand for housing remained the same in the face of a supply of housing sold in the market that consisted of the sum of one-fifth of the existing housing stock plus production of new housing that was
PRODUCTIONISM, SAY’S LAW, AND UNEMPLOYMENT 579
5 percent larger than the previous year’s production of new housing, the initial fall in the price of housing would be on the order of .5 percent. For in this case, the initial overall increase in market supply would be on the order of .5 percent, inasmuch as the 5 percent increase in the current production of housing must be divided by the previous year’s market supply that was 10 times as large as the previous year’s current housing production.
In this case, there is some modest tendency toward a fall in the aggregate value of the housing stock that will go on over a protracted period of time. But what is highly significant in this or any such case is that even with total demand for the item being fixed, there is a pronounced tendency for the regular business sellers, as opposed to those who sell their previously purchased goods (whether consumers or businesses), actually to enjoy growing sales revenues in the period of adjustment. This is because the increase in supply is concentrated in their hands. And thus, from year to year they claim a growing proportion of the total funds expended to buy such goods. For example, starting with an aggregate demand for housing that is 10 times the size of the demand for new housing, the proportion of that aggregate demand that is claimed by new housing will go on increasing so long as the supply of new housing goes on increasing relative to the overall housing stock and thus the market supply of housing. 60
The principle that emerges from this discussion is that as the result of increasing production, or a more rapid rate of increase in production, the proportion of any given economy-wide aggregate demand that is claimed by current production, as opposed to previously produced goods, goes on increasing until the rate of increase in the supply of previously produced goods catches up. Thus, from the perspective of business, the effect of increases in production and the falling prices they cause is analogous to the effect of the economy of one country growing relative to that of others. Namely, it attracts a growing proportion of the quantity of money and volume of spending of the economic system to the segment that is increasing relative to the rest of the system.
As for the value of the preexisting stock, what is present is only some measure of increase in the normal kind of loss of value that follows the purchase of goods. And this loss of value, I must point out, is mitigated, even if not entirely overcome, by the increase in the quantity of money and volume of spending that accompanies largescale increases in production as a virtually inevitable by-product. Thus, even in the face of a growing population, there is almost certainly no reduction in the ability of the average member of the economic system to earn any given sum of money and thus to repay debts. (And, as we shall see very shortly, even if the growth in population and the supply of labor did bring about modestly falling wage rates, the effect would be of no longrun significance.) Moreover, in the case of housing or any other expensive durable good, where the demand is entirely dependent on saving, it is likely that the achievement of economic progress or more rapid economic progress would be founded at least in part on an increase in the proportion of economy-wide aggregate demand that is devoted to the purchase of such goods. This would be the case insofar as the process of economic progress was inaugurated by a rise in the degree of saving. 61
Thus, it is virtually impossible that economic progress or more rapid economic progress, would ever for very long be accompanied by any actual reduction in the aggregate nominal value of the stock of housing, automobiles, or any other such goods; rather, it would be accompanied by a continuing rise, and probably from the very beginning. It is equally impossible that it would cause the difficulty that the average member of the economic system experiences in repaying his debts to be any greater than whatever difficulty he normally experiences in repaying debts for such things as the purchase of automobiles or major appliances. For example, even if it were the case that the price of houses fell on the order of 5 percent a year, so long as the money income of the average homeowner remained the same, or fell only modestly, his difficulty in repaying mortgage debt would be no greater than is the difficulty of automobile purchasers, say, in repaying automobile installment debt, which debt is typically repaid out of income rather than the rapidly declining resale value of used cars.
In addition to all of the foregoing, it is necessary to realize that at least in the very important case of housing, the source of increases in supply is not confined to new production. This is because it is possible to varying degrees also to increase the supply represented by the preexisting stock—for example, through all manner of home improvements. To the extent that this occurs, the resale value of older units of the supply is maintained, for they themselves participate in the increase in supply. If our hypothetical 5 percent annual rate of increase in the housing supply were achieved mainly in this way, the price of a base unit of housing might fall on the order of 5 percent a year from the very beginning and there would be no necessary fall in the aggregate value of the accumulated stock of housing even under the assumption of the most rigidly fixed aggregate monetary demand for housing; at the same time, the resale value of older units of the housing stock would be maintained.
Falling Prices Resulting from a Larger
Supply of Labor
I turn now to the final variant of the fallacy that falling
prices caused by increases in supply constitute deflation. This concerns the fact that a growing supply of labor tends to reduce wage rates. It might be thought that to the extent that wage earners have debts, a fall in their wage rates brought about in this way would constitute a leading symptom of deflation. This would not be so, however, for a number of reasons.
First of all, insofar as the larger supply of labor represents the employment of more married women or more offspring of the initial workers, there is no decline in the income of the average working family. There is just the fall in prices of goods that results from the greater production. Thus there is an increase in the real income of the average working family and, therefore, almost certainly an increase in its ability to repay any given amount of debt. 62 Insofar as the larger supply of labor is the result of immigration, then, it is true, there is a reduction in the income of the average working family already present and a correspondingly greater difficulty for such a family in repaying debts. But, by the same token, there is an increase in the income of the immigrant families and a correspondingly reduced difficulty of repaying debts as far as they are concerned. There is no greater difficulty of repaying debts on the part of the average working family as such. Such a general greater difficulty could occur only to the extent that the aggregate demand for labor fell. As we know, the only explanation for such a fall taking place suddenly and dramatically is a decrease in the quantity of money and/or an increase in the need to hold money, which latter follows from a decrease in the quantity of money or reduction in its rate of increase. 63
Finally, it should be realized that if a fall in wage rates resulting from a growing supply of labor were accompanied by a greater difficulty of repaying debts, the difficulty would not be lastingly alleviated by a more rapid increase in the quantity of money that would prevent the fall in wage rates. As subsequent discussion will show, if the rate of increase in the quantity of money were stepped up to keep pace with the rate of increase in the supply of labor, the result would be a rise in the nominal rate of profit and interest by the same percentage. This means, for example, that if a 2 percent annual increase in the supply of labor were operating to reduce wage rates on the order of 2 percent a year, a 2 percent annual increase in the quantity of money and volume of spending, which would make possible a 2 percent annual increase in the demand for labor and thus prevent wage rates from falling, would ultimately add 2 percentage points to the average rate of profit and interest in the economic system. In other words, if the average rate of profit and interest would otherwise be 4 percent, now it would be 6 percent. 64 Thus, while workers would not experience a fall in their money wages any longer, they would have to pay a correspondingly higher rate of interest on their debts. This, together with the reduced ability of prices to fall, which must result from the same more rapid increase in the quantity of money, would deprive them of any advantage of avoiding the fall in their money wages.
In reality, as we have seen, in a progressing economy, the quantity of money, volume of spending in general, and demand for labor in particular do all increase. As the result of the rise in the productivity of labor (and thus, one can presume, an increase in the quantity of money per capita), they increase not only absolutely but also relatively to the size of the population. And thus it is virtually impossible for falling wage rates to be the norm in such an economy. At the same time, however, the more rapid rate of increase in the quantity of money does serve correspondingly to raise the rate of profit and interest, including the rate of interest that wage earners must pay on any debts they incur, and it does serve correspondingly to diminish the rate at which prices fall. Thus while increases in the supply of labor do not actually serve to make wage rates fall from year to year, wage earners derive no permanent advantage from that fact.
PART C
UNEMPLOYMENT
1. The Free Market Versus the Causes of Mass Unemployment
It is now necessary to explain how mass unemployment can exist despite all that I have shown in Chapter 2 and in the first two parts of this chapter. That is, how it can exist despite a limitless need and desire for wealth and consequent inherent and ineradicable scarcity of labor, despite all the truths of productionism that follow from these facts, and despite the fact that, as Say’s Law shows, all that is necessary for the creation of real demand is supply. Moreover, as I will show in Chapter 16, the process of production itself generates the monetary profitability that makes production financially worthwhile. It is necessary to show how mass unemployment is possible despite the existence of this fact as well.
There is a simple explanation that is perfectly consistent with all of these facts. It is that unemployment is caused by an improper relationship between money wage rates and the demand for labor in the economic system. Specifically, the average money wage rate is too high relative to the aggregate demand for labor. And since the aggregate demand for labor is determined by the quantity of money and the degree of saving in the economic
PRODUCTIONISM,SAY'SLAW,ANDUNEMPLOYMENT 581 system,onecansaythattheproblemofunemployment is the result of money wage rates that are too high in relationtothesemagnitudes,aswell. 65
Thisexplanationofunemploymentisapparentinthe formulaIpresentedforthedeterminationoftheaverage level of money wage rates earlier in this chapter. Namely, that the average money wage of workers em-ployedequalstheaggregatedemandforlabordividedby theaggregatesupplyoflabor,withtheaggregatedemand for labor being understood as manifested in a definite total expenditureofmoney to employ labor in the economic system, that is, in total payrolls of a given size, and the aggregate supply of labor being understood as manifestedinadefinitetotalquantityoflaboremployed. Theformula,ofcourse,is
W = D L .
S L
Andanillustrationofitis
$1trillion
$10,000perworker = .
100 million workers
The formula shows that with any given aggregate demand for labor, there is no limit to the number of workersthatcanbeemployed.Allthatisnecessaryisan appropriate level of money wage rates. For example, while a trillion dollar aggregate demand for labor em-ploys100millionworkersatanaverageannualwageper workerof$10,000,thatsameaggregatedemandforlabor couldemploy200millionworkersiftheaverageannual wageperworkerwere$5,000insteadof$10,000.Bythe sametoken,itcouldemployonly50millionworkersat an average annual wage of $20,000 per worker. The principleisthatwithagivenaggregatedemandforlabor intheeconomicsystem,thenumberofworkersthatcan beemployedvariesininverseproportiontotheaverage money wage rate per worker. Given the aggregate demand for labor as some definite amount of money, the division of that sum by any given average wage rate implies an inversely proportionate quantity of labor demanded.
When the demand for labor is diagrammed, as in Figure 13–4, the result is essentially the same as the productionist aggregate demand curve of Figures 13–2 and13–3.Justasbefore,thedemandcurveisasymptotic, unit elastic, and potentially capable of purchasing an unlimitedsupply.AndjustasinFigure13–3,underthe freedomofcompetitionwhatdeterminestheactualquan-titydemandedandsupplypurchased,asopposedtothe unlimited potentialquantitydemanded and supplypurchased,isnothingbutthesupplythatexistsandwhose owners want to sell it. Supply in this sense determines the quantity actually demanded—a quantity equal to itself—by virtue of its effect on the wage level, just as beforeitdidsobyvirtueofitseffectonthepricelevel. Thus,asbefore,it“createsitsowndemand,”sotospeak.
Figure 13–4 shows that one and the same aggregate demandforlaboriscapableofbeingaccompaniedbyfull employment in the face of any magnitude of supply of laborseekingemployment.Thesupplyoflaborseeking employmentis whatisdepicted bytheverticallineSS. Althoughonlyonesupplyoflaborseekingemployment
Figure13-4
TheDemandForLabor
Wage Level 4.0
D S
2.0
1.0
.5
S 0 .5F F
D
Quantity 2F ofLabor
is depicted in Figure 13–4, it is clear that the line SS could be placed anywhere to the right and still be accompanied by full employment. This is because no matter how much the supply of labor seeking employment increases, the quantity of labor demanded becomes equal to it, provided only that the level of wage rates falls correspondingly. The supply of labor seeking employment becomes synonymous with the supply of labor employed by virtue of the necessary fall in wage rates, which serves to enlarge the quantity of labor demanded to equality with the supply of labor seeking employment.
Figure 13–4 also shows that with a given demand for labor and any given supply of labor seeking employment, it is possible to have not only full employment but also, alternatively, either mass unemployment or a labor shortage of varying degrees of severity. Which of these possibilities actually exists depends strictly on the relationship between the wage level and the demand for labor. At the wage level 1.0 on the vertical axis, the quantity of labor demanded along the aggregate demand curve DD is equal to the supply of labor seeking employment, which is represented by the line SS. Hence, at that wage level, full employment exists. Accordingly, on the horizontal axis I have marked the point directly below the intersection of DD and SS with the letter F, to indicate that that point represents full employment.
