VIII. Addendum 1978 Introduction By Sudha Shenoy

Professor Hayek’s writings on inflation and monetary policy, during the six years since the publication of the first edition of this book, are contained in his other IEA publications: Full Employment at Any Price? (1975), Choice in Currency (1976) and Denationalisation of Money (1976 and 1978). This second edition has been enlarged by the addition of three early analyses of the Keynesian approach. These early articles are notable for Professor Hayek’s anticipation of the kinds of difficulties now being encountered, after some thirty-odd years of attempting to maintain full employment by increasing the level of spending.

At this juncture, I should like to add a few condensed reflections on the distinction between the average price-index approach to the analysis of the effects of inflation, and the ‘relative’ price structure approach on which the following extracts are based. This distinction derives from the difference between two alternative views of prices. One view sees them as components in some general equilibrium system. The other sees prices as empirical reflectors of specific circumstances. Such a distinction would appear to be important for the continuing debate on the nature of inflation.

Virtually all analyses of inflation are couched in terms of a movement in an index of prices. ‘Keynesian’ and ‘Chicago-ite’ may differ over whether or not the money supply is active or merely adjusts passively; but neither school goes beyond the impact (if any) on (or via) a price index.

The ‘Austrian’ would agree with the Chicago-ite on the ‘active’ role of the money supply. But he departs fundamentally thereafter. He emphasises that changes in a price index cannot encompass the major dislocating effect of increases in the supply of money. A price index is a statistical construct—it is an ex post facto compilation from previous changes in individual prices. An increase in the money supply does not affect all prices simultaneously and equi-proportionately—it affects some first and other prices afterwards; it affects different prices differently and at different times.

Economic decision-makers (individuals, firms, families) face not a price ‘index’ but specific individual prices. Different economic units face different prices. In an inflationary context, their problem is not to forecast the change in a price index as calculated in the future; it is rather to judge the specific changes made by a changing money supply at a specific time on the specific prices they deal with, as opposed to all the other influences also acting on these prices. The ‘average’ such change, as calculated some time later, is basically irrelevant—it provides no guide to the individual price changes that precede the calculation of the change in the price-index. The knowledge that the money supply is increasing gives little help (if any) in separating out from all other components that component of individual price changes resulting from such an increase in the money supply.

Guiding Role of Individual Price Changes

It is individual price changes and price relationships that in practice guide production and employment. The pattern of output and employment is thus altered in accordance with a monetary change—the different lines of production and employment follow the same path as those particular price changes brought about by the change in the money supply. But these price changes now reflect increases in the supply of money. They do not tell us whether or not the underlying real influences have changed in the same direction. The alterations in the pattern of output and employment made in response to these price changes are thus discoordinated: the real changes brought about by the expansion cannot ‘mesh’ with changes that reflect real influences. As this lack of coordination becomes clear, resources have to be withdrawn from the former lines of output and employment and transferred into those lines that do correspond with the underlying pattern of relative real scarcities and preferences. Such transfers are not costless: higher capital and operating losses and higher unemployment are the necessary concomitants. Continuing monetary expansion implies a continuing and continuous discoordination—i.e., resources are rendered less productive than they might be.¹

In this context, to reason in terms of any sort of general equilibrium model can be seriously misleading: such models must presuppose an ‘evenly-rotating economy’, in Professor Mises’s graphic terminology.² The ‘Austrian’ position is that, in a world of continuous change, relative real scarcities and preferences themselves have to be rediscovered continuously.³ Monetary expansion brings about price changes that are uncoordinated: they do not reflect real scarcities and preferences. The resulting patterns of output and employment therefore cannot be sustained. A price index by its very mode of construction abstracts from these real relative changes in the process of pricing. ‘Indexation’ of money payments would add yet another random and uncoordinated influence to an already uncoordinated situation. It would not assist in the fundamental task of bringing about a better correspondence between the patterns of prices, available real resources, and preferences.

Sudha R. Shenoy

University of Newcastle

New South Wales

January, 1978

21. GOOD AND BAD UNEMPLOYMENT POLICIES

In 1944 Professor Hayek emphasised that sustainable employment depends on an appropriate distribution of labour among the different lines of production. This distribution must change as circumstances change. Sustainable employment thus depends on appropriate changes in relative real wage-rates. If established producers—both unions and capitalists—prevent such relative changes from becoming effective, there follows an unnecessary rise in unemployment. Sustainable employment now depends on successfully tackling these established labour and capital monopolies.

