tutee Marx—though, as may be the case sometimes, neither would have been completely pleased with the other’s performance. decreased and population will have become ‘redundant,’ which is what Ricardo set out to prove. Ricardo concluded from this that the opinion prevailing in ‘the labouring class, that the employment of machinery is frequently detrimental to their interests, is not founded on prejudice and error, but is conformable to the correct principles of political economy.’ It was this sharp-edged pronouncement that monopolized professional attention, reinforced as it was by another passage in the same chapter which affirmed that in cases like the one discussed ‘there will necessarily be a diminution in the demand for labour, population will become redundant, and the situation of the labouring classes will be that of distress and poverty.’ Friends and foes seem to have seen nothing else and, ever since, Ricardo has stood in doctrinal history as the chief exponent of the view that those statements in fact do seem to express. But, if we take account of the rest of the chapter and bear in mind that it professedly deals with what Ricardo used to call permanent effects, it is clear, first, that they do not follow from the numerical example alluded to and, second, that Ricardo was aware of this and did not mean at all what these statements say. As regards the first point, Ricardo’s example covers only part of the course of events that the introduction of the machine sets into motion: his analysis of the case is indeed an example of the method of Comparative Statics, but the second of the two states compared is not a definitive state of equilibrium, for we are not told what happens to the workmen who have lost their jobs, yet they cannot remain unemployed unless we are prepared to violate the assumption that perfect competition and unlimited flexibility of wages prevail. As regards the second point, Ricardo, though in a particularly narrow and inconclusive way, fully recognized that mechanization may increase productive efficiency so greatly ‘as not to diminish the gross produce’ (gross produce in his sense, that is, the net national product including wages) in terms of commodities. This amounts to saying that real wage income (in our sense) need not fall ‘permanently’; and that in any case, the purchasing power of profits and rents being increased by the fall in prices resulting from mechanization, ‘it could not fail to follow’ that, with constant propensity to save, capitalists and owners of natural agents would fill up the depleted wage fund again by means of increased savings. These admissions (for brevity’s sake I neglect others) are not exceptions to his argument but result logically from it, if it be continued beyond the point reached by the numerical example. Thus they make Ricardo the father of what Marx called the Theory of Compensation—the theory that the working class is being compensated for initial sufferings, incident to the introduction of a labor-saving machine, by favorable ulterior effects—which Marx attributed to James Mill, McCulloch, Torrens, Senior, and J.S.Mill, thereby constructing an entirely unrealistic contrast between these men and Ricardo. More or less, most economists have done the same thing, even those who did not wish, as did Marx, to single out this so-called theory of compensation for vituperative comment (see Das Kapital, vol. I, ch. 15, sec. 6). The controversy that went on throughout the nineteenth century and beyond, mainly in the form of argument pro and con ‘compensation,’ is dead and buried: as stated above, it vanished from the scene as a better technique filtered into general use which left nothing to disagree about (see reference to Hicks’s Theory of Wages, first footnote of this subsection). Nevertheless, in order to understand an important phase of past doctrinal History of economic analysis 652 history, a few clarifications will be useful. In the first place, the reader must not think that Ricardo was wrong in the result that he formulated in the two statements quoted above. On the contrary, if we interpret him to have meant that mechanization may permanently decrease labor’s relative and possibly even absolute share in national income (no matter whether this be real income in our sense or in Ricardo’s), he was correct. Only, his argument taken as a whole does not prove it. In the second place, so far as Ricardo meant to convey not only an abstract theorem but a picture of practically relevant processes and likelihood, he obviously underrated the effects of the increase in productive power that mechanized capitalism would display and of the expansion of output that would result therefrom—so that long-run ‘distress and poverty’ looms larger in his text than it should in a realistic picture. On the one hand, this was due to something that is much worse than defective technique, namely, to lack of imagination: he never clearly realized that the essential fact about capitalist ‘machinery’ is that it does what, quantitatively and