However, at the doubled wage level 2.0 on the vertical axis, which causes the quantity of labor demanded to be cut in half, namely, to .5F on the horizontal axis, mass unemployment equal to 50 percent of the supply of labor seeking employment exists. On the other hand, at the halved wage level of .5 on the vertical axis, which causes the quantity of labor demanded to be doubled, to 2F on the horizontal axis, a severe labor shortage exists, with twice as many jobs being offered as there are workers to fill them.
To make the same point in terms of the example of a trillion dollar aggregate demand for labor and a supply of 100 million workers seeking employment: while an average annual wage rate of $10,000 per year achieves full employment for this supply of labor, an average annual wage rate of $20,000 per year results in a 50 percent unemployment rate, and an average annual wage rate of $5,000 per year causes a labor shortage so severe that there are two jobs offered for every worker available to fill a job.
Thus, the difference between full employment, unemployment, and a labor shortage is a matter of differences in wage rates relative to the demand for labor. Depending on the height of wage rates, one and the same aggregate demand for labor is consistent not only with an unlimited potential quantity of labor demanded and thus with full employment no matter how large is the supply of labor seeking employment, but also, as we now see, both with mass unemployment and, alternatively, with severe labor shortages. If wage rates are too high relative to the demand for labor, unemployment is the result. If they are too low, a labor shortage is the result.
Because of its great importance, a few further observations are in order concerning the aggregate demand for labor. Its constancy, indeed, its tendency to grow over time, is implied by the quantity theory of money. Its relationship to the demand for consumers’ goods—and the wider relationship of the total demand for factors of production, that is, the demand for labor plus the demand for capital goods, to the total demand for goods, that is, to the demand for consumers’ goods plus the demand for capital goods—is determined by the degree of saving in the economic system. Its relationship to the demand for capital goods is also determinate, but even in conditions in which the demand for labor might fall as the result of a rise in the demand for capital goods, the result is not against the interests of the average wage earner, as I have already indicated. 66 Furthermore, as we shall see, in the conditions of a depression and then of recovery from a depression, there is every reason for believing not merely that the demand for labor would remain constant in the face of a fall in wage rates, but that it would actually increase when the fall in wage rates took place and decline in the face of a failure of wage rates to fall! 67
Earlier in this book, I demonstrated the following points. The self-interest of buyers and sellers automatically operates to set prices and wages sufficiently high so that no shortages exist—so that, as I put it, quantities demanded are levelled down to equality with the supplies available. The setting of prices in this way is to the self-interest of buyers as well as sellers, and of poor buyers as well as rich ones. Shortages are created by government intervention into the economic system in the form of price controls, specifically, maximum price controls establishing legal ceilings, above which one is not allowed to sell. Shortages are exacerbated by the government’s policy of inflation, which operates to raise the demand for the goods and services that are under price controls and which also creates the conditions in which price controls are imposed in the first place. 68
I will now proceed to show that the case of mass unemployment is essentially similar. In a free market the self-interest of buyers and sellers operates to set wage rates low enough to allow the quantity of labor demanded to expand to the point of equalling the supply of labor seeking employment and thus to prevent or quickly eliminate unemployment. This process is to the self-interest of wage earners as well as employers. 69 Mass unemployment, like shortages, is the product of the gov—
ernment thwarting the operation of the market participants’ self-interest through a policy of price controls—this time, various forms of minimum wages establishing legal floors, below which one is not allowed to buy or sell labor. In addition, mass unemployment is precipitated by the government’s policy of inflation—at the point where the inflation results in monetary contraction.
In a free labor market, the existence of unemployment automatically tends to reduce money wage rates to the level required to achieve full employment. This is because it is to the self-interest of the unemployed workers to offer to work for lower wages than those presently employed, in order to obtain jobs. At the same time, it is to the self-interest of employers to confront their present employees with the alternative of accepting a cut in wages or else replacement by presently unemployed workers. Thus, the competition of the unemployed workers for jobs and the self-interest of employers operate to bring down wage rates. The effect of the fall in wage rates, in turn, is to stretch the funds available for the employment of labor and thus to create new and additional job opportunities. For it increases the purchasing power of payrolls and thereby enables more workers to be employed with the same-sized payrolls. In this way, what may appear as a competition among workers for a given number of jobs has the effect of increasing the total number of jobs employers offer. (As we have seen, what is present here is actually nothing but Say’s Law in the form of an additional supply of labor creating a corresponding additional real demand for labor by virtue of increasing the buying power of payroll funds.)
Of course, even with a fixed aggregate monetary demand for labor, the fall in wage rates would not produce proportionately more employment in each and every company or industry, but only in the economy as a whole. Just as with any other increase in production, people do not want proportionately more of each and every good with the increase in production due to the achievement of full employment, but very different additional quantities of the various goods. Hence, the reemployed workers are employed in different proportions among the various industries and companies than those who are already employed.
It is appropriate to observe here that while my analysis is carried on in terms of aggregates and averages, it is vital that the individual wage rates of all specific occupations and industries, in all their particular locations, be free to fall to the varying extents that are necessary. While isolated wage rigidities will not prevent the achievement of full employment, their effect is to require greater than necessary reductions in wage rates elsewhere and to cause unnecessary disproportions in the relative production of the various goods, and inefficiencies in the methods of production that are used. This is because those who are prevented from being employed in the lines where wage rates do not fall, or fall less than they would in a free market, must crowd into other lines, thereby further reducing wage rates in them. At the same time, production is artificially curtailed in the lines that maintain high wage rates (and high prices) and artificially expanded in the lines that bear a greater-than-necessary reduction in wage rates and prices. Insofar as this is the case with respect to the production of capital goods, the effect is that the supply of some capital goods is artificially held back, while the supply of others is artificially expanded. The effect is necessarily a lower productivity of labor as compared with what would exist with the appropriate proportions of the various capital goods.
Full Employment, Profitability, and Real Wages
It is important to realize two further points. First, consistent with the discussion of Say’s Law and the average rate of profit earlier in this chapter, it should be understood that the fall in wage rates and prices needed to eliminate unemployment does not reduce the average rate of profit in the economic system. Increases in production do not reduce the average rate of profit whether they result from increases in the productivity of labor or from increases in the supply of labor, as in the present case. To show this, we can use the same example as before, in which the assumption of the full vertical integration of business was made for purposes of simplification. Thus, if the aggregate demand for consumers’ goods in the economic system were fixed at 500 monetary units and the aggregate demand for labor at 400 monetary units, the amount of profit in the economic system would essentially be fixed at 100 monetary units, and thus, the amount of capital invested remaining the same, the average rate of profit in the economic system would remain the same. 70
This would be so irrespective of the number of workers employed for the 400 monetary units and irrespective of the resulting supply of goods produced and sold for the 500 monetary units. The fall in selling prices would not reduce the rate of profit because it would be preceded by a fall in unit costs to the same extent, based on the fall in wage rates. To state matters in an equivalent but more precise way, to whatever extent a larger output, in having to be divided into 500 of demand for consumers’ goods, would reduce prices, that same larger output, in having to be divided into 400 of demand for labor, would reduce unit costs. At the same time, to whatever extent profit per unit was reduced, the increase in the number of units would precisely offset it, inasmuch as the fall in prices, unit costs, and profit per unit are all in inverse proportion to the increase in production and supply. The realization
584 CAPITALISM that nothing is present to reduce the rate of profit in the process of achieving full employment is necessary in order to answer critics of the free market, above all, Keynes and his followers, who claim that the process causes a fall in the rate of profit and interest to a level so low that investment ceases to be worthwhile and the demand for money rises without limit. 71
The second point that should be realized, and which is no less important, is that the fall in wage rates that is necessary to achieve full employment does not imply a fall in the standard of living of the average worker—that, indeed, even in the short run, it would almost certainly result in a rise in his actual standard of living, and would unquestionably do so in the long run. The reason is that the fall in wage rates would be accompanied by a fall in the prices of consumers’ goods to the same extent, thereby leaving the purchasing power of the average worker’s wages—his socalled real wages—unchanged. In addition to this, the achievement of full employment would mean the elimination of the burden of supporting the unemployed, whether they are supported through charitable contributions or through taxation. This is a burden which is always borne almost entirely by those who are employed, even when taxes to support the unemployed are levied on profits or interest. 72 As a result, the fall in the prices of consumers’ goods would tend to be greater than the fall in the average worker’s “take-home” pay, thereby increasing the buying power of his take-home pay.
The conclusion that the fall in prices would be as great as the fall in wages follows on the basis of the formulas for the general level of wages and consumer prices. These formulas, once again, are
W = D L
S L and
P = D C .
S C
The conclusion follows on the basis of the continued assumption that the aggregate demands for labor and consumers’ goods remain unchanged, coupled with the further assumption that the productivity of labor remains unchanged as the number of workers employed increases and full employment is achieved. The productivity of labor in the present context means the output of consumers’ goods produced and sold per unit of labor employed. If it remains constant as the number of workers employed increases, then a larger supply of labor employed means proportionately more consumers’ goods produced and sold.
On these assumptions, the employment of more workers requires an inversely proportionate fall in wage rates. But the employment of more workers also results in a directly proportionate increase in the supply of consumers’ goods produced and sold. Since the increase in the supply of consumers’ goods produced and sold is in the same proportion as the increase in the supply of labor employed, it results in a reduction in prices that is in the same proportion as the reduction in wages, given that the aggregate demand for consumers’ goods as well as the aggregate demand for labor is fixed.
For example, in the face of a constant demand for labor, the employment of ten-ninths the workers, to eliminate an unemployment rate of 10 percent of the labor force, causes wage rates to fall to nine-tenths of their initial height. Because the productivity of labor is unchanged, it also results in an increase in the supply of consumers’ goods produced and sold that is in the ratio of ten-ninths. In exactly the same way that ten-ninths the supply of labor reduces wage rates to nine-tenths of their initial height in the face of a constant demand for labor, so ten-ninths the supply of consumers’ goods reduces the prices of consumers’ goods to nine-tenths of their initial height in the face of a constant demand for consumers’ goods. Stated algebraically, using an asterisk to denote the fixity of the demands, we have:
∗
9 W = D L
10 10
9 S L and
∗
9 P = D C .
10 10
9 S C
Thus, the fall in prices is in the same proportion as the fall in wage rates.
Identically the same conclusion, that the fall in prices is as great as the fall in wage rates, follows on the view of cost of production as the determinant of prices. This is because if the productivity of labor remains the same, then a fall in wage rates implies a corresponding fall in the fundamental—labor—costs of production, and thus in prices.
I have said that the average worker’s standard of living actually rises, by virtue of the elimination of the burden of supporting the unemployed, which has the effect of making the fall in his “take-home” pay less than the fall in prices. The following example illustrates this point. Thus imagine that in a state of mass unemployment, the average employed worker earns $400 per week and contributes $20 a week toward the support of the unemployed. As a result, his actual take-home pay is $380. Now, as implied by a 10 percent fall in average wage
rates, imagine that the elimination of unemployment requires a drop of $40 a week in his wages, which is accompanied by a 10 percent drop in the general consumer price level. His wage of $360 now buys all that a wage of $400 did before. However, this worker must actually be better off now than he was before. Because even though he used to earn $400 a week, only $380 of it was actually his to dispose of. For such a worker, therefore, the elimination of unemployment is accompanied by a fall in his take-home wages not from $400 to $360, but from $380 to $360, while prices fall in proportion to the fall in his gross wage rates from $400 to $360. In other words, while prices fall by one-tenth, our worker’s take-home pay falls by only one-nineteenth. Thus, he is able to buy significantly more with his $360 of take-home pay than he used to be able to buy with his $380 of take-home pay.
There is really nothing surprising in the conclusion that the average previously employed worker comes out ahead, even though he earns less money. The conclusion does not depend on the choice of any specific set of numbers. It is implied in the very nature of things. Imagine, for example, a desert island which is inhabited by ten people. If one of them does not work and yet is to live, he must be supported by the labor of the other nine. If that individual now goes to work and supports himself, the standard of living of the other nine must certainly be improved, because now they will be able to keep for themselves the portion of their output which they used to turn over to him.