One of the obstacles to a successful employment policy is, paradoxically enough, that it is so comparatively easy quickly to reduce unemployment, or even almost to extinguish it, for the time being. There is always ready at hand a way of rapidly bringing large numbers of people back to the kind of employment they are used to, at no greater immediate cost than the printing and spending of a few extra millions. In countries with a disturbed monetary history this has long been known, but it has not made the remedy much more popular. In England the recent discovery of this drug has produced a somewhat intoxicating effect; and the present tendency to place exclusive reliance on its use is not without danger.

Though monetary expansion can afford quick relief, it can produce a lasting cure only to a limited extent. Few people will deny that monetary policy can successfully counteract the deflationary spiral into which every minor decline of activity tends to degenerate. This does not mean, however, that it is desirable that we should normally strain the instrument of monetary expansion to create the maximum amount of employment which it can produce in the short run. The trouble with such a policy is that it would be almost certain to aggravate the more fundamental or structural causes of unemployment and leave us in the end in a position worse than that from which we started.

Maladjustments

The main cause of this kind of unemployment is undoubtedly the disproportion between the distribution of labour among the different industries and the rates at which the output of these industries could be continuously absorbed. At the end of this war we shall, of course, be faced with a particularly difficult problem of this character. In the past the best known disproportion of this kind and, because of its connection with periodical slumps the most important, was the chronic over-development of all the industries making equipment for use in further production.

It is more than likely that these industries, because of the intermittent way in which they operated, have always had a larger labour force than they could continuously employ. And while it is not difficult to create by means of monetary expansion in those industries another burst of feverish activity which will create temporarily conditions of ‘full employment’, and even draw still more people into those industries, we are thereby making more difficult the task of maintaining even employment. A monetary policy aiming at a stable long-run position would indeed deliberately have to stop expansion before ‘full employment’ in those industries had been reached, in order to avoid a new maldirection of resources.

Though this is the most important single instance of structural maladjustments responsible for unemployment, the recurrent depression constitutes only part of our problem. The hard core of persistent unemployment is an even greater menace and is due largely to maldistributions of a different kind which monetary policy can do even less to cure. We must here face the fact that the problem of unemployment is in the last resort a wage problem—a fact which used to be well understood but which a conspiracy of silence has recently relegated into oblivion.

Wages and Mobility

Demand shifts constantly to new articles and industries, and the more rapidly we advance the more frequent such changes become. Though the increased speed of change will necessarily swell the numbers temporarily out of work while looking for a new job, it need not cause an increase of lasting unemployment, or a reduction in the demand for labour as a whole. If movement into the advancing industries were free, they should readily absorb those laid off elsewhere. The new development which more and more prevents this, and which has become the most serious cause of protracted unemployment, is the tendency of those established in the progressing industries to exclude newcomers. If the increase in demand in those industries leads, not to an increase of employment and output, but merely to an increase of the wages and profits of those already established, there will indeed be no new demand for labour to offset the decrease. If every gain of an industry is treated as the preserve of a closed group, to be taken out almost entirely in higher wages and profits, every shift of demand must add to the lasting unemployment.

The very special and almost unique experience of this country in the years after the pound was artificially raised to its former gold value has produced a fallacious preoccupation with the general wage level. Where such an artificial increase of the national wage level is the cause of unemployment, monetary manipulation is indeed the simplest way to cure it. Such a situation, however, is altogether exceptional and not likely to occur, except in consequence of currency fluctuations.

In normal times employment depends much more on the relation between wages in the different industries—or, rather, on the degree of mobility which the wage structure allows. There is little that monetary policy can positively achieve in this connection. Indeed, if Lord Keynes is right in emphasising that workers attach more importance to the nominal figure of their money wages than to real wages, any attempt to meet the problems of wage rigidity by monetary expansion can only increase the immobility which is the real trouble: if money wages are maintained in declining industries the workers will become even more hesitant to leave them in order to break the protective walls sheltering the privileged groups in the advancing industries.

The struggle against unemployment is in the last resort the same as the struggle against monopoly. Need it be added that on this fundamental issue we are not moving in the right direction? Or that it would be a poor service to the community to pretend that there is an easy way out which makes it unnecessary to face the basic difficulties?

