Essay 1: Non-Monetary Causes of Economic Depression
QUERY: "Whether power to command the industry of others be not real wealth? And whether money be not In truth tickets or tokens for conveying and recording such power and whether It be of great consequence what materials the tickets are made of?" The Querist.
(On November 17, 1932 I lectured to the institute of Bankers In Ireland on "The world crisis .. Its non-monetary background". The lecture was mainly an analysis of the dangers to consumption/production relationships, both nationally and internationally, resulting from the prevalence of economic nationalism. Much the same dangers are now in 1968 implicit in the growth of economic regionalism. The main ideas expounded in that lecture are therefore relevant to the present situation both nationally and internationally. The lecture is reprinted with grateful acknowledgement to the editor of the Irish Institute's Journal. JJ 1969)
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It is convenient to sum up the facts of the present crisis by stating that it is a crisis of superabundance -- a case of the production of wealth outrunning its consumption. One may then go on to point out that the technique of wealth production was never more perfect than it is today, but that somehow the machinery for exchanging the products of the world's
economic activity has failed to place the whole of its products in the hands of the final consumers at a price they can afford to pay.
As money is an essential part of this mechanism it is only natural to look for the essential causes of the breakdown in the money machine as it has functioned in recent years. It may well be that this is the right approach, but before finally concluding that it is, we ought to fix firmly in our minds the major economic facts of the depression, non-monetary as well as monetary.
In the words of the Macmillan Report (p93):--- "the monetary system failed to solve a problem of unprecedented difficulty and complexity set it by a conjunction of highly Intractable non-monetary phenomena."
We may ask ourselves at a later stage whether any mere monetary policy - as hitherto understood - could have adjusted itself to the rough edges of these facts or can do so in the near future with or without the fullest international co-operation.
Before describing some of these intractable facts it is well to remind ourselves of a few economic principles, elementary in their nature, but far-reaching in their applications and implications. The nature of wealth itself is continually misunderstood by the plain man, and that misunderstanding is unintentionally encouraged by realistic economists who deal mainly in statistics.
You can measure stocks of wheat and cotton, as they pile up, just as you can measure the distance of the moon from the earth, but these facts are not facts of the same order. Cotton and wheat are not wealth until they reach the stage of being consumed. Like all other economic goods they are only conditions of the satisfaction of human want. In reality, the wealth of which these are material conditions only begins to exist when the appropriate satisfactions begin to be experienced.
You cannot measure human satisfactions or human suffering. If we could, the results In the present condition of the world would be appalling. Statistical measurements however valuable and important, must not be allowed to suggest to us that wealth has any real existence as such, apart from its ultimate consumption and enjoyment.
From this point of view, the production of wealth can never outrun its consumption. Economic goods may Indeed be coming Into existence in greater volume than they are being consumed. It may be that with a better organisation for the distribution of goods to the final consumer consumption would Increase, and the surplus product of industry be absorbed. Unless and until that Improvement takes place all the efforts devoted to the production of the surplus are wasted efforts. They are economically unproductive.
The rate at which wealth in all its forms is being consumed always determines the rate at which it is economic to produce it. When the economic system is working below capacity, as at present, consumption must somehow be increased if production is to be increased. The first step in the addition to production that would automatically follow will involve no additional labour or sacrifice. Economic goods will be sold and consumed which otherwise would have been wasted.
The economy of production cannot be considered apart from the economy of consumption. Demand, as the text-books inform us, is the ultimate governor of production. It determines not only the total volume which can continue year after year to be produced, but the proportion in which productive activity will, In the long run, continue to be distributed amongst various goods and services.
Producers must produce in anticipation of demand, and sometimes they suffer in profits for their errors as prophets. This.is a chronic cause of instability inseparable from our present economic system. The economic circumstances of the War and post-War years have aggravated the tendency to misdirect efforts on the part of the organisers of production.
An important part of the cause of the world depression may in fact be traced to this source. The defects in the economy of production are glaring if we look at the world as a whole, but is the economy of consumption always perfect?
The text-books inform us that the unconscious aim of all persons as consumers is to distribute their spending power in such a proportion amongst the various commodities and services they acquire, that their resultant satisfaction will be a maximum. With any given distribution of income amongst the various classes of society it may be shown that the theoretically perfect economy of consumption will only be achieved if the satisfaction derived from the consumption of the final increment of each commodity acquired is equal.
Within the limits of their spending power, people will first provide themselves with primary necessities of food, clothing and shelter, and go on to acquire more or less of secondary necessities, comforts and luxuries,.until they reach a balance between the desirability of spending and not spending.