Exactly the same situation prevails in a modern economic system. What makes it difficult for most people to realize this is that almost everyone normally judges the economic effect of things exclusively in terms of their effect on money income and does not stop to consider their effect on prices. As a result, people are easily misled by the fact that the effect of the competition of a larger number of workers for jobs is a fall in the average money wage rate. What needs to be done to make one’s thinking correspond to the facts, which are so obvious in the case of a desert island, is to realize that in the context in which the employment of more workers means lower wages, the sale of the products of those additional workers means proportionately lower prices. And thus the result is that the saving of the expense of supporting the unemployed works out to be a net gain.
What we have here, in other words, is another instance of the vital distinction that so often needs to be drawn between money value, on the one side, and actual physical wealth and the general standard of living, on the other. The two can go different ways in the context of the economic system as a whole, and we must not be misled into thinking that merely because something may operate to reduce the average money income that is earned, it therefore operates to reduce the physical wealth that is obtained and the standard of living that is enjoyed.
Some economists argue that a condition of restoring full employment is a drop in real wages—a fall in prices that is less than the fall in wage rates. 73 The basis for this conclusion is the belief that the employment of more workers will be accompanied by the operation of the law of diminishing returns, as more labor is applied in conjunction with a given, existing quantity of plant and equipment. As reemployment occurs, plant and equipment will have to be worked more intensively. It will also be necessary to bring back into use older, less efficient plant and equipment that was idle during the depression. As a result of these circumstances, it is held, the increase in output will be somewhat less than proportionate to the increase in the supply of labor employed, and thus the fall in prices will be less than proportionate to the fall in wage rates.
In addition, it is held, there must be a recovery in profits, which are all but wiped out in the depression. And thus, for this reason, too, it is argued, the fall in prices will be less than proportionate to the fall in wage rates. Indeed, to cast this argument in terms of our supply and demand formulas and the discussion of the relationship between profits and net investment that will come in Chapter 16, it could be argued that recovery requires an increase in the proportion of workers employed in the production of plant and equipment, which proportion was sharply reduced during the depression. As a result, some significant part of the output of the reemployed workers will be retained within business enterprises and not show up in the current supply of consumers’ goods, thus further limiting the fall in prices relative to the fall in wage rates.
Now the first thing that must be observed in connection with these arguments is that even if they were correct, all they would imply is that the fall in money wage rates necessary to eliminate unemployment would be accompanied by a fall in real wage rates no further than to approximately the level prevailing before the depression. The arguments about diminishing returns and the restoration of profitability imply that during the depression, the real wages of those fortunate enough to retain their jobs are artificially increased by virtue of those workers being able to work only with the newest, most productive plant and equipment, and by virtue of the consumption of capital. Thus the arguments imply that with recovery, and the elimination of those factors, the real wages of those who had retained their jobs merely fall back to a more normal level.
Secondly, it should be realized that even if these
586 CAPITALISM arguments were correct, the fall in real wages accompanying the restoration of full employment would be of a temporary nature only. It is not possible for real wages to be elevated permanently on the basis of unemployment and capital decumulation. The restoration of full employment and the end of capital decumulation—the resumption of positive capital accumulation—means that as time goes on, better and better grades of plant and equipment will spread to the whole labor force, whose productivity will be raised correspondingly, with the effect of raising the average level of real wage rates to the same extent. 74 And, because full employment represents the use of a substantially larger labor force as compared with mass unemployment and thus makes possible a significantly greater division of labor, it will itself help to make possible the ongoing rise in the productivity of labor that is attributable to a greater division of labor. 75
Thus, even if real wages did have to fall with the restoration of full employment, the fall in money wage rates would still be to the longrun material self-interest of the average wage earner. This is so because not only would unemployment be eliminated, thereby eliminating the burden of supporting the unemployed, but also the assumptions of the case imply that the fall in real wages is necessary to the maintenance and increase in the supply of capital goods, and to the division of labor being carried to a greater extent, which also promotes capital accumulation. 76 These developments are necessary to increases in the productivity of labor and thus real wages in the future. Higher real wages today, obtained at the cost of capital decumulation or the failure to accumulate substantial additional capital goods that otherwise could have been accumulated, and at the closely related expense of the extent to which the division of labor is carried, cause real wages in the future to be lower or to increase by less.
However, the argument that diminishing returns and the restoration of profitability imply a fall in real wages, is by no means correct even in application to the short run. It overlooks both the elimination of the burden of supporting the unemployed and the fact that the approach to full employment is probably accompanied by a rise in the average productivity of labor, despite the operation of the law of diminishing returns in connection with a given stock of plant and equipment. This is because the increase in production takes place mainly in accordance with the increase in the employment of direct—i.e., “blue-collar”—labor, and thus tends to be more than in proportion to the increase in the total supply of labor employed.
As illustration of this point, imagine that in a state of mass unemployment, for every ten direct, blue-collar workers working, there are ten overhead, “white-collar,” administrative-type workers working. Now, with full employment, there are twenty direct workers working for every ten overhead-type workers working. Thus, putting aside diminishing returns for the moment, output doubles with less than double the labor—with only three-halves the total labor employed. The principle that the overall average productivity of labor rises with recovery from a depression is not affected if, because of the operation of the law of diminishing returns, output increases somewhat less than in proportion to the increase in the employment of direct workers, which would fully satisfy the conditions of the law of diminishing returns. Nor is it affected by the probable need to employ some additional overhead-type workers along with the additional direct workers. It holds so long and insofar as the unemployment is more heavily concentrated in the blue-collar ranks than in the white-collar ranks (which is usually the case) and output increases basically in accordance with the increase in blue-collar employment. 77
Furthermore, the rise in the average productivity of labor that occurs is compatible with prices falling less than costs, to allow a recovery in profitability, and yet as much as or even more than wages, which also fall by less than costs. For example, wages might fall by 10 percent, costs by 15 percent (because of the increase in the average productivity of labor as well as the fall in wage rates), and consumers’ goods prices by 12 percent. The fall in prices here is less than the fall in costs, which allows an increase in profitability, and yet greater than the fall in wages. Indeed, this very sort of phenomenon can be seen to have taken place in the recovery from the recession of 1982 in the United States. In that recovery, the reduction in unemployment was accompanied by the first rise in real wages to have taken place in many years.
But even if real wages did have to fall to make possible the restoration of full employment, then, as I have shown, the process would still be to the longrun self-interest of the employed workers, not to mention the self-interest of the unemployed workers, who would once again have jobs.
It should be realized that the fall in prices that accompanies the fall in wage rates in the process of eliminating unemployment greatly mitigates any greater difficulty in repaying debts that might be experienced by workers whose wages fall. And when the effect of the elimination of the burden of supporting the unemployed is taken into account, it is probable that in most cases, any greater burden of repaying debt is more than offset.
This conclusion can be understood in the light of our example of the fall in the wages of the average worker from $400 per week to $360 per week. Let us imagine that such a worker has to make debt payments and meet
other fixed obligations, such as a lease, that average $100 per week. In that case, the funds he initially had available for meeting his other expenses were $300 per week—actually, $280 per week, when the burden of supporting the unemployed is taken into account. Now, with the fall in his income to $360 per week and the elimination of the burden of supporting the unemployed, he has $260 a week to spend as he wishes. This sum, of course, is $20 less than the amount he initially had available for purposes other than meeting fixed obligations. However, with the fall in prices of 10 percent, the buying power of these $260 is the equivalent of significantly more than that of the initial $280—in fact, it is equal almost to that of $289 in terms of the initial, lesser buying power of money, for at nine-tenths the prices, the buying power of any given sum is ten-ninths as great, and ten-ninths of $260 is approximately $289.
Moreover, even the fixed obligations of the workers are not permanently fixed. Within one to three years, practically all apartment leases come up for renewal, and in that time these fixed obligations come to be restated in accordance with the lower prevailing level of prices. In addition, within this time, many debts are paid off, such as most installment loans, and are replaced with smaller debts that represent equivalent buying power. Even mortgage payments can be reduced to correspond to the fall in prices, once a homeowner refinances his home at a lower rate of interest or sells his present house and buys another, equivalent house at a lower price. (As this last observation suggests, perhaps the only case of significant loss of buying power for wage earners occurs not in their capacity as wage earners but as homeowners, whose equity may be sharply reduced or wiped out by the fall in the price of houses. Of course, this loss in many cases is the loss merely of an equity that was created by preceding inflation.)
Finally, whatever additional debt burden, if any, the fall in wage rates might place on wage earners who already had jobs, it certainly does not place any additional debt burden on all wage earners taken together— those who were unemployed before the fall in wage rates, as well as those who had jobs. Before the fall in wage rates, the incomes of the unemployed workers were zero, which meant that they had absolutely no earnings with which to pay their debts. The fall in wage rates of the workers already employed is the foundation of a rise— the coming into being—of the wage rates of the workers who were unemployed and is the basis of their being able to pay their debts. Any greater debt burden on wage earners as a whole is not imposed by a fall in wage rates, which, in eliminating unemployment, at most serves to increase the debt burden of some wage earners while reducing that of others, but by a fall in the aggregate demand for labor, which, of course, is also what precipitates mass unemployment. A fall in the aggregate demand for labor means a reduction in the total of the wages paid in the economic system, and, in the face of a given magnitude of debts on the part of wage earners, necessarily makes the repayment of those debts more difficult. Thus, the actual damage to the ability of wage earners as a group to pay their debts is done before the fall in wage rates. It is the result of a financial contraction. 78
The fall in wage rates, as I say, at most merely redistributes the greater debt burden. And, as I have shown, in the process it actually improves the economic situation of the wage earners to whom the debt burden is transferred, by virtue of bringing about full employment and thus the elimination of the burden imposed on these workers of having to support the unemployed, while at the same time reducing the prices these workers must pay. And then, of course, following the fall in wage rates and prices, with the passage of time and the replacement of expiring debt contracts with new ones made in accordance with the lower level of prices, the greater debt burden is eliminated altogether. In addition, the greater division of labor and resumption of capital accumulation or more rapid capital accumulation that goes with full employment in a free market operates progressively to raise the productivity of labor and real wages. In sum, when unemployment exists, a fall in wage rates is a necessary and benevolent phenomenon that eliminates the unemployment and operates to raise the general standard of living.
A case in which the fall in wage rates necessary to eliminate unemployment might actually reduce the average level of real wages in a country is that of a relatively small country whose citizens are confined to the narrow labor market of their own country by other countries’ immigration barriers. To the extent that the fall in wage rates in such a country achieves full employment by reducing the costs of production and prices of its exports, it is the real wages of workers in other countries that are increased. In this case, however, there is present not only the at least partially offsetting beneficial effect of eliminating the burden of the unemployed, but also the incentive to additional foreign investment in the country that is provided by its lower level of wage rates. And, of course, the workers of the country benefit from all wage reductions in foreign countries insofar as they lead to lower prices of imports into the country.
This case appears to fit present conditions in Ireland, for example, where there is a substantial unemployment rate. Ireland could achieve full employment by means of a fall in its wage rates, which in large part would make its exports more competitive and so expand employment
in its export industries. However, for the reasons explained, the effect would be a fall in real wages in Ireland until such time as wage reductions abroad and the resulting decline in the price of imports into Ireland came into play.
This case has bearing on the conditions within particular industries and regions in countries of any size. Always the effect of wage cuts and the resulting reductions in costs of production and prices is to raise the real wages of the workers who buy the product. The rise in the real wages of the workers who help to produce the product depends on the fall in wage rates and costs of production and prices in the industries whose products these workers themselves buy.
Government Interference
It should be obvious from our discussion of how the free market operates to establish full employment that what is responsible for unemployment is government interference with the operations of a free market, specifically, interference of the kind that prevents unemployed workers and employers from pursuing their self-interest. Such interference, in the form of attempts to increase or maintain the level of money wage rates, forcibly holds the level of money wage rates too high relative to the aggregate demand for labor and thus prevents the number of jobs offered from coming up to equality with the number of jobs sought. Minimum-wage laws and laws giving labor unions the power to force employers to accept artificially high union pay scales are leading examples. These laws push up or keep up wage rates and make the existing aggregate demand for labor inadequate to employ all the workers seeking employment. Unemployment insurance and welfare allowances that are high enough to be competitive with the wages that workers can earn also contribute to unemployment, by virtue of taking away the incentive to seek work.