Dangers Ahead

It is easy to see how much more serious our problems must become if the present fashion should prevail and if it should become the accepted doctrine that it is the task of monetary policy to make good any harm done by monopolistic wage policies. Even apart from the effect on those responsible for wage policy, who are thus excused the responsibility for the effect of their action on employment, the one-sided emphasis on monetary policy may not only deprive our efforts of full results, but also produce effects as unlooked for as they are undesirable.

While it is true that an intelligent monetary policy is a sine qua non of the prevention of large-scale unemployment, it is equally certain that it is not enough. Short of universal compulsion we shall never lastingly conquer unemployment until we succeed in breaking the rigidities of our economic system which we have allowed the monopolies of capitalists and labour to create. To forget this and to trust solely to monetary policy is the more dangerous as it may succeed long enough to make it impossible to try anything else: the more we are induced to delay the more difficult adjustments, because for the time being we seem to be able to keep things going, the greater the sector of our economic system will grow which can be kept going only by the artificial stimulus of credit expansion and ever-increasing Government investment.

It is a path which would force us into progressively increasing Government control of all economic life, and eventually into the totalitarian state.

(‘Good and Bad Unemployment Policies’)

22. FULL EMPLOYMENT ILLUSIONS

In this 1946 article Professor Hayek argues that even a continued increase in the demand for consumers’ goods would not necessarily lead to a parallel increase in the demand for producers’ goods. Continued increases in spending would not thus be sufficient to maintain ‘full employment’. This happens because, as the boom continues, the rise in the demand for consumers’ goods is met by switching from the use of fixed to circulating capital. Consequently, the demand for fixed capital eventually declines, as the demand for consumers’ goods continues to rise. In these circumstances, to maintain or increase expenditure would not prevent a decline in the producers’ goods industries.

The analysis Professor Hayek set out in 1946 thus predicted the appearance of ‘stagflation’ some 30 years before it emerged so unexpectedly.

It is a favourite trick of radical reformers to appropriate for a pet theory of their own some good word describing an attractive state of affairs, and then to accuse everyone who is not prepared to swallow their proposals of callously disregarding the social good at which they aim. At the moment the most dangerous of these catchwords which seems to describe merely a desirable state of affairs, but in fact conceals a particular theory about the manner and extent to which it can be achieved, is, of course, ‘full employment’. There is reason to believe that even many of those who originally gave currency to this phrase are becoming apprehensive about the way it is being used.

In the writings of the learned men who first systematically used the phrase, it did not mean what it was bound to come to mean in popular discussion: a guarantee to everyone of the kind of work and pay to which he thinks himself to be entitled. But this does not diminish the responsibility of those who in the first instance deliberately chose a popular catchword for a highly technical concept. It is more than likely that the belief they have created that full employment in the popular sense can be easily and painlessly achieved will prove the greatest obstacle to a rational policy which really would provide the maximum opportunity of employment which can be created in a free society.

Money Expenditure and Employment

It is an old story that in most situations an increase in total money expenditure will for a time produce an increase in employment. This has of old been the stock argument of all inflationists and soft-money people. And any person who has lived through one of the great inflations can have little doubt that up to a point it is true. There is, however, a further lesson to be drawn from the experience of these inflations which ought not to be forgotten. They have not only shown that a sufficient increase of final demand will usually increase employment; they have also shown that in order to maintain the level of employment thus achieved, credit expansion has to go on at a certain progressive rate. This is shown particularly well by the great German inflation, during most of which the level of employment was very high. But as soon, and as often, as the rate was slowed down at which inflation progressed, unemployment at once reappeared, even though incomes and prices were still rising, yet at a somewhat slower rate than before.

An Old Argument in New Form

But if the substance of the argument is not new, the new hold it has gained on our generation is due to the fact that it has been restated in an original and apparently much improved form. If in the way in which it is usually propounded, this new theory is highly technical, the essence of it is very simple. What it amounts to is little more than the following: if all people were employed at the jobs they are seeking, total money income would be so and so much. Therefore, it is argued, if we increased total money income to the figure it would reach if everyone were employed, everybody will be employed. Could anything be simpler? All we need to do is to spend sufficient money so that aggregate expenditure can take care of the aggregate supply of labour at the wage figure for which men will hold out.

It is useful at once to test this theory on a situation which has occurred often in recent times. Assume that in any country there has been a great shift of demand from one group of industries to another. It does not matter whether the causes of this are changes in tastes, technological progress, or shifts in the channels of international trade. The first result will be, as was the case in so many countries in recent times, that we shall have a group of depressed industries side by side with others which are fairly prosperous. If then, as is the rule rather than the exception at present, labour in the progressive industries prefers to take out the gain in the form of higher wages rather than in larger employment, what will happen? Clearly the consequence will be that those who lose their jobs in the declining industries will have nowhere to go and remain unemployed.