How much of each economic good each consumer will buy will depend on his total income, on his anticipated satisfaction from varying amounts of each, and on the relative prices of the infinite variety of economic goods, both commodities and services. A distribution of income less unequal then the present would cause a redistribution of demand amongst the
several economic goods, and a perfect economy of consumption on this new level would, as both socialists and economists inform us, produce a greater sum of human satisfaction than is possible at present.
At all events, it would do so if the economy of production automatically, without waste, dislocation, or serious impairment, adjusted itself to the new economy of consumption.
An important part of the world's crisis is the fact that drastic redistributions of income have resulted from war and postwar finance, and from the social policy now being developed by the State in some of the more highly civilised countries. The economic system has lost the major portion of its pre-war elasticity, and has proved itself quite unable to make the necessary adjustment to these almost revolutionary changes in the distribution of spending power.
Whatever may be the distribution of the national income it may be doubted whether the perfect economy of consumption, so simple in theory, is ever realised in practice. Wise spending and a proper balance between so-called spending and saving, between the acquisition of consumers' and producers goods, demand qualities of human nature which are by no means universal. Even within the sphere of consumers' goods, to equate the satisfactions derived from the final unit of food, clothing and shelter consumed is by no means easy.
It becomes more difficult as the standard of living rises, for then luxury objects of durable consumption, typified by gramophones and wireless sets, come within the reach of the masses, or appear to do so. The units of expenditure required by such objects are large units, whether they are bought outright, or on the instalment system. The acquisition of such objects, so seductively recommended with all the art of modern salesmanship, is liable to disorganise any domestic budget of expenditure.
In the years of apparent prosperity in America that culminated in 1929, it must have often happened that the butcher, the baker, the grocer and the milkman were left unpaid because the instalment was due on the wireless set. Who could trace the manifold reactions on agriculture, and on the relations between agriculture and industry as a whole, that may have followed from myriads of such injudicious decisions in the homes of millions of consumers -- and not only in America?
One of the major disequilibria of the present time is the lack of balance between agricultural production as a whole and industrial production as a whole. In the years that preceded the War we are told on the highest authority that the world as a whole was becoming over-industrialised(2). In consequence, the price level of agricultural produce was relatively higher than the price level of manufactured articles, and the terms of the fundamental exchange that takes place between agriculture and industry in the world as a whole were changing to the advantage of the farmer.
Mr Keynes anticipated that this situation would continue in the post-War period, but in this respect, at least, he was not a true prophet. Owing partly to revolutionary developments in the technique of agricultural production, and partly to the peculiar character of industrial development since 1918, the terms of exchange are now more adverse to the farmer than ever, and there Is a serious problem of agricultural overproduction.
The disequilibrium between agriculture and industry is not the only disequilibrium which threatens the stability of the economic system In every country of the world except Russia. In fact, wherever we turn we are confronted with disequilibria, as plentiful as the autumnal leaves of Vallombrosa:
- disequilibria of national price-levels,
- disequilibria between wholesale and retail prices,
- disequilibria between the prices of raw materials and finished goods,
- disequilibria between the prices of consumers' goods and producers goods,
- disequilibria between the prices of "cartellised" and "non-cartellised" industrial raw materials, and semi-manufactured goods,
- disequilibria between the supply of labour and the demand for it,
- disequilibria between the rates of long term interest current in different countries,
- disequilibria between supply and demand at the prevailing prices of a host of commodities,
- disequilibria between the different elements of the price structure within the nations, and a consequent dislocation of the price system as a whole.
Price movement is the balancing factor which has hitherto been relied on, and not in vain, to restore and maintain some kind of equilibrium which would enable the world economic system to continue functioning, however, imperfect its functioning might in some respects be from a non-economic point of view. In the pre-War world there was comparative elasticity in most of the elements of the price structure. About the only price which was firmly fixed was the price of gold. In the post-War world we meet a host of new price rigidities, for example, the price of labour in sheltered industries, and the price of goods monopolistically produced -- to mention only two of them.
The rigidity of certain elements in the price structure throws all the strain of economic adjustment on other less rigid elements, particularly on profits, including the profits of agricultural enterprise. Wholesale and farmers' prices must fall more because retail prices will not fall enough. When there is a downward pressure on wages, wages in export industries must come down a great deal, partly because wages in the sheltered industries will scarcely budge at all.
In a sense, the economic system is never in equilibrium, for it is dynamic - not static. Adjustments are continually being made, and the tide of economic activity fluctuates in response to the all-pervasive influence of demand, just as the flux and reflux of the sea obeys the pull of the heavenly bodies, but with no such regularity. For demand is more and more capricious and unaccountable.