The effect of these kinds of interference is greatly compounded by further government interference of the kind described in the last chapter, which has the effect of causing monetary contractions and thus actual reductions in the aggregate demand for labor on a largescale. When this happens, a fall in money wage rates is made necessary in order to maintain the previous level of employment. But government interference with wage rates and with the incentives to work prevents the necessary fall, and so turns the reduction in the aggregate demand for labor into a cause of permanent mass unemployment.
The government interference that causes monetary contraction is, of course, the previous adoption of a policy of inflation—i.e., an increase in the money supply at a rate more rapid than the increase in the supply of precious metals—above all, the policy of encouraging credit expansion and the creation of fiduciary media. 79 The effect of this policy is to cause demand of all types, including the demand for labor, to increase to a level that can be sustained only by the continuation, indeed, only by the acceleration of the inflation. When the inflation is stopped, significantly slowed, or even merely fails to accelerate sufficiently, a contraction in spending develops.
In effect, inflation operates like a narcotic, whose stimulative effect requires increasing doses. If the narcotic is cut off, or available only in lesser quantity, or even just in insufficiently increased quantity, there is a crash. Inflation has these effects because it induces people to overextend themselves financially, in the expectation of gaining from the effects of further inflation. 80
As we have seen, once underway, a monetary contraction can be accompanied, and greatly intensified, by an actual deflation of the money supply—that is, by an actual reduction in the quantity of money. This occurs as the result of a substantial number of borrowers becoming unable to repay debts to banks. Inflation and credit expansion had encouraged them to borrow heavily, in the expectation of gaining from the fall in the value of money caused by inflation, and from the rate of profit and rise in prices continuing to outstrip the rate of interest they had to pay, which was artificially held down by credit expansion. 81 When this turns out no longer to be the case, people find that they are saddled with debts that they cannot pay. 82 Their default on debts to banks then destroys the solvency of various banks, with the result that such banks cannot honor their deposits. Insofar as the deposits in question are checking deposits, the effect is a reduction in the quantity of money. Checking deposits held at a solvent bank are a means of payment, just as much as currency and coin. Checking deposits held at an insolvent bank have more in common with Czarist bonds. They cannot be used in making payments. As a result, as banks fail, the quantity of money is actually reduced. 83
As we know, this causes a further contraction in spending, greater difficulties in repaying debts, and still more bank failures. Potentially, the process could go on until all of the debt-backed money supply—all the fiduciary media—had been eliminated, and all that remained was standard money—that is, money that is not a claim to anything else, but is itself the means of final payment, such as gold coin or bullion on a gold standard. 84 This appears to have been on the verge of happening in the banking crisis of 1933.
Knowledge of the fact that unemployment can be eliminated by virtue of a fall in wage rates and prices, and that government interference is what prevents this,
implies that there is absolutely no necessity for any kind of “trade-off” between inflation and unemployment, as is claimed by the supporters of the socalled Phillips curve. 85 In a free market, full employment is achievable precisely by means of a fall in wage rates and prices. The Phillips curve analysis, however, is so imbued with the spirit of government intervention and Keynesianism that it is blind to the very possibility of this occurring. In effect, in terms of the most elementary supply-and-demand analysis, it fails to see how increases in quantities bought and sold can be achieved from the side of supply, at lower prices. It assumes that increases in quantities bought and sold originating on the side of supply are simply impossible and that only increases originating on the side of demand are possible. Only in that way can it arrive at the notion that a reduction in the unemployment rate must be accompanied by rising prices. As we shall see, where government interference makes it impossible to eliminate unemployment by means of a fall in wage rates and prices, it is also not possible to eliminate unemployment by means of increases in demand—that is, by means of increases in the quantity of money and volume of spending in the economic system. 86
2. Unemployment and the 1929 Depression
We now know that monetary contraction is the precipitating cause of mass unemployment, which is then perpetuated by government interference in the labor market, which prevented the fall in wage rates necessary to eliminate the unemployment. In the early 1930s, the United States did not have a federal minimum-wage law. And the labor unions, although already extremely powerful in the construction and railroading industries, were not nearly as widespread as they were later to become. Nor were the incentives to avoid seeking work nearly as powerful as they were later to become. Nevertheless, in this period, the federal government, under President Hoover, actively intervened against a fall in wage rates, and at a series of White House conferences obtained the agreement of the leading businessmen of the country not to reduce wage rates. Hoover, along with a majority of the businessmen of the time, naïvely believed that a fall in wage rates was equivalent to a fall in total wage payments and would thus result in a reduction in consumer spending and a deepening of the depression. 87 This mistaken belief was the reason he intervened against falling wage rates. Hoover’s intervention was reinforced by the influence of the philosophy of altruism insofar as that philosophy played a role in the decisions of businessmen. For altruism too implies that employers should not take advantage of the existence of unemployment to reduce wage rates. 88
The effect of such interference was that the fall in wage rates took place at a much slower rate than in any previous depression. Average wage rates dropped less than 2.5 percent in 1930 and only about 6.5 percent in 1931. 89 In contrast, they had dropped 19 percent in one year in the depression of 1920–21, which was extremely short-lived as a result. 90
The effect of the failure of wage rates to fall was an unnecessary deepening of the depression, requiring a much greater fall in wage rates to restore full employment than would have been necessary if they had been allowed to fall right away. This was the case because businessmen who contemplated investments in plant and equipment and inventory accumulation had to realize that until wage rates fell, the level of construction costs and inventory acquisition costs was substantially higher in the present than it was likely to be in the future, with no compensating advantage of lower costs in the present compared with the past. 91 As a result, businessmen had a powerful incentive to postpone such investments—and did postpone them. Investment spending for plant and equipment and the net change in business inventories fell by 37 percent in 1930, by 45 percent in 1931, and by 83 percent in 1932! 92
This collapse in investment spending and inventory holdings, because of the failure of wage rates to fall, caused a virtual wiping out of business profitability. The wiping out of business profitability ensued because the collapse in plant and equipment spending meant a corresponding reduction in business sales revenues in the economic system, while depreciation costs, reflecting the plant and equipment spending of many prior years, could hardly fall at all. Similarly, the drop in spending for inventory and work in progress also meant a corresponding decline in sales revenues in the economic system. But cost of goods sold continued to reflect the higher outlays for inventory and work in progress made in previous years, and thus fell only with a lag. 93 As a result, with sales revenues reduced far more than the costs deducted from those sales revenues, profits were slashed in tandem with the fall in investment.
With the decline in sales revenues and profits came a corresponding diminution of the ability of business firms to repay debt. Thus, as a further result, bank failures were precipitated which otherwise need not have occurred. The deflation of the money supply caused by these bank failures, of course, resulted in further declines in the volume of spending, and thus in more unemployment and in a need for a still greater decline in wage rates if full employment were to be restored.
In creating the prospect that investments made in the present would be at a major competitive disadvantage with investments made in the future, the effect of the
failure of wage rates to fall, or to fall sufficiently, was to block a major source of the inherent profitability that exists in a free economy in the form of virtual “springs to profitability,” as it were, whose nature I will explain later in this book. Had wage rates fallen to their equilibrium level, so that there would have been no problem of investments made in the present being at a competitive disadvantage with investments made in the future, then, as we shall see, the very fact of the absence of profitability, or its unduly low rate, would itself have provided an impetus to an increase in the degree of capital intensiveness in the economic system and thus to stepped up investment and thereby the restoration of profitability. It could not do so, however, in an environment in which more-capital-intensive investments made in the present were also likely to turn out to be losing propositions in competition with more-capital-intensive investments made in the future. 94
It should be observed, of course, that an important implication of the fact that until wage rates fall to their equilibrium level, investment spending is postponed, is that when wage rates do fall to their equilibrium level, the demand for labor actually increases. This is because at that point investment spending is restored. An important implication of this increase in the demand for labor, in turn, is that it is actually a mistake to look at the level of total payroll spending in the depths of a depression and to assume that the fall in wage rates necessary to achieve full employment must be such as to permit the full number of workers to be employed with that level of payroll spending. Actually, the necessary fall in wage rates is substantially less than this, because the fall in wage rates to the point of full employment will be accompanied by a rise in total payroll spending in conjunction with the decline in the demand for money that occurs as the result of the restoration of the competitiveness of investments made in the present with investments made in the future.
With the restoration of investment spending, of course, comes a restoration of general business profitability as well. For business sales revenues now rise relative to depreciation costs and cost of goods sold. Thus, the fall in wage rates to their new equilibrium level is the foundation not only of the restoration of full employment, but also of investment spending and general business profitability. 95
3. Unemployment, the New Deal, and World War II
I have explained how government interference in the early 1930s prevented a fall in wage rates from eliminating unemployment and thus deepened the depression and greatly intensified the problem of unemployment. The monetary contraction which represented the onset of the depression was also the product of government interference, as I have shown. 96 Specifically, it was the product of the expansionary monetary policy of the Federal Reserve System and foreign central banks in the 1920s, which built on a base laid by the massive inflations of World War I. This led to a rise in the velocity of circulation of money, which could be sustained only by the continuation—indeed, ultimately, only by the acceleration—of inflation and credit expansion. It also led to the incurrence of an even greater increase in the volume of debt, because inflation in the form of credit expansion holds interest rates at an artificially low level relative to the higher rate of profit and the rise in prices it causes. It thus encourages people to contract larger volumes of debt relative to their already artificially increased revenues, incomes, and asset values. 97 In addition, the process of inflation and credit expansion leads to numerous malinvestments—investments whose profitability is created and exists only so long as the inflation and credit expansion continue or accelerate. 98 Finally, the potential for the actual deflation of the money supply was also created by government interference—interference in support of fractional reserve banking, in order to make credit expansion possible. This form of interference spanned generations, as previously explained. 99 Having thus created all the necessary potential for a monetary contraction, that potential was actualized by the Federal Reserve’s return to a very modest 1.1 percent compound annual rate of increase in the money supply between June 1925 and June 1929. 100
Starting in 1933, with the New Deal and the overthrow of the gold standard, the government was able to inaugurate a policy of permanent inflation. Since 1933, the quantity of money and the total volume of spending in the economic system—including, of course, payroll spending—has increased significantly in almost every year. Despite the rise in payroll spending, mass unemployment continued in the United States until the country’s entry into World War II. It did so, because the far more powerful labor-union movement created under the New Deal was able to increase wage rates at a substantial rate even in the midst of mass unemployment, with the result that the larger payrolls achieved by inflation could not employ correspondingly more labor or, indeed, enough additional labor to make any major headway in eliminating unemployment. (The rates of increase in average annual wages paid by private employers for the years 1934 to 1937 were 5.7 percent, 4.9 percent, 5.6 percent, and 8.3 percent respectively. 101 ) Thus, while approximately 12 million workers were reported as unemployed in 1932, and 12.8 million in 1933, the numbers for 1934–1940 were not radically reduced. Indeed, when the
substantial numbers of workers employed by the government in various artificial work-relief programs are added to the number of workers reported as openly unemployed, the unemployment record turns out to be as follows: 1933: 13.5 million; 1934: 12.7 million; 1935: 12.1 million; 1936: 11.4 million; 1937: 9.3 million; 1938: 12.5 million; 1939: 11.5 million; 1940: 9.9 million. 102
The increase in union power began with The Norris-La Guardia Act of 1932, passed in the final year of the Hoover administration. This act prohibited the granting of federal court injunctions against mass picketing and other forms of union coercion. It was followed by the National Industrial Recovery Act of 1933, which was subsequently declared unconstitutional but whose provisions dealing with labor were reinstated in the Wagner Act of 1935. This legislation compelled employers to recognize labor unions and to bargain with them. These laws were the basis of the unionization of such major industries as steel, automobiles, coal, rubber, clothing, meatpacking, and cement. Their result was to compel even most nonunion employers to match union wage increases, lest they too be unionized and end up not only having to pay the higher union wages but also lose much of their ability to determine methods of production. The Fair Labor Standards Act of 1938 established a federal minimum wage. Thus, prounion legislation and minimum-wage legislation substantially raised wage rates in the midst of mass unemployment and thereby prevented the larger payrolls produced by inflation from substantially reducing, let alone eliminating, unemployment.