There is much indication that a great part of modern unemployment is due to this cause. How much can the measures of so-called ‘fiscal’ policy or any inflationary measures accomplish against this kind of unemployment? The problem is clearly not merely one of the total volume of expenditure but of its distribution, and of the prices and wages at which goods and services are offered. Before leaving this simplified illustration, let me underline a few important facts which it brings out clearly and which are commonly overlooked.

The Shortcomings of Fiscal Policy

Firstly, it shows that the significant connection between wages and unemployment does not operate via changes in the general wage level. In the instance given it may well be that the general wage level will remain unchanged, and yet there can be no doubt that the unemployment is brought about by the rise of the wages of a certain group.

Secondly, this unemployment will not arise in the industries in which the wages are raised (which are the prosperous industries, in which the increase in wages merely prevents an expansion of employment and output), but in the depressed industries where wages will be either stationary or actually falling.

Thirdly, the illustration makes it easy to see how an attempt to cure this kind of unemployment by monetary expansion is bound to produce inflationary symptoms, and how the authority, if it persists in its attempt, will soon be forced to supplement its monetary policy by direct controls designed to conceal the symptoms of inflation. So long as the people insist on spending their extra income on the product of the industries where output is restricted by monopolistic policies of labour or capital, this will only tend to drive up wages and prices further but produce no significant effect on employment. If expansion is pressed further in the hope that ultimately enough of the extra income will spill over into the depressed industries, price control, rationing, or priorities will have to be applied to the prosperous industries. This is a very important point, and most of the expansionists make no bones about the fact that they mean to retain and even expand controls in order to prevent the extra money incomes which they propose to create, from going in ‘undesirable’ directions. There is little doubt that we shall see a good deal more of the same people on the one hand advocating more credit expansion, lower interest rates, etc., etc., and on the other demanding more controls in order to keep in check the inflation they are creating.

Cyclical Unemployment

The illustration I have given may seem to refer mainly to long-run or technological unemployment, and the advocates of the fashionable type of full employment policy will perhaps reply that they are mainly concerned with cyclical unemployment. This would, of course, be an admission that their ‘full employment’ is not really full employment in the sense in which the term is now popularly understood, but at most a cure of part of the unemployment we used to have in the past. The more careful defenders of the new policy often admit this. The late Lord Keynes, for instance, shortly before this war, once stated that England had reached practically full employment though the unemployment figure was still well over one million. This is not what the public has now been taught full employment to mean. And it will be inevitable in the present state of opinion that so long as such a strong remnant of unemployment remains there will be intense pressure for more of the same medicine, even though on the full employment theorists’ own views it can do only harm and no good in such a situation.

It is more than doubtful, however, whether even so far as cyclical unemployment is concerned, the fashionable ‘full employment’ proposals offer more than a palliative, and whether in the long run their application may not make matters worse. To the extent that they merely aim at mitigating the deflationary forces in a depression, there has of course never been any question that in such a situation an easy money policy may help a recession from degenerating into a major slump. But the hopes and ambitions of the present ‘full employment’ school go much further. Its adherents believe that by merely maintaining money incomes at the level reached at the top of the boom they can permanently keep employment and production at the maximum figure reached. This is probably not only an illusion but a certain way to perpetuate the underlying causes of the decline in investment activity.

In many ways the problems of smoothing out cyclical fluctuations are similar to those created by shifts in demand between industries. The main difference is that in the case of the business cycle we have to deal not with what may be called horizontal shifts in demand, from industries producing one sort of final goods to those producing another, but with changes in the relative demand for consumers’ goods and capital goods respectively. The decline in the demand for consumers’ goods, which occurs in the later phases of the depression, is a consequence of the decline of employment and incomes in the industries producing capital goods: and the basic problem is why in the latter, employment and production periodically decline, long before any decrease in the demand for consumers’ goods occurs.

The current belief, which inspires all the popular full employment propaganda, is of course that investment expenditure is directly dependent upon, and moves with consumers’ expenditure and that therefore the more we spend the richer we get. This argument has a certain specious plausibility because in times of all around unemployment a mere revival of monetary demand may indeed lead to a proportional, or even more than proportional, increase in production. But it is utterly fallacious at other times and almost ridiculous if applied to the position which exists at the end of a boom and the onset of a depression. It is well worth while to examine its implications for a moment and to consider the paradox to which it leads if it is consistently followed.