Under normal conditions there are all sorts of economic activities enjoying varying degrees of prosperity. There are nascent industries, developing industries, industries which have reached their full stature, others which have passed the zenith of their greatness, some definitely on the downward path, and others dying or dead. Such a system, International as well as national in its character, might be said to be in equilibrium when, taken as
a whole, it is producing the commodities and services which people want in the proportion, as measured by economic demand, in which they want them.
The mainspring of this system is the desire for profit, and the regulation of it is price. Price performs its essential function when it moves up or down in such a way that the whole of an available supply is absorbed by an effective demand. If price is fixed otherwise than by market competition there is the danger that some portion of the available supply will fail to find purchasers at that price. There is in consequence dis-equilibrium between supply and demand, or, as it is said, production outruns consumption.
This happens under monopolistic conditions when prices are maintained in a falling market with the result, as in the case of copper, that sales fall off and production must be curtailed; there is consequent unemployment and disuse of some proportion of productive capacity.
But it can happen also under competitive conditions where various economic frictions, as in the case of retail trade, cause competition by way of price reduction to go out of fashion, with the result that the whole burden of price reductions, as well as the unmarketable surplus, is thrown back on the producer at an earlier stage of production. Retailers explain that their incomes are not really any greater, even if profit margins widen, because their overhead charges remain the same, and their average volume of sales may, owing to various causes, be diminishing rather than increasing.
In this, and other ways, price may fall to perform its essential function of equilibrating supply and demand, or may only produce a kind of spurious anti-social equilibrium by making part of the physically available supply ineffective, and in fact destroying wealth to that extent, for wealth that fails to be consumed is wealth destroyed.
The throwing back of an excessive burden of price reduction on producers at the earlier stages reacts on those concerned, not only as producers, but as consumers. The purchasing power of farmers and other primary producers has been seriously impaired in recent years, and their consequent inability to buy the usual quantity of industrial products has contributed to the slowing down of industrial production.
This initiates a vicious circle in the relations between agriculture and industry to which the industrialist.reacts by restricting output to maintain the price, and the farmer by increasing output in the vain attempt to add to his diminishing purchasing power.
Price falls still further as agricultural output increases, and thus the initial disequilibrium between agricultural production and prices and industrial production and prices is intensified.
In the end a certain proportion of farmers will, of course, be forced out of production, surplus stocks will gradually be consumed, and a new equilibrium will be established between agriculture and industry, at a much lower level of production for both.
This will involve a wholesale sacrifice of human happiness and productive capacity. If such a procedure were an essential feature of the present economic system it would be difficult to defend it. But perhaps it is more the result of the increasing economic rigidities which have impaired the flexibility of that system.
Relatively high retail prices are not the only factors which can produce results like these, but they are typical of the economic frictions which, in increasing number, clog the channels along which goods are trying to circulate. They act as a kind of export tax on goods passing from the producer, who is not in touch with consumer's markets, along that difficult and dangerous Jerusalem to Jericho road which terminates with the ultimate consumer.
In fact, anything which impedes the passage of goods, in whatever country produced, to the consumer in the home or foreign market is reflected in higher prices to the consumer, and lower prices to the producer, who is one or more stages removed from the consumer, and is reflected also in more or less wastage of productive effort and wealth. Tariffs, import quotas and the other paraphernalia of the economic nationalist are the outstanding examples of these economic frictions.
To sum up -- the economy of production is now threatened with collapse because the various elements in its price structure are out of harmony with one another. The economic rigidities imposed by trade unionism, war finance, economic nationalism, retail trade policy, etc are inconsistent with its essential character. There are only three alternatives. We must either go on to the complete discipline of a Bolshevik regime on an international scale, or revert to a greater elasticity of economic relations, or witness the gradual disappearance of international trade and large scale industry, the atrophy of our elaborate commercial and financial organisation, and retrogression through the present 16th century atmosphere of economic nationalism to the Middle Ages from which we thought we had emerged.
Doubtless, the monetary inflation that took place in many countries during and since the War, and the deflationary policy pursued by England after 1920 contributed to the disorganisation of economic relations, and account for some of the existing disequilibria of prices.
Every change in the general purchasing power of money, whether inflationary or deflationary, automatically redistributes real income in a different proportion among the various classes of the economic community. The economy of production is constantly trying
to adjust itself to the economy of consumption, and when the latter is changing rapidly, from whatever causes, the organisers of production are set an increasingly difficult task.