Furthermore, insofar as the additional employment which resulted in connection with the policy of inflation was employment on government projects, or in providing the materials and equipment for such projects, it did not represent any real solution to the unemployment problem, as I have indicated. Indeed, it represented an actual loss to the workers producing in the rest of the economic system, who had to support it. The workers in the rest of the economic system had to supply goods and services to the workers newly employed in connection with government projects—substantially more goods and services than would have had to be provided if those workers had remained unemployed. This is because they had to supply them with a higher standard of living than the newly employed workers would have received had they remained unemployed. In addition, they had to supply them with materials and equipment with which to work, which would not have been required had those workers remained unemployed. But all that the workers in the rest of the economic system could receive from those newly employed workers was the government projects, which were undertaken not because of any actual value on their part but because of a desire to create employment. In the circumstances, the projects could not constitute compensation to those whose goods and services had to pay for them. In effect, a broken circle existed: part of the output of those already employed—a greater part than before—was turned over to those newly employed, but the output of the newly employed went to the government and thus could not constitute compensation to those already employed. In effect, it was a case of Mr. A giving employment to Mr. B, and sending the bill to Mr. C. The last individual, Mr. C—the mass of the general public—necessarily lost by such an arrangement.
(As an example of this phenomenon that I give to my students, I ask them to imagine that our class constitutes an economic system and that the students in the front row are unemployed. I assume the role of the government and offer to employ those students in doing various jobs for me. In a closed economic system, the rest of the class is the only possible source of goods and services for these reemployed students. Thus, in one way or another it will be billed for their employment. I point out how much greater its bill will be if I employ the previously unemployed students in a project that requires the use of substantial materials and equipment, such as building a house for me.)
Thus, to the extent that it exists, the effect of government-caused reemployment is to reduce the standard of living of those already employed. This is in sharpest contrast to the effect of reemployment achieved by the competition of a free market, which is to eliminate the burden of supporting the unemployed. In a free market, an unemployed worker gets a job and supports himself. Under government make-work schemes, the previously unemployed worker becomes a greater burden than before.
The problem of mass unemployment came to an end with the country’s entry into World War II. This happened not because, as the consumptionists believe, the war created new and additional needs and desires for wealth. As I have shown, for all practical purposes the need and desire for wealth are always infinite. It did not even happen because the war was largely financed by a massive creation of new and additional money. In a context in which monopoly labor unions and other government intervention prevent unemployment from being eliminated by a fall in wage rates, the same forces operate to cause a rise in wage rates in the face of a rising demand for labor and thus to make the rising demand for labor incapable of eliminating the unemployment.
Why Inflation Cannot Achieve Full Employment
As I have just indicated, in a context of powerful monopoly labor unions, inflation of the money supply, by itself, cannot achieve full employment. This is be—
cause it removes the brake on union demands for higher wages. Its very existence makes it possible for the unions to pursue their policy of raising wage rates, even in the midst of mass unemployment, because it puts them in the position of being able to do so without fear of causing still greater unemployment of their members. For, with inflation, employers have the necessary funds to pay higher wage rates to an unchanged number of workers, and buyers of products have the necessary funds to buy an unchanged quantity of output at the higher prices corresponding to the higher wage rates. In addition, the unions are encouraged in their demands because, as we have seen, the spending of a larger quantity of money operates to increase nominal profits. The rise in profits operates as a red flag to the unions, signalling an automatic justification in their eyes for a rise in wage rates. Finally, as soon as the increase in the quantity of money and volume of spending begin to raise prices—whether because they encounter goods available only in limited quantity, whose prices must rise in the face of an increased demand, or because they lead to a rise in wage rates and thus costs of production, in the ways just described—the unions feel entitled to demand wage increases to keep pace with the price increases. For these reasons, in a context in which a fall in wages and prices is prevented from achieving full employment, a policy of inflation by itself also cannot achieve full employment.
Inflation Plus Price and Wage Controls
What made it possible for World War II to be accompanied by the restoration of full employment was not even the drafting of more than twelve million men into the armed forces, though this did make some contribution. For insofar as these men had jobs and were supporting, or helping to support, families before our involvement in the war, their disappearance from the labor market necessarily caused large numbers of women and youths to enter the labor market in order to serve as substitute breadwinners. The reason there was a larger total number of jobs available when these groups entered the labor market was the combination of a policy of massive inflation coupled with wage and price controls.
The effect of this combination was that when inflation raised the demand for labor and products, wage and price controls prevented a corresponding rise in wage rates and prices. Thus, the larger volumes of spending for labor and products were able to purchase larger quantities of labor and products. Indeed, very quickly, mass unemployment and a situation of unsalable goods was transformed into an actual shortage of labor and products. In this way, the war did solve the unemployment problem. It did so in accordance with the same principle on which the problem could have been solved without a war—namely, a fall in wage rates and prices relative to the volume of spending for labor and goods.
This relative fall could have taken place in peacetime, without inflation, by means of free competition serving to reduce wage rates and prices absolutely in the face of a slowly increasing quantity of money. Instead, it took place in wartime, by means of the combination of inflation and wage and price controls, which achieved the necessary relative fall in wage rates and prices by means of a rapid increase in the quantity of money coupled with forcible restraint on the ability of wage rates and prices to rise.
Thus, the war was not at all necessary to achieve full employment. Its only economic contribution was that it served to nullify the destructive peacetime government interference in the labor market that had prevented the achievement of full employment, namely, the fixing of wage rates too high in relation to the demand for labor. It did this in the course of unleashing far greater, far more destructive government interference in the economic system and in people’s lives generally, which is the inevitable accompaniment of any major war. How much simpler it would have been to achieve full employment by openly repealing the peacetime government interference in the labor market and avoiding the war. One may think of the government’s peacetime interference in the labor market as the equivalent of forcing someone to wear a pair of shoes that is several sizes too small and thus extremely painful. The obvious, simple way to solve the problem is to stop forcing the person to wear that pair of shoes and to let him choose his own pair of shoes. War as a means of eliminating unemployment, through the combination of inflation and price controls, is comparable to the government making the wearer’s feet fit the wrong pair of shoes by means of chopping off part of his feet. And to this, of course, must be added all the grosser dismemberments and destruction of life and property that are the literal accompaniment of war.
World War II as the Cause of Impoverishment in the United States
The fact that World War II was accompanied by the restoration of full employment does not mean, as is so often believed, that it was a period of prosperity. While some people were rendered materially better off, the immense majority were severely impoverished. As we have already seen, as the result both of the wholesale prohibition of major categories of civilian production, in order to concentrate on war production, and of shortages of practically all civilian goods that were still allowed to be produced, the standard of living of the average American family during World War II was reduced to a point far below its level in the worst years of the depression. 103
As in the case of government make-work schemes in peacetime, any additional employment achieved by the government in wartime is at the expense of the great majority of people who are already employed. From their perspective, such additional employment is always a case of their having to pay the bill for the additional employment, in terms of the part of their output that they turn over to the reemployed or provide to them in the form of materials and equipment, and for which they receive no compensating output because the goods and services of the reemployed are of minimal economic value or altogether economically useless, which last is certainly the case when the output is war goods.
An additional aspect of the reduction in the standard of living of the great majority of the American people was the fact that people worked longer and harder during the war and, as I have indicated, many people found it necessary to work who otherwise would not have found it necessary to work, such as many housewives, high school students, and retirees. As shown, despite all extra work, the average family received much less than it did before the war. This was the inevitable result of the economic system being made to produce for the war. If roughly half the net output of the economy goes for the war, as it did in World War II, then the most that can remain for the producers is roughly half of the net product of their labor. Such a situation means that the average family must have less and work more, in order not to have too much less.
As we have also seen, during the war most people did not realize how much worse off they actually were, because people usually measure their wellbeing in terms of the money they earn or their property is worth. The massive creation of money during the war increased practically everyone’s money income and the money value of his assets. People simply didn’t stop to think that much of the money they earned was unuseable for anything but the purchase of government bonds, or the accumulation of savings accounts invested in government bonds. In addition, as I explained in my discussion of universal price controls in Chapter 7, the very existence of shortages contributed to a delusion of prosperity during the war. Under shortages, nothing more is required of a businessman than that he succeed in delivering to the market some semblance of what his product is supposed to be, because the buyers will snap up practically anything that has greater utility than the otherwise unspendable paper money. By the same token, anyone can quickly find employment who fulfills even the most minimal requirements of a job. 104
And, finally, it should never be forgotten that the full employment of World War II was accompanied by a profound threat to the freedom of employment, owing to the chaotic conditions that always accompany a shortage of labor. This threat, of course, was expressed in President Roosevelt’s proposal of forced labor in the United States, in his 1944 State of the Union Message. 105
Prosperity Based on the Return of Peace
While the war was accompanied by full employment under conditions of impoverishment, full employment under conditions of prosperity was made possible only by the return of peace. The restoration of peace made possible a radical reduction in government spending and thus in the portion of the output of the economic system absorbed by the government. It put an end to the government’s massive printing of money to buy up output and correspondingly reduce the output remaining to the citizens, who had produced the output. Between 1944, the last full year of the war, and 1946, the first full year of peace, federal government spending was reduced from $100 billion (which equalled more than half of the net national product of the time) to $38 billion, and approximately eight million soldiers and sailors were discharged. 106
The reduction in government spending made possible a corresponding increase in private spending to the extent that taxes were slashed and the funds previously going to the purchase of government bonds likewise became available for private use. The government’s spending for tanks, planes, and artillery shells was replaced by private spending for passenger automobiles, houses, and all kinds of other civilian goods, whose physical production was made possible by the fact that labor and capital were no longer required to produce the war goods. Of course, the returning soldiers and sailors also greatly contributed to the rise in the standard of living of the average family, insofar as their labor did not merely take the place of the labor of other family members but was added to it or represented more productive labor. This made possible an increase in the total volume of production. The abolition of wage and price controls following the end of the war eliminated the shortages and inefficiencies they had caused, and thus it too powerfully contributed to an increase in the overall volume of production and rise in the standard of living.
The end of wage controls was not accompanied by any substantial increase in unemployment. This was because the return to peace made possible a vast increase in private employment and rise in the general standard of living not only in the ways I have described, but also by virtue of increasing the capital funds in the possession of business firms. Thus, when government spending fell and demand shifted from war goods to peacetime goods, business did not simply shift a given amount of capital funds from war production to peace production. On the
contrary, the total amount of capital funds in its possession increased, as the result of sharp reductions in its tax burden and in the drain of funds into the purchase of government bonds. Thus, business was in a position to increase its overall demand for labor and capital goods. The return to peace, therefore, meant a rise in wage payments relative to consumer spending, and a rise in the demand for, and production of, capital goods relative to consumers’ goods. Our discussion of the determinants of real wages and the general standard of living in the next chapter will show that no development could be more conducive to raising the general level of real wages and to enabling them to go on rising. 107 In this context, major increases in wage rates, both nominal and real, could take place without causing unemployment or higher prices. At the time, and thereafter, the unions followed their normal, relatively conservative policy of seeking increases in real wages only modestly above those provided by the market. Such increases can, of course, gradually produce a substantial rate of unemployment over a period of years, and should not, therefore, be dismissed as unimportant. But the contribution of the labor unions to an immediate problem of mass unemployment is generally in the context of a depression, when the demand for labor sharply falls and the unions refuse to allow corresponding reductions in money wage rates.
A Rational FullEmployment Policy
Governments all over the world are concerned with policies designed to achieve or maintain full employment. To achieve this end, they typically enact policies of inflation, public works, featherbedding, and, indeed, war. But this chapter points to a far more rational policy. Namely, the establishment of a free market in labor, so that wage rates can be adjusted to correspond with the state of the demand for labor and thus make any given monetary demand for labor—any given amount of payroll spending—sufficient to provide full employment. It and the chapter before it also point to the adoption of a 100-percent-reserve gold standard, so that no financial contraction need ever occur and thus no precipitation even of temporary mass unemployment. Such contraction would not occur, because there would be no preceding inflation or credit expansion to set the stage for it by artificially increasing the velocity of circulation of money, promoting the incurrence of debt, and creating money of the kind whose supply can subsequently be decreased by the failure of debtors.