Consumers’ Goods Demand and Investment Activity

If it were true that an increase in the demand for consumers’ goods always led to an increase of investment activity the consequences would indeed be astounding. It is important that at the top of the boom, or even at the early stages of an incipient depression, there are practically no unused resources available which would make it possible substantially to increase the output of investment goods without drawing labour and other resources away from the production of consumers’ goods. In other words, if this curious theory were true it would mean that the result of people insistently demanding more consumers’ goods would be that less consumers’ goods would be produced for the time being. This in turn would undoubtedly lead to a rise in their prices and the profits made in their production, and according to the same theory this should lead to a still further stimulus to investment and therefore to another reduction in the current output of consumers’ goods. This spiral would go on ad infinitum, presumably until a stage was reached when, because people so insistently demanded current consumers’ goods, no consumers’ goods at all would be currently produced and all energy devoted to create facilities for an increased future output of such goods.

Purchasing Power and Prosperity

The economic system is however not quite as crazy as all that. There indeed exists a mechanism through which in conditions of fairly full employment an increase of final demand, far from stimulating investment, will actually discourage it. This mechanism is very important both as an explanation of the break of the boom and for our understanding of the reasons why an attempt to maintain prosperity merely by maintaining purchasing power is bound to fail.

Why the Slump in Capital Goods Industries?

The mechanism in question operates in a way which will be familiar to most business men: Any given increase of prices will increase percentage profits on working capital by more than profits on fixed capital. This is so because the same difference between prices and costs will be earned as many times more often as the capital is turned over more frequently during a given period of time. If, then, in a situation where prices of consumers’ goods tend to rise, the capital at the disposal of a given firm is limited; the need for working capital, as experience amply demonstrates, regularly has precedence over the need for fixed capital. In other words, the limited capital resources of the individual firm will be spent in the way in which output can be most rapidly increased and the largest aggregate amount of profit earned on the given resources, i.e., in the form of working capital, and outlay on fixed capital will for the time being actually be reduced to make funds available for an increase of working capital.

There are many ways in which this can be done rapidly: working in double or treble shifts, neglect of repair and upkeep, or replacement by cheaper machinery, etc. If the inducement of high profits and the scarcity of funds is strong enough, this will sooner or later lead to an absolute reduction of the outlay on fixed capital.

So far this explains only why firms will allocate their capital outlay differently, more for working capital and less for fixed capital, and not why their total outlay falls, which is what we have to explain if we are to account for the slump in the capital goods industries. But we are in fact very close to an answer to this question and only one further step is needed.

The answer lies in a special application of a principle long known to economists under the name of ‘the acceleration principle of derived demand’. It shows why the effect of any change in final demand on the volume of production in the ‘earlier stages’ of the processes in question will be multiplied in proportion to the amount of capital required. In the case of an increase of final demand the additional capacity will have to be created by installing machinery, building up stocks, etc., and for a time outlay will increase very much more than output. Similarly in the case of a decrease in final demand it will be possible for a time to decumulate stocks and machinery and outlay will be reduced more than output.

When we remember that this acceleration effect works both ways, positively and negatively, equally multiplying the effects of an increase or of a decrease of final demand many times insofar as the dependent investment demand is concerned, and that its strength depends on the amount of capital used per unit of output, it is easy to see what the results must be if outlay of the consumers’ goods industries is shifted from fixed to circulating capital. Fixed capital means by definition a large amount of capital per unit of output and the decrease in the demand for fixed capital goods will therefore produce a very much greater decrease of production in the industries producing these capital goods. The simultaneous increase of the demand for circulating capital cannot compensate for this. Because, though the increased demand for circulating capital sets up a positive acceleration effect, this will be much less strong, since much less circulating capital is required per unit of final output. The net result of the initial shift in the outlay of the consumers’ goods industries will therefore be a net decrease in the total demand for investment goods—caused ultimately by an excessive increase of final demand.