Yet a brief survey of the outstanding economic facts of the War and post War period will show that the causes of initial disturbance were by no means exclusively monetary.
The War intensified the need of Europe for raw materials and food stuffs produced in overseas countries, while at the same time her factories and workshops were otherwise employed, and were unable to supply overseas countries with the manufactured goods they had been in the habit of importing.
Russia, formerly an Important source of grain for other European countries, was now definitely out of the picture. Hence overseas agriculture expanded the acreage under cultivation to make good this deficit and satisfy the insatiable demands of the belligerents.
At the same time overseas countries, deprived of European manufactures;. were forced to undertake the more necessary of these for themselves. There was a rapid development of the cotton industry in China and Japan and India, and of other textiles in Australia and Canada.
Eventually the War came to an end, but it took Europe some time to restore
the shattered fabric of her economic life. By 1925 world production had
increased by 16%, but European production only by 2% as compared with 1913. By 1929, European production, assisted by a liberal investment of American capital, had forged ahead. It showed an increase of 17 per cent. over the 1925 level, while in the world as a whole the increase was only 11%. Both agriculture and industry in Europe were now more productive than before the War. Yet this very increase contained the seeds of the present trouble.
For the peasant cultivators of Europe, now debarred from emigration to the USA, were increasing in number, especially in Eastern Europe and were attempting to force from the soil by primitive methods the products of
cereal husbandry which the New World hod meanwhile organised itself to produce with all the equipment of modern science and modern mechanism.
The problem of excess capacity, latent in the post-War world, had now become all too evident. Even before the bursting of the American boom, as early as the spring of 1928, there were signs that the prices of important agriculture products and raw materials were threatening to break.
The price of wheat would have broken much sooner had it not been for the efforts of the Federal Farm Board to hold it up, with monetary facilities provided by the banking system.
The price eventually did break -- more disastrously than if it had been let take its course. This episode alone is sufficient proof that no mere monetary policy can raise or sustain prices in the face of increasing stocks and declining or stationary consumption.
From 1921 to 1925 there was indeed a continuous growth of tariffs on industrial products, but as lately as 1927 there seemed some prospect of a tariff truce, and of a general downward revision of all tariffs. In 1928-29 the agricultural States of Europe began to feel the first price stringency resulting from excess production and the unequal competition of the old methods with the new tariffs, especially for the protection of cereal production. Since then the economic situation of cereal producing countries has gone from bad to worse, while tariffs on every kind of industrial and agricultural product have been multiplied more and more.
There is now no international price level for wheat, formerly the most characteristic commodity of international trade. There is a series of segregated domestic markets for it in various countries. Those which import some wheat can protect the domestic producer and the price is high, those which must export a surplus are the helpless victims of low prices. Wheat was 79 USA cents a bushel in France in January, 1932, and 44 cents in the Argentine.
Cereal production is not the only form of agriculture. The animal husbandry of Denmark and Ire1and is one which uses the products of cereal husbandry as raw materials, and therefore benefits by their diminishing cost. There is some evidence that the agriculture of the world was readjusting itself in the direction of a greater production of the animal products, for which there is an expanding demand from industrial populations so long as their standard of living is rising. This would have been the normal and healthy method of working off and absorbing a surplus of cereal production.
A greater variety of the things people did want would have been produced instead of too much of the one primary necessity for which the demand notoriously collapses as soon as the paint of satiety is reached. But this healthy development was prevented by the tariff policies of a host of States. They succeeded admirably in disorganising the economic life of the world as a whole, though they did not solve the problem of the export surplus for any of the countries concerned.
In fact by their indirect effects in scaling down the worker's standard of life, till recently improving, they have made the problem of the wheat surplus insoluble except by a large scale contraction of cultivation, and created a new problem for the producers of animal products. For the declining standard of life of the worker, employed or unemployed, it is no longer compatible with the consumption of Danish and Argentinian products on the pre-1929 scale.
In industry, as well as agriculture, the years between 1925 and 1929 brought to light a problem of excess capacity which had been implicit since the exigencies of war had duplicated the industrial plants of Europe in non-European countries. It was the older standardised industries, eg textiles, which had been established abroad, and it is significant that even in the years of apparent prosperity that ended in 1929 - and even in America -
these industries remained depressed.
The industries which expanded rapidly were chiefly concerned with semi-luxury products like artificial silk, or articles of durable consumption, also of a semi-luxury character, like gramophones, motor cars, and cinema equipment.