This policy would guarantee full employment in a context of the highest possible productivity of labor. The policies presently pursued by governments are all highly destructive, in serving to reduce the productivity of labor. In addition, for the most part, they are not even capable of actually increasing the overall volume of employment but merely the employment of some at the expense of the employment of others. Unlike those policies, this policy would operate to the benefit of everyone.
The achievement of a free market in labor and a 100-percent-reserve gold standard would mean the elimination of one of modern life’s greatest anxieties: the fear of losing one’s job and not being able to find another, and thus of being deprived of the ability to support oneself and one’s family. With a free market in labor and a 100-percent-reserve gold standard, there would always be jobs available. And they would be available without having to wait for any largescale decline in wage rates. Thus, there would always be a readily available way to earn money. The loss of any given job would cease to be the life-threatening calamity it now so often is and would at most be the source of some temporary unpleasantness.
Appendix to Chapter 13: Inventories and Depressions
An accumulation of business inventories which is excessive in relation to prospective sales volume is almost always associated with the beginning of a depression or recession. 108 The basis of the association is usually explained in the following way: Businessmen find that their inventories are excessive and begin to liquidate them. In order to liquidate them, they attempt to expand their volume of sales while at the same time reducing their volume of production. In reducing their volume of production, they cut back orders with their suppliers and lay off workers. The effect of these cutbacks is to make it more difficult for business firms to expand their sales volume. For the firms that supply other
firms find their orders cut. And the firms that sell to consumers find that many of their customers are unemployed. Thus, inventories continue to be excessive, and further production cutbacks are undertaken, leading to a repetition of the same results.
On the basis of this view, it is easy to conclude that the wealth which the excess inventories constitute is an obstacle to production, employment, and prosperity— that its existence drives economic activity to lower and lower levels, until, by one means or another, it is finally consumed. And, indeed, most people apparently do draw this conclusion. It is generally believed that only the elimination of the wealth constituted by the excess inPRODUCTIONISM, SAY’S LAW, AND UNEMPLOYMENT 595 ventories can set the stage for a restoration of production and employment; only then, supposedly, will there be a purpose to be served by maintaining production and employment. This belief is propounded in virtually all financial publications and in practically all economics textbooks. They allege that excess inventories are a cause of depressions and that recovery from a depression begins when inventories have been reduced to the point where additional sales physically require additional production.
The following quotation from a story in the financial section of The New York Times some years ago clearly expresses this idea:
He [the Assistant Secretary of Commerce for Economic
Affairs] cited, in particular, as a probable cause of continued downturn, the fact that businesses continued to add to their inventories in the fourth quarter. . . . The inventory position of businesses is important because, to the extent that businesses have more inventory on hand than they really need, they cut their production schedules until they have sold the excess. 109
Similarly, a widely-used economics textbook argues that businesses are “ready to start up again,” after they
110 have reached “a position where inventories are short.”
It should be held in mind that these statements and countless similar statements are made not in reference to the production of particular products, but in reference to economic activity in general. They do not say that the production of this or that particular item will be decreased or increased depending on whether its inventory is excessive or deficient. They claim that the general level of economic activity is inversely related to the size of inventories—that the presence of excess inventories is a general economic depressant, and that a shortage of inventories is a general economic stimulant.
Now such ideas have absurd implications. They imply that the existence of wealth is a cause of poverty and, further, that prosperity could be achieved through the destruction of wealth. These implications are inescapable, for if, in fact, the existence of excess inventories were an obstacle to production and employment, the wealth they represent would be a cause of poverty. And it would follow that production, employment, and prosperity could be restored by burning down warehouses and destroying the excess inventories.
The supporters of the excess-inventory doctrine, of course, are rarely consistent enough to draw such logical inferences from their premises. Instead of recommending arson, they recommend government spending. The government, they urge, should give people money to buy up quantities of goods, thereby reducing inventories and, it is held, restoring the need to produce. Whether they recommend arson or government spending, however, what is essential is that they perceive the physical wealth constituted by excess inventories as an obstacle to prosperity and call for its removal.
What I will show is that the existence of excess inventories relative to sales volume, while certainly a cause of unemployment in particular lines of work, is not a cause of general unemployment or depressions, even though it is almost always closely associated with these phenomena. I will show that the reason for the association of excess inventories with depressions is that both are the effects of the same underlying cause: namely, an inflation of the money supply. I will show that inflation— i.e., an increase in the quantity of money caused by the government—brings about a wasteful accumulation of inventories at the expense of other, more efficient forms of wealth, thereby reducing the overall quantity of wealth. When inflation stops or is significantly slowed, these losses are revealed. The existence of the excess inventories themselves, however, then serves to help make good for the losses which have occurred in other forms of wealth.
The connection I will demonstrate between excess inventories and the impoverishment of depressions can be described by the following analogy: Imagine a miraculous kind of typhoon that came and pulled out all the lumber in houses and left it neatly stacked in lumber yards. The existence of this lumber would have two connections to the state of economic wellbeing. On the one hand, the greater the quantity of such lumber, the more damaging the preceding typhoon must have been. On the other hand, the existence of the lumber would be a means to repair the damage, and if more lumber could be brought into existence through means other than the typhoon, the restoration of prosperity would be so much the easier. This, I will show, is the nature of the excess inventories that exist at the onset of a depression. They are the effect of a process of impoverishment, but are themselves a cause acting in the direction of prosperity. The real problem is not that they are excessive, but, from the standpoint of making up for the damage done, deficient. In addition, as part of this demonstration, I will show that the decline in the spending of money that takes place with the onset of a depression is not the result of the existence of excess inventories, but of other factors associated with inflation and its cessation or slowing down. In other words, I will show that all of the adverse or seemingly adverse consequences usually attributed to excess inventories are merely associational and not caused by the inventories, and that the effect of the existence of the inventories themselves is entirely to the good.
Inventories and Capital
The underlying fallacy in the doctrine that excess inventories cause depressions and general unemployment becomes obvious when one considers the situation
596 CAPITALISM of an imaginary Robinson Crusoe on a desert island. If Crusoe is able to salvage a year’s supply of canned goods from his ship, he has an excess inventory of food. Does this mean that if he is an industrious person and does not want to spend a year stagnating on his beach, until the need to obtain additional food is forced upon him by the exhaustion of his inventory, he should throw the canned goods back into the ocean? Common sense and economic science must answer no.
The possession of the excess inventory of food does not prevent Crusoe from working. It simply spares him the necessity of directly and immediately producing additional food. During the year in which he does not have to devote his labor to picking berries or killing animals with his bare hands, he can produce other goods, which without the inventory of food he would not have had the time to produce. Above all, he can produce tools, implements, and materials which will enhance his ability to produce food and other goods after his initial inventory is exhausted.
The excess inventory of food is not an obstacle to Crusoe’s employment and production. On the contrary, it is the source of his employment in the production of other things. It is a fund which supports him while he works and thus makes possible the production of other things. As the inventory of food is consumed, other forms of wealth are produced. Indirectly, by way of supporting his labor, the excess inventory of food is transformed into tools, implements, materials, and supplies of goods that are ready for final consumption, none of which wealth is excessive in any sense.
Were it not for this excess inventory, certainly, Crusoe’s production would be curtailed, both in the present and in the future. In the present, he would be limited to the attempt to produce the barest supply of food. And in the future, his production would not have the advantage of the tools, implements, and materials which are made possible by the excess inventory of food. The time which he could devote to employment in the abstract would be no less, but he would have no employment insofar as it contributed to or depended on the use of tools, implements, and materials whose production only the excess inventory of food could make possible.
The underlying fallacy in the doctrine that excess inventories cause depressions is that it does not see production in its full context. It does not see excess inventories as a base for the production of tools, implements, plant and equipment, and other inventories which are not excessive. It does not grasp how one type of wealth can be transformed into another type by means of its consumption serving as the support for the other’s production.
The principles pertaining to Crusoe’s economy pertain equally to the more complicated, monetary economy of today.
An inventory is a source of sales receipts. A firm which possesses an excess inventory possesses to that extent a source of revenue which does not have to be devoted to the reproduction of the inventory. The money gradually coming in from the sale of the excess inventory over time is available to be spent by the firm for other purposes or to be lent to other firms. It can be used to finance construction projects, the purchase of machinery, or the production of inventories of other goods. What is certain is that the money will not be hoarded merely because it is not required to reproduce the same inventory. Not spending to reproduce a particular inventory is not, as is naïvely assumed, not to spend at all.
A canning firm with an excess inventory will reduce its expenditures to produce inventories of canned goods, just as Crusoe with an excess inventory of food will not labor to produce food. But this does not mean that the overall expenditures of the canning firm or of those to whom it lends will be reduced, any more than it means Crusoe does not work because he does not work at producing food.
Moreover, it is not a contradiction to argue that firms with excess inventories may employ the revenues those inventories bring in to expand the plant facilities for producing the very goods inventories of which are said to be excessive. It is altogether possible, for example, that an automobile firm might employ the revenues from its excess inventory for the purpose of installing additional facilities for the production of automobiles. For its present inventory is not excessive in the absolute sense that there are not enough potential buyers of cars—at lower prices there would be. It is only excessive in the sense that present costs, using present plant and equipment, are too high to make the rapid sale of the inventory profitable at the lower prices that would be necessary to sell it quickly. If, however, the inventory can be used to finance the installation of lower-cost plant and equipment, it is altogether possible that subsequently the firm’s regular production and sales might be profitable at such an expanded volume that what is presently considered to be an excessive inventory in relation to sales, would at that time be considered a deficient inventory.
The causal as opposed to the associational relationship between inventories and depressions is not merely different from what is generally believed, it is the exact opposite. In a depression and in the period which precipitates a depression, inventories are excessive only in relation to sales volume. As an asset item, however, they are deficient. They are deficient in the sense that if they
PRODUCTIONISM, SAY’S LAW, AND UNEMPLOYMENT 597 were sufficiently larger, the mass bankruptcy of business enterprises, which is an outstanding feature of a depression, could not possibly take place. An inventory is an asset. No firm has ever or will ever go bankrupt because its assets are too large. Bankruptcies result from assets— from inventories—not being large enough.
To the degree that an enterprise possesses a large inventory, it is necessarily in a sounder financial position. Its assets exceed its liabilities by that much more. Its owners are richer. It represents a safer investment for creditors. It itself is more in a position to grant credit to others. To argue that it could go bankrupt because it possessed excessive inventories is to argue that Rockefeller could go bankrupt because he owned too many oil wells.
An inventory is wealth. Whoever possesses an inventory obtains the money he needs by the sale of goods out of his inventory, and, if necessary, can always borrow against the inventory. A rich man is not someone with a great hoard of money, but someone with a large ownership of physical assets, of which inventory is a major form. To be wealthy does not mean to have a vast hoard of paper dollars in some strongbox. It means owning a store full of valuable goods, a lot full of automobiles, a warehouse full of merchandise.
By definition, wealthy people do not go bankrupt so long as they continue to be wealthy. And they continue to be wealthy to the degree that they own physical assets such as inventories.
What is true is that an enterprise can be plunged into bankruptcy if it holds an excessive inventory that is financed by the incurrence of debt. But then the cause is not the inventory, but the debt. If the firm had a larger inventory and the same debt, it would be less likely to be bankrupted, while if it had a smaller inventory and the same debt, it would more surely be bankrupted.
The possession of excess inventories is not only incompatible with the bankruptcy of those who possess them, but of others, who do not possess them. The existence of excess inventories guarantees a state of genuine credit ease. The owners of such inventories are ready lenders to those seeking capital. Businesses do not go bankrupt when credit is easily obtainable. They go bankrupt when credit is difficult to obtain. And it becomes difficult to obtain when capital, of which inventories are a leading form, is deficient and funds must be retained in the enterprises which earn them in order to maintain current or prospective operations.