If this analysis is correct, it is clearly an illusion to expect investment demand to be maintained or revived by keeping up final demand. An increase of final demand may produce this kind of result at the bottom of a depression, when there are large reserves of unused resources in existence. But near the top of a boom it will have the contrary effect: investment will slacken further and it will seem as if there were an absolute lack of investment opportunities, which can be cured only by the government stepping in, while in fact it is the very policy intended to revive private investment which prevents its revival. Again we find that a policy of merely maintaining purchasing power cannot cure unemployment and that those who try to do so will be inevitably driven to control not only the amount of expenditure but also the way in which it is spent.

The worst of the popular illusion, that we can secure full employment by merely securing an adequate supply of expenditure, is, however, not that the hopes that it creates are bound to disappointment, but that it leads to a complete neglect of those measures which really could secure a stable and high level of employment. It will lead us further and further away from a free economy in which reasonable stability can be expected.

(‘Full Employment Illusions’)

23. FULL EMPLOYMENT IN A FREE SOCIETY

In this 1945 review of Full Employment in a Free Society Professor Hayek highlights two major difficulties with the ‘demand-deficiency’ analysis of unemployment in the book. Firstly, there are extreme variations in the scale of unemployment from industry to industry and from area to area. These large variations must cast considerable doubt on whether a general lack of demand is the cause of widespread unemployment. Secondly, the book argues that the rise in the marginal propensity to save means that eventually consumer spending must fall short of the value of consumer goods output, thus producing a decline in total output. This argument overlooks the implications of changes in output. Since fluctuations in output in the capital goods industries are larger than fluctuations in the consumer goods industries, the marginal propensity to consume tends to be higher than the rate of increase in consumer goods output.

If the present concern with full employment were the result of a belated recognition of the urgency of the problem, we should have much reason to be ashamed of the past and to congratulate ourselves on the new resolution. But this is not the position.

In England, in particular, unemployment has for nearly a generation been the burning problem that constantly occupied statesmen and economists. The reasons for the intensified agitation must be sought elsewhere. The fact is that the remedies proposed by the economists had been persistently disregarded because they were of a kind that hurt in the application.

Then Lord Keynes assured us that we had all been mistaken and that the cure could be painless and even pleasant: all that was needed to maintain employment permanently at a maximum was to secure an adequate volume of spending of some kind. The argument was not less effective because it was couched in highly technical language. It gave the support of the highest scientific authority to what had always been the popular belief, and the new view gained ground rapidly.

It is the great merit of democracy that the demand for the cure of a widely felt evil can find expression in an organised movement. That popular pressure might become canalised in support of particular theories that sound plausible to the ordinary man is one of its dangers. But it was almost inevitable that some gifted man should see the opportunity and try to ride into political power on the wave of support that could be created for some such scheme. This is what Sir William Beveridge is attempting. His Full Employment in a Free Society is as much a political manifesto as a handbook of economic policy. Its appearance coincides with the author’s entry into Parliament, and together with his earlier report on social security constitutes his programme of action.

This is not to say that Sir William does not bring special qualifications to the task. But they are not mainly those of the economist. Himself a brilliant expositor who earned his spurs as a leader-writer on one of London’s big dailies, a successful administrator with the essential skill of tapping other people’s brains, and an acute student of unemployment statistics, he has called in the assistance of a group of younger economists for the more theoretical parts of the book. Its strength and its weakness reflect this origin. The clear exposition and the stress on some important facts that are not always recognised are Sir William at his best, and the great interest in changes in government machinery equally characteristic.

But the theoretical framework is that of Lord Keynes as seen by his younger disciples and familiar to American readers mainly through the writings of Professor A.H. Hansen. Only one of Sir William’s collaborators, N. Kaldor, appears by name as the author of a highly ingenious appendix, which to the economist is the most interesting part of the book and supplies the foundation for much of it.

It is open to question whether the attempt to combine Sir William’s characteristic views with the fashionable Keynesian doctrines has made the book more valuable, though it will certainly make it more acceptable to many of the younger economists. Although Sir William is confident that his own approach and ‘the revolution of economic thought’ effected by J.M. Keynes’s are ‘not contradictory but complementary’, the book leaves many inconsistencies unresolved. One of Sir William’s most valuable contributions, e.g., is the emphasis on the extreme diversity of the extent of unemployment from industry to industry and from place to place, which certainly throws much doubt on the adequacy of an explanation in terms of a general deficiency of demand; yet he swallows the demand-deficiency theory lock, stock, and barrel.