The growth of,these new industries may, as already suggested, have helped to disorder the economy of consumption, and ultimately the economy of production. Urban population was certainly increasing in Western Europe and America, and rural areas were losing population - a natural and necessary corollary to improvements in the technique of agriculture. But the directions in which industry as a whole was now developing, instead of helping to maintain the fundamental balance between agriculture and industry, were perhaps helping to distort it. Too many urban workers were producing and exchanging services from which only urban residents could benefit. The prices of the industrial products in which the farmer was interested tended to keep up, and are still relatively too high.
It used to be considered a good thing to make two blades if grass grow where one grew before. But for an urban boy or girl to go to the pictures twice a week, where formerly once was sufficient, is perhaps typical of a consumption economy which brings no grist to the farmer's mill, and may help to account for the disequilibrium between agriculture and industry.
Anyhow the industrial development of these years, such as it was, could not and did not help to increase the consumption of cereal products, as the agricultural development to some extent did. Sooner or later this must have produced an economic crisis. If there had been no monetary disturbances, and no spectacular departures from the gold standard, we would still have had a first-class world economic crisis, and everyone would have admitted that the unbalanced relationship between agriculture and Industry was the central feature of it.
It is important to realise that the present depression differs from all previous depressions in some essential aspects of its character, but most of all in its intensity. Other depressions have shown their chief effects on the commercial and financial organisation, while the production of the concrete things which that organisation exists to circulate, maintained a remarkably even tenor. This depression is not only a disturbance of the outward surface of economic life. It has shaken it to its foundations.
Production and commerce, both international, are not only unbalanced, but have seriously diminished, and are threatened with still further diminution.
Only in the case of foodstuffs and raw materials for consumers' goods has production in 1931 approached the level of 1929. The diminution is less than 5 per cent. On the other hand, the falling off in the production of the raw materials for producers' goods - iron, steel, copper, etc. - has reached alarming proportions, and is reflected in the statistics of unemployment and industrial production in all the major industrial countries.
For the world as a whole this class of raw material production has fallen from 1929 to 1931, in the ratio of 113:82. The proportions differ for different countries and the figures for the United Kingdom are by no means the worst. As compared with 1929 the production of pig iron in that country was nearly 60% less in September, 1932. It was indeed 62% less in September, 1931(3).
Crude steel is down by 47%, and coal by nearly 25% though it is perhaps pleasant to know that the production of artificial silk is up by 20%. In the second quarter of 1932 industrial production as a whole in Great Britain was 78%, in Germany 58%, in France 75%, in the United States 54%, and in Canada 70% of the average for 1927-1929.
The falling off in the production of producers' or investment goods has been much more serious in most countries than the falling off in consumers' goods(4).
Taking 1927-29 as the base period, the index figures for Germany were respectively 46% and 86%, for the United States 35% and 83%, and for the United Kingdom (with a slightly different base) 78 and 93%, in the first quarter of 1932.
With this is closely connected the fact that the production of producers' goods is in many countries to a large extend 'cartellised', that is, carried on under monopolistic or semi-monopolistic conditions. Such associations have held up prices at the expense of output and employment. The consequent disequilibrium between the prices of producers' and consumers' goods has incidentally deterred new investment, and in fact constitutes one of the chief obstacles to recovery from the present depression.
Business cannot expand and the volume of production in general recover without substantial purchases of new capital equipment and this will be deferred till producers'goods become cheaper or consumers goods dearer(5).
The rapid disappearance of international trade is, perhaps, the chief characteristic of the present depression. This has been the result, in the first instance, of the depression itself, but the foolish and futile remedies of tariff maniacs in many countries have created a world situation in which international trade cannot continue to survive. Unless the process is reversed there is a real danger that we may find ourselves in a new mediaevalism that will stink with the odour of organic decay. For the existing economic order, though not consciously organised on a world basis, is essentially a world organism, and cannot survive in the stifling atmosphere of economic nationalism.
In 1931 the value of world trade as a whole was 40 per cent less, and the volume 26 per cent less, than the average of the period 1925-1929(6). The value of the United Kingdom imports fell by 39%, and exports by 47% between January 1930 and January 1932. The monthly average of British exports was less by £6 millions in the third quarter of 1932 than in the first, though the tariff enthusiasts had not been idle in the meantime(7).
An economic nationalist may, perhaps, derive some comfort from the fact that German exports declined in value by 49% and American by 64% between January 1930 and January 1932, in spite of -- or because of -- their tariffs.
There is no evidence that the Gaderene swine of economic nationalism have yet stayed their course, or realised their destination; and there is no hope for the world unless the Spirit of Him who cast out devils shall in some way dominate our international relations, to the exclusion of the diabolical obsessions which are shattering the body and destroying the soul of European civilisation.
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