In sum, if inventories were truly excessive, there could not possibly be a credit contraction or mass bankruptcies. Those who truly possess excessive inventories do not appear in the market with a desperate need for funds; they more likely appear as lenders rather than as borrowers. And because—to the degree that their inventories are excessive—they afford strong security on any loans they have taken out, they are not pressed by their creditors; if they are asked to repay their debts, they have the means of doing so. It is firms with an asset-inventory deficiency which have an urgent need for money; it is such firms which are unable to repay their debts and which go bankrupt. But even many of these firms would not go bankrupt, if other firms possessed excess inventories and were therefore in a position to extend them credit.
Rather than calling for the elimination of excess inventories, it would be far more logical to argue that what is needed to end a depression is precisely an accumulation of inventories. For it is additional capital that is required, and to whatever extent additional inventories could be brought into being without first entailing a loss of other forms of capital, they would constitute additional capital. A policy of deliberate consumption of inventories, on the other hand, only destroys the means of supporting employment and production and of extending credit. Such a policy can only intensify a depression.
“Excess” Inventories, Malinvestment, and the
Deficiency of Inventories
None of these observations is contradicted by anything in anyone’s experience. For example, it might be thought that the large inventories held by the automobile industry in the recession of 1974–75 were a cause of that recession. This is not true. The only connection between the inventory of the automobile firms and the recession was that the capital to produce this inventory had been invested at the expense of other employments which could have put it to better use. Had the auto industry not proceeded with the production of this inventory, capital funds would have been available to construct other things, such as power plants, houses, and, perhaps, lower-cost manufacturing facilities for automobiles. Instead, this capital was wasted to a significant degree by having been invested in an inventory of automobiles. But given the malinvestment of capital in producing automobiles, it is far better that the inventory of automobiles existed than that it did not exist. This is so because the sale of cars out of inventory made it possible for much of the malinvested capital to be recovered. Revenues the auto industry took in from the sale of its inventory could be made available for financing these other things, thus helping to rectify the initial mistake.
And if, given the same degree of malinvestment, the inventories of the auto firms had been larger than they were, the severity of the recession would have been less. Imagine, for example, that by some miracle, the auto industry had awakened one morning in 1975 to find
598 CAPITALISM everything else the same except that instead of having an inventory equal to three or four months’ sales, it had an inventory twice as large. This would have represented a vast increase in the wealth of the automobile industry and of the whole economy. The auto industry, of course, would have cut back its rate of production still further. It might even have suspended current production altogether. But it would have had the financial means of continuing to pay its workers and suppliers enough to retain their services until such time as normal production resumed, and it would have had the means of infusing substantial sums of capital into all other industries. Home building could have revived, improved manufacturing facilities could have been constructed in a host of industries, more bridges and tunnels could have been built, and so on—all with funds flowing in from the sale of automobiles that did not have to be reproduced. And the suppliers and workers of the auto industry would have participated to a significant degree in the opportunities created by this genuine capital boom. The steel industry, for example, would have turned out more steel for construction and machinery while it turned out less steel for automotive use. And many of the auto industry’s workers would have been employed in producing bulldozers, cranes, trucks, locomotives, farm machinery, and the like.
As matters stood, the inventories of the auto industry and all other industries were grossly insufficient to finance all the power plants, pipelines, factories, machines, homes, and so forth, that had been neglected as the result of the malinvestment of capital due to inflation in the years preceding the 1974–75 recession.
Inflation and Credit Expansion as the Cause of Malinvestment in Inventories
Inflation is responsible for the malinvestment of capital in inventory at the expense of other forms of wealth in the following way. As the additional money constituted by inflation comes to be spent and respent, the sales revenues of businesses rise and prices rise. After a while, the continuation of this process comes to be anticipated. Businessmen come to believe that they will be able to sell inventories of goods into a steadily rising demand and at higher prices. Thus, they begin to accumulate inventory. The accumulation of inventory is greatly facilitated—indeed, would probably not be possible otherwise—by the fact that much of the expansion of the money supply enters the economy in the form of new loans. Because this additional money appears on the market as an additional supply of loanable funds, it drives down the rate of interest or prevents the rate of interest from rising to the height it would achieve as the result of inflation alone. This means that it becomes possible to borrow money at relatively low rates of interest and use it to finance the wasteful accumulation of inventories. 111
Such conditions characterized the American economy in the 1970s. Interest rates were below the rate at which prices were rising. Thus, it was possible to make money merely by stockpiling inventory.
This stockpiling of inventory is very aptly characterized by the analogy I used earlier of a typhoon that pulled the lumber out of houses and stacked it in lumber yards. The inventories, of course, do not result from the literal disassembly of already produced goods. They do result, however, at the expense of the production of other goods. Thus, piles of inventory accumulate at the expense of factories, machines, houses, and so forth, that could have been produced, if the means of producing them had not been diverted to producing inventories instead. The net result is as though these goods were destroyed and their remains thrown into piles of inventory. Inflation and credit expansion are indeed a kind of typhoon.
Why “Excess” Inventories and Monetary
Contraction Are Associated
When inflation is stopped or significantly slowed down, the uneconomic nature of the investments in inventory is revealed. First, interest rates rise, because the depressing effect on the rate of interest of inflation-financed loans is removed. And then the rise in sales revenues and prices begins to abate, because the quantity of money no longer increases or increases much less rapidly. Thus, the profit is taken out of the wasteful inventory investments, and, unless the inflation is quickly resumed, these inventories must be sold on the market at a loss.
The cessation or slowing down of inflation thus reveals widespread losses of capital in the form of unproductive inventory investments. In addition to revealing losses, the cessation or slowing down of inflation increases the need of business firms to hold cash. This effect explains why the liquidation of inventories in depressions is accompanied by “cash hoarding” rather than equivalent spending in support of other forms of capital accumulation.
During inflation, and so long as inflation is expected to continue rapidly enough, businessmen are induced to operate with unduly low levels of cash in relation to the financial size of their operations. Cash holdings fall as a percentage of assets, liabilities, revenues, and expenditures. Among the reasons is the fact that inflation in the form of credit expansion leads businessmen to believe that credit will be easily available when they need it. At the same time, they come to expect to be able to sell their inventories easily and profitably. On the basis of such convictions, they come to regard their existing levels of
PRODUCTIONISM, SAY’S LAW, AND UNEMPLOYMENT 599 cash as unnecessarily large and as better placed in income-earning assets. Thus, cash holdings come to be drawn down. Since the cash does not disappear from the economic system, but is merely transferred in exchange for something to someone else, who will also tend to be less conservative in his attitude toward cash holdings, what happens is an expansion in the volume of spending, lending, borrowing, and trading of all kinds, in relation to the quantity of money. When inflation stops or is significantly slowed down, however, the basis of the low cash holdings is removed, because credit turns out not to be available or to be available only at a much greater cost and with much greater difficulty than had been expected. And inventories turn out not to be as readily and profitably saleable as believed. Thus, when inflation stops or is significantly slowed down, business enterprises must begin to rebuild their cash holdings.
This necessary rebuilding of cash holdings is why there is a reduction in the general rate of spending in the economy and why the liquidation of excess inventories in the aftermath of an inflation, does not provide an equivalent financial support for other business activities. Namely, practically all firms are trying to retain a larger proportion of the funds they take in, in the form of cash. The sellers of the excess inventories use part of their proceeds to rebuild their own cash positions; and of the funds that these sellers do make available to others, as loans, for example, a portion is retained by the recipients in the form of replenished cash holdings. And it is the same with the liquid funds realized in any other way. Thus, the rate of spending slows down. It cannot be stressed too strongly that it is not the excess inventories that are the cause of the reduced volume of spending. On the contrary, both the excess inventories and the reduced volume of spending are the consequence of the distortions created by the preceding inflation and credit expansion.
What has been shown is that the relationship between excess inventories and depressions is one of association, not causation. Excess inventories and depressions are both the result of a process of inflation—specifically, of an inflation that enters the economy in the form of loans granted out of newly created money, that is, of credit expansion. The excess inventories represent impoverishment only in their origin—insofar as they are the result of the diversion of capital from other, more important employments. In their consequence, however, the effect of the existence of these inventories is to help make good for the losses entailed in their accumulation. And these losses would be all the more easily made good, if, with the same degree of malinvestment, the excess inventories were greater. In this sense, inventories in a depression are deficient, not excessive.
The existence of assets can never be the cause of bankruptcies. The existence of wealth can never be the cause of poverty. The possession of excess inventories that is associated with depressions does not contradict these principles in the slightest.
Notes
1. Concerning the fundamental problem of economic life, see above, pp. 42–51 and 54–61.
2. Most of what follows in this part derives from my article “Production Versus Consumption,” Freeman 14, no. 10 (October 1964), pp. 3–12; reprinted as a pamphlet (Laguna Hills, Calif.: The Jefferson School of Philosophy, Economics, and Psychology, 1991).
3. In reality, Ricardo and especially James Mill propounded it with far greater clarity and consistency than Say. In my judgment, the law should actually be called James Mill’s Law. 4. See above, p. 112.
5. For a brilliant analysis of this error and of its consequences, see Henry Hazlitt, Economics in One Lesson, new ed. (New Rochelle, N. Y.: Arlington House Publishers, 1979). See also Frederic Bastiat, “What Is Seen and What Is Not Seen” in Frederic Bastiat, Selected Essays on Political Economy, trans. Seymour Cain (New York: D. Van Nostrand, 1964).
6. On the subject of the confusion of need with demand, cf. Hazlitt, Economics in One Lesson, chap. 3.
7. John Maynard Keynes, The General Theory of Employment, Interest, and Money (New York: Harcourt Brace, 1937), p. 129. I previously quoted this passage as an illustration of irrationalism in economics, above, p. 35.
8. See below, pp. 559–561.
9. This last is because with a fixed total expenditure of money, the variation of quantity demanded with the price level is inversely proportionate. On the meaning of unit elasticity, see above, p. 158.
10. For a full explanation of the vital role of the productivity of labor in determining real wages, see below, pp. 618–622. 11. Cf. above, p. 159.
12. Cf. the brilliant analysis of the effects of machinery in Hazlitt, Economics in One Lesson, chap. 7. 13. See above, pp. 59–61. See also below, pp. 559–561. 14. See above, pp. 358–360 and 362–364.
15. See below, pp. 663–664.
16. Concerning the causes of unemployment, see below, pp. 580–589.
17. On the subject of spread-the-work, cf. Hazlitt, Economics in One Lesson, chap. 8.
18. See above, p. 277.
19. On this subject, cf. Hazlitt, Economics in One Lesson, chap. 3.
20. For elaboration of the principles involved, see below, pp.
622–642, especially pp. 622–629 and 634–639.
21. Cf. Hazlitt, Economics in One Lesson, chap. 4.
22. For an explanation of the nature of producers’ and consumers’ labor, and why government employees must be classified as the latter, see above, pp. 446–447.
23. As we shall see, consumptionist views on the benefits of a policy of imperialism go hand in glove with the balance-of-trade and balance-of-payments doctrines and thus with the latters’ own militaristic implications, which were pointed out in the previous chapter. See above, p. 526.
24. In cases in which consumptionists recognize the necessity of imports, such as minerals that cannot be found domestically, they may still denounce the imports—as somehow representing the “exploitation” of the backward countries that provide them. A logical connection between consumptionism and such denunciations is provided by the affinity of consumptionism with socialism, which will be explained below, on p. 559. Concerning the actual nature of the effects of foreign “exploitation” of natural resources on the local populations, see above, pp. 323–326.
25. On the subject of the balance of trade and payments, see above, pp. 526–536.
26. See above, p. 351. See also Hazlitt, Economics in One Lesson, chap. 9.
27. See above, pp. 351–354.
28. The wording of this and the following two sections has been little changed from my article “Production Versus Consumption.”
29. For an exposition of this view by one of its most prominent contemporary supporters, see John Kenneth Galbraith, The Affluent Society (Boston: Houghton Mifflin, 1958), pp. 154, 159.