Equally important is Sir William’s stress on the close connection in Great Britain between unemployment and foreign trade. Yet his remedies are almost entirely of a domestic nature. Indeed, though he realises that hardly any of the imports of Great Britain before the war ‘can be described as luxuries’, he suggests as a way out ‘the alternative of cutting down imports and becoming more independent’ because ‘the stability of international trade is as important as its scale’. The former champion of free trade has travelled far!

Perhaps most surprising of all is that, while Sir William admits that ‘a policy of outlay for full employment, however vigorously it is pursued by the State, will fail to cure unemployment . . . if, with peace, industrial demarcations with all the restrictive tendencies and customs of the past return in full force’, these factors have no place in his diagnosis of the causes of unemployment. One wonders to what conclusions the author would have been led had they been given their proper place in the analysis and not merely added as an afterthought.

One of the main differences between Sir William’s proposals and the British White Paper on employment policy is that Sir William refuses to accept the fact that private investment tends to fluctuate, and to confine himself to compensating measures. As an out-and-out planner, in the modern sense of the term, he proposes to deal with this difficulty by abolishing private investment as we knew it: that is by subjecting all private investment to the direction of a National Investment Board. It is mainly here that apprehensions must arise against which the second half of the title of the book is meant to reassure us. Sir William endeavours to show that, despite all the controls he wishes to impose, ‘essential liberties’ will be preserved. But private ownership of the means of production is, in his opinion, ‘not an essential liberty in Britain, because it is not and never has been enjoyed by more than a very small proportion of the British people’.

It is surprising that he should not yet have learned that private ownership of the means of production is important to most people not because they hope to own such property, but because only such private ownership gives them the choice of competing employers and protects them from being at the mercy of the most complete monopolist ever conceived.

However interesting the points of detail on which Sir William differs from the current Keynes-Hansen theory, much the most important fact about his book is that he lends the weight of his prestige in support of this view. If all the conclusions he draws do not necessarily follow from it, they certainly stand and fall with the belief that a deficiency of final demand is the initial cause of cyclical unemployment.

This theory holds that as employment increases a progressively increasing share of the new income created will not be spent but will be saved. This, it is suggested, must sooner or later produce a situation in which final demand is insufficient to take the output of consumers’ goods off the market at remunerative prices. One may grant the first statement and yet deny that the alleged consequences are at all likely to follow. The larger share that is saved out of the additional income would necessarily lead to an insufficiency of final demand only if the additional output contained as large a proportion of consumers’ goods as total output.

This assumption seems highly implausible, however. Along with all other students of these matters Sir William stresses that unemployment during a depression is very much greater in the industries making capital goods than in the others. An approach to full employment therefore increases the output of capital goods proportionally much more than the output of consumers’ goods. And if no larger proportion of the additional income were saved than was saved out of the smaller income final demand would grow much faster than the supply of consumers’ goods.

As a matter of fact, it seems highly unlikely that the share saved out of additional income during a recovery will be even as big as the share of the additional output that is in the form of capital goods. What then becomes of the case that depressions are brought on by over-saving and under-consumption? Of course, we can assume that the decline of investment in a slump must be due to an initial deficiency of final demand. This, however, is simply reasoning in a circle.

The cause of the decline of the demand for capital goods must, therefore, be sought elsewhere than in a deficiency of final demand, and may even be an excessive final demand. All the fashionable remedies, including Sir William’s, not only fail to touch the root of the matter but may even aggravate the problem. Of course, once final demand shrinks on the scale that will occur as a result of extensive unemployment in the capital goods industries, this will start the vicious spiral of contraction. But the crucial question is: what causes the initial decline of the capital-goods industries?

If, as is more than likely, it is that they tend to overgrow during the boom, all attempts to maintain activity in them at the maximum will only perpetuate the causes of instability.

(Review of Sir William (later Lord) Beveridge’s book,
Full Employment in a Free Society)

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¹The above argument is highly condensed; a more extended statement is in G.P. O’Driscoll, Jr., and Sudha R. Shenoy, ‘Inflation, Recession, Stagflation’, in E.G. Dolan (ed.), Foundations of Modern Austrian Economics (Lawrence, Kansas: sheed and Ward, 1976); cf. F.A. Hayek, Prices and Production (London: Routledge and Kegan Paul, 1935), pp. 28–30.

²Ludwig von Mises, Human Action (Chicago: Regnery, 1966), pp. 244–56.

³F.A. Hayek, ‘Competition as a Discovery Procedure’, in New Studies in Philosophy, Politics, Economics and the History of Ideas (London: Routledge and Kegan Paul, 1978).