30. See above, p. 56.
31. See below, pp. 629–631.
32. See Alvin Hansen, A Guide to Keynes (New York: McGraw-Hill Book Company, 1953), pp. 25–35. Hansen, who was the leading proponent of the doctrine of secular stagnation was also the teacher of Paul Samuelson, the author of the textbook so often quoted in these pages to illustrate errors in economic theory. (For example, see the very next note.) 33. Paul Samuelson and William Nordhaus, Economics, 13th ed. (New York: McGraw-Hill Book Company, 1989), pp. 721– 722.
34. Ibid., p. 306.
35. For elaboration of this point, see below, pp. 817–818. See also below, pp. 569–580.
36. For another instance of the fallacy of composition in connection with consumptionism, see above, pp. 543–544.
37. See below, pp. 762–767.
38. Not surprisingly, Prof. Samuelson has missed few opportunities to belittle the gold standard over the course of the fourteen editions of his book.
39. David Ricardo, Principles of Political Economy and Taxation, 3d ed. (London, 1821), chap. 21; reprinted as vol. 1 of The Works and Correspondence of David Ricardo, ed. Piero Sraffa (Cambridge: Cambridge University Press, 1962), pp. 291–292. Italics supplied.
40. All of these propositions, of course, presuppose a normal context, that is, a context in which business firms have not been led into a state of illiquidity by a preceding inflation or credit expansion and now realize their need to rebuild liquidity. In such conditions, monetary demand falls. Its stabilization and renewed increase requires a fall in wage rates and prices sufficient to accommodate the fall in the velocity of circulation of money that is the necessary accompaniment of the rebuilding of liquidity. The problem of adjustment can be compounded by a fall in the quantity of money, in which case a further reduction in wage rates and prices is necessary. For further discussion of these points, see below, pp. 580–589 and 938–940.
41. James Mill, Commerce Defended (London, 1808), chap. 6; reprinted in Selected Economic Writings of James Mill, ed. Donald Winch (Chicago: The University of Chicago Press, 1966), p. 135.
42. I choose the fraction one-third for the new price of potatoes simply because it is the first fraction with one as the numerator that is less than a half, and is thus probably the easiest fraction to work with.
43. It should be realized that it is no objection to Say’s Law to question the assumption that the “other goods” no longer offered for the given good are equivalently exchanged against themselves. To whatever extent they might not be, the corollary effect would be that the supply of such other goods brought to market would be equivalently less. Thus, to whatever extent the rise in aggregate demand turned out to be less than the increase in the supply of the given good, it would be less only to the extent of the accompanying decrease in the supply of other goods. The proposition would remain that the increase in aggregate demand was precisely equal to the increase in aggregate supply, whatever it was.
44. I elaborate on this point below, on pp. 568–569.
45. See above, pp. 53–54.
46. Concerning mass unemployment, see below, pp. 580–582. Concerning the determination of real wages, see below, pp. 618–622.
47. See below, p. 725, for confirmation of this statement. 48. For such an analysis, see below, pp. 719–859, which provide a full elaboration of the theory of aggregate profit and interest. See also below, pp. 622–642, which explain the vital role of the demand for capital goods in the process of capital accumulation and raising the productivity of labor.
49. Even though there is no demand for capital goods in the conditions of full vertical integration, there could still be capital—in the form of capitalized wage payments. For example, if a sum such as $1 million is paid to wage earners to construct a durable asset, or to produce inventory, that $1 million is capitalized in the asset accounts of the firm that pays the wages. 50. See below, p. 576, for an explanation of why broad-based increases in production under a commodity money system actually tend to be accompanied by a higher rather than a lower average rate of profit.
51. See above, pp. 543–544.
52. For a comprehensive explanation of how improvements in the productivity of labor are the essential cause of rising real wages, see below, pp. 613–663.
53. See above, p. 518.
54. Closely related to this last are cases in which an increase in the demand for money results from the demand for money having first been artificially reduced in expectation of an accel—
PRODUCTIONISM, SAY’S LAW, AND UNEMPLOYMENT 601 eration in the rate of increase in the quantity of money. In cases of this kind, the demand for money increases if the expected acceleration in the rate of increase in the quantity of money does not take place.
55. See above, pp. 519–526.
56. The need for accelerated depreciation of business plant and equipment as the result of more rapid economic progress should not be taken to imply any tendency toward a substantially smaller accumulated value of net plant and equipment in the conditions of an invariable money, still less, any reduction in the degree of capital intensiveness in the economic system. On the contrary, it is accompanied by an increase in the degree of capital intensiveness. For an explanation of the reasons why, see below, pp. 786–787.
57. See below, pp. 589–590. See also Ludwig von Mises, Human Action, 3d ed. rev. (Chicago: Henry Regnery Co., 1966), pp. 568–569.
58. From that point on, the stock of housing in any given year would consist of the new housing production of that year and of 49 prior years, with each succeeding year’s housing production being 5 percent greater than that of the year before. In the next year, each of the 50 terms representing a year’s housing production would increase by 5 percent, with the result that the total stock of housing would increase by 5 percent.
59. Today’s depressed housing market in places such as California should not be ascribed to an inelastic demand for housing. Rather it is the result of a fall in the demand for housing following decades in which credit expansion artificially encouraged housing construction and then experienced major interruption. The problems of the housing market in California are also greatly compounded by the fact that the state has been rendered economically uncompetitive by the policies of its government, which have included higher taxes and more regulation than competing states, as well as numerous measures deliberately designed to discourage economic progress. 60. Ultimately, the supply of new housing will stand to the total stock of housing not in the ratio of 1:50, but in the substantially n = 50 higher ratio of 1.05 50 ÷ ∑ 1.05 n .
n = 1
61. On the role of saving in the demand for expensive durable goods, see below, p. 694. On the relationship between saving and economic progress, see below, pp. 622–629.
62. See below, pp. 663–664.
63. See above, pp. 513–514 and 519–526. As we will see, there can also be reductions in the aggregate demand for labor in conjunction with increases in the aggregate demand for capital goods. But such reductions are relatively slow and modest in the overall economic system, and when they occur are the basis of a more rapidly growing ability to produce, including a growing ability to produce or import the precious metals, and thus of an expanding quantity of money and growing demand for labor. On this subject, see below, pp. 639–641.
64. See below, pp. 762–767.
65. Concerning the role of saving in the demand for labor, see above, pp. 478–480, and below, pp. 632–634, 683–685, 694– 696, and 725–736. Finally, on the relationship between the demand for labor and the demand for capital goods and why decreases in the demand for labor caused by increases in the demand for capital goods are not against the interests of the average wage earner, see below, pp. 639–641.
66. See above, the last reference in the preceding note.
67. On this subject, see below, p. 590.
68. See above, Chapters 6–8.
69. We have already seen how it is to the advantage of poor wage earners, above, on pp. 382–384.
70. The legitimacy of generalizing about the rate of profit from the results of the assumption of the full vertical integration of business was explained earlier in this chapter, on p. 570, when the assumption was first introduced. At that time, it was also explained how capital can exist even in the absence of a demand for capital goods. See above, the preceding page, n. 49.
71. See below, pp. 864–878, for a detailed exposition of Keynes’s theories. Following that exposition, I show that the effect of a fall in wage rates necessary to achieve full employment is actually to increase the rate of profit rather than merely leave it unchanged. See below, pp. 879–884, especially pp. 883–884. 72. For an explanation of why taxes levied on profits or interest are a burden to wage earners, and the magnitude of that burden, see above, pp. 306–310. See also below, pp. 826–829.
73. This is the view of von Mises, for example. See Human Action, pp. 776–777.
74. As I will show in the next chapter, a rising productivity of labor is the only possible cause of a sustained, significant rise in average real wages, which, other things being equal, vary in direct proportion to the average productivity of labor. See below, pp. 618–622 and 646–653.
75. See above, pp. 358–360. The greater division of labor contributes to the rise in the productivity of labor not only directly, but also indirectly, insofar as it brings about a greater production of capital goods. On this subject, see below, pp. 634–636, where it is shown how anything that serves to increase production in general, increases the production and accumulation of capital goods.
76. On this last point, see the preceding note.
77. Unemployment tends to be more heavily concentrated in the blue-collar ranks, probably because, by and large, such workers tend to be easier to replace than the administrative-type workers. 78. In order for any major problem of greater difficulty of paying debt to be caused by a fall in the aggregate demand for labor, the fall in the aggregate demand for labor must itself be major. As we are already in a position to know, the explanation of such a fall is a general financial contraction brought on by a decrease in the quantity of money and/or increase in the demand for money for holding, which last is itself caused by a cessation or slowdown in the rate of increase in the quantity of money. On this subject, see below, the next two notes.
79. On the nature of inflation, see above, pp. 219–220 and 503–506, and below, pp. 895–907. On the role of fiduciary media and credit expansion in the precipitation of monetary contractions, see above, pp. 511–517 and 519–526. See also below, pp. 938–941.
80. See above, pp. 519–526.
81. See above, pp. 520–522, and below, pp. 938–940.
82. Also present here is the phenomenon known as “credit crunches,” which also are the result of credit expansion. On this aspect, see below, pp. 939–940.
83. See above, pp. 513–514.
84. See above, ibid.
85. On the subject of the Phillips curve, see Samuelson and Nordhaus, Economics, pp. 328–335.
86. See below, the next section, especially pp. 591–592. 87. See Murray N. Rothbard, America’s Great Depression (Princeton, N. J.: D. Van Nostrand & Co., 1963), pp. 187–190, 236–239.
88. It is appropriate here to recall the words of Adam Smith, who wrote, “I have never known much good done by those who affected to trade for the public good.” (See Adam Smith, The Wealth of Nations [London, 1776], bk. 4, chap. 2; reprint of Cannan ed. [Chicago: University of Chicago Press, 2 vols. in 1, 1976], 2:478.)
89. See U.S. Department of Commerce, Bureau of Economic Analysis, The National Income and Product Accounts of the United States, 1929–1976 Statistical Tables (Washington, D. C.: U.S. Government Printing Office, 1981), pp. 238 and 253. These pages provide the data on the basis of which the calculations in the text have been made.
90. See Rothbard, America’s Great Depression, p. 183.
91. On the significance of the qualification concerning compensating advantage, see above, pp. 576–578.
92. See National Income and Product Accounts of the United States, 1929–1976 Statistical Tables, p. 1, for the data used to make these calculations.
93. As should be evident from this discussion, there are determinants of aggregate profit other than the difference between consumption expenditure and wage payments, notably, net investment. For elaboration, see below, pp. 744–750 See also pp. 700–706, which deal with the nature of net investment. 94. On the subject of springs to profitability, see below, pp. 778–787, especially p. 784.
95. The restoration of investment spending, when wage rates fall to their equilibrium level, is guaranteed by the operation of the aforementioned springs to profitability.
96. See above, pp. 511–517 and 519–526.
97. On these points, see below, pp. 938–940. See also below, pp. 935–936.
98. On the subject of malinvestment, see below, pp. 935–936. See also below, pp. 597–598.
99. See above, pp. 515–516.
100. See above, p. 524.
101. See National Income and Product Accounts of the United States, 1929–1976 Statistical Tables, pp. 238 and 253 for the data underlying these calculations. The calculations use the data for private industries in line 3 of the tables.
102. Data for the number of workers reported as openly unemployed are from U.S. Department of Commerce, Bureau of the Census, Historical Statistics of the United States Colonial Times to 1970 (Washington, D. C.: U.S. Government Printing Office, 1975), p. 126. Data for the number of workers employed in the various government work-relief programs are from the National Income and Product Accounts of the United States, 1929–1976 Statistical Tables p. 253.
103. See above, pp. 258–262, especially p. 262.
104. See p. 262.
105. See above, pp. 287–288.
106. See National Income and Product Accounts of the United States, 1929–1976 Statistical Tables, pp. 3, 23, and 254. My calculations of federal government spending include “government transfer payments to persons.”
107. See below, pp. 622–629 and 632–634.
108. This appendix is a revised version of my article “Inventories and Depressions,” Il Politico 31, no. 2 (June 1966). 109. New York Times, January 17, 1975, p. 47.
110. George L. Bach, Economics, 8th ed. (Englewood-Cliffs, N. J.: Prentice-Hall, 1974), p. 171.
111. For a numerical illustration, see below, p. 935.
Capitalism: A Treatise on Economics
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