qualitatively, could not be done at all without it or, to put it differently, that it ‘replaces’ workmen who have never been born. But, on the other hand, this was due also to the shortcomings of his analytic apparatus, which did not lend itself readily to the description of quantitative expansion. In particular, in the Ricardian system prices can fall to cost level directly, that is, in a way other than by increase of output (Principles, ch. 30): hence he failed to see that total output in terms of goods must increase, under conditions of perfect competition, which he assumed, in consequence of mechanization. He further failed to see clearly that, if we express the wage fund also in terms of commodities, it can increase without any increase in saving, though it is then much more natural to say simply that real wage incomes (in our sense) increase than it is to say that the wage fund increases and that real wages increase in consequence of this. In the third place, the reader who, on perusal of Ricardo’s chapter on machinery, sets it down as a mess is perfectly right; and he may well ask for the reason. It seems to me that the reason is that Ricardo, while retaining his own approach in terms of real value (‘labor embodied’), at the same time repeatedly crossed the frontier that separates this approach from analysis in terms of goods. Why he did this is clear: his exact reasoning is always in terms of the labor-embodied approach; but this approach does not lead to any results about anyone’s distress or welfare, which were what interested him in this chapter. And so he mixed up the two, sometimes speaking of ‘distress of labor’ when summing up an argument that was in terms of labor embodied and hence irrelevant to real incomes in our sense that is real income in terms of goods, sometimes speaking in terms of his real value in the course of an argument that makes sense only in terms of absolute quantities of goods. Finally, in the fourth place, additional clarification may be desirable as regards that increase in saving by capitalists to which Ricardo attributed effects that would or may remedy the injury the machine does to workmen. Since this injury, within Ricardo’s wage-fund method, is described as a reduction in the Ricardian value of the wage fund, additional saving will in fact tend to repair the damage. Now this additional saving comes from profits for two alternative reasons. First, even if the rate of profit be not increased permanently (if, in Ricardo’s language, the ‘value’ of profits be not increased), a fall in prices of the goods they consume makes it easier for capitalists to save, which (if propensity to consume remains constant as it always is with both Ricardo and Keynes) they will accordingly do. But, second, if the cheapened goods are, wholly or primarily, General economics 653 consumed by workmen, then, according to Ricardo’s theory, the rate of profits will increase. And increased saving will follow from this. Let me add that J.S.Mill did accept Ricardo’s methods, but did not follow them closely. The main comfort he had to offer to the working class was that mechanization occurs in a process that produces ample savings that easily replace reductions in the wage fund caused by mechanization (they would otherwise spill over into colonies and so on) so that these reductions are likely to be potential rather than real. Marx ought to have liked this—for it offers a nice suggestion for the socialist theory of imperialism (see below)—but he did not display gratitude when he used it. Marx (op. cit. ch. 15) accepted Ricardo’s analysis, adding nothing essential but minimizing the Ricardian qualifications, beating out the slender result to its thinnest leaf, making the most of the unemployment that has been historically associated with the process of mechanization, and allowing himself to be carried on by his glowing rhetoric to a pitch of excitement such that he even overlooked some points he might have made for his own theory or against the hated theory of compensation. Perhaps this shows, as do in his case other excesses of this kind, that he was not quite sure of his ground. Certainly it shows that he was aware of the decisive importance of the mechanization problem for his ultimate conclusions concerning the future of the capitalist system. Machines had to throw the laborers ‘on the pavement’—still better, because of English machines the bones of Indian weavers had to ‘bleach in the sun.’ Marxist unemployment is essentially technological unemployment. This technological unemployment had to create a permanent ‘industrial reserve army’—Ricardo’s redundant population. And the presence of this permanent industrial reserve army—only temporarily absorbed in spells of high prosperity—had to depress real wages (in our sense) to levels of everincreasing misery, degradation, and so on (Verelendung) that would eventually goad the proletariat into the final revolution. Of course, this was only an ‘absolute law.’ 105 Of course, Marx’s effective display of severely selected his- 105 The reader should remember what this phrase means in the Marxist lingo, namely, the same thing as an abstract tendency that is not necessarily verified in any given stretch of economic history. History of economic analysis 654 torical facts, which fill out his analysis in that chapter, contains a considerable number of qualifications of his own as do some passages in the third volume. But since abstract tendencies drive nobody into misery and despair and since Marx took little heed of his qualifications when it came to ultimate conclusions and purposes (see, e.g., ch. 32, ‘Historical Tendency of Capitalistic Accumulation’), no Marx apologetics can be successful that proceed on either of those lines. We have no choice but to take statements like that above seriously. If we do, the failure of Marx’s attempt to turn the possibility that Ricardo envisaged into inexorable necessity endangers the logical structure of his system as much as the actual history of the working class endangers any claim it might have to realism. 106 But it is only the thesis about increasing misery that needs to be dropped from Marx’s analysis of the process of technological development, although, from the standpoint of Marxist orthodoxy, it may be all-important. Other results remain. In order to see them in their proper light, let us remember that, in Marx’s general schema, social evolution is propelled by a force that is immanent or necessarily inherent in the profit economy. This force is Accumulation: under pressure of competition, the individual concern is compelled to invest as much of its profits as possible in its own productive apparatus; 107 and it is compelled to invest them primarily in technological capital, naturally looking always for machines of ever-new types. This does not permanently benefit ‘capitalists’ as a class 108 for, as Ricardo had already pointed out, any supernormal gain is quickly eliminated by competitors’ adopting each technological improvement. But the temporary advantage gained by the one who is first to move gives him a lead in the race: rushing down on declining average-cost curves and annihilating (‘expropriating’) the weaker ones in the process, capitalist concerns, individually growing in size. build up vast powers of production that eventually burst the framework of 106 There are Marxists who actually do not mind taking up the ridiculous position that a tendency for the working class’s standard of life to fall is in fact observable. Others have confined themselves to the less absurd proposition that Marx’s abstract law has been put out of operation, owing to uniquely favorable conditions that have prevailed in the nineteenth century (such as the opening up of new sources of foodstuffs and raw materials through the spectacular cheapening of transportation), but will assert itself eventually if it has not done so already in the 1930’s. Still other interpreters have made efforts to make Marx’s law mean relative misery only, i.e. a fall in the relative share of labor, which, besides being equally untenable, clearly violates Marx’s meaning. 107 Of course, this is saying the same thing as that the individual concern is compelled to save, a phrase the highly undesirable implications of which Marx fought like a lion to avoid. In pointing out the existence of this compulsion he did, however, betray a much deeper understanding of the capitalist mechanism than can be attributed to the ‘bourgeois’ economists of his age. But in common with them, he saw nothing but the mechanical aspect of accumulation, hence not the reality of capitalist evolution but only its reflection in growing heaps of inanimate things: besides accumulating these, ‘capitalists’ did nothing but exploit. 108 On the ‘law of the falling rate of profit.’ see above subsec. 6c. General economics 655 capitalist society. Not all this has stood up. Particularly vulnerable is the last point: Marx never made it clear precisely how the economy of giant concerns is to break down, and his break-down theory (Zusammenbruchstheorie) has in fact been renounced by some of his most eminent followers. On the whole, however, one cannot but be impressed by both the analytic and realistic virtues of this conception of capitalist evolution, especially if one compares it to the modest elements of it that Marx found in Ricardo’s chapter on machinery. History of economic analysis 656 CHAPTER 7 Money, Credit, and Cycles 1. ENGLAND’S PROBLEMS IT IS THE COMMON opinion that the foundations of the monetary science of today (or yesterday) were laid by the writers who discussed the issues of English monetary and banking policy from the Restriction Act (1797) to the gold inflation of the 1850’s. This neglects indeed the French and Italian work of the eighteenth century but nevertheless comes nearer to the truth than such sweeping statements usually do. Many of those writers moved on an unusually high level. They soared with ease into the sphere of abstract generalization and were possessed of a genuine will to analyze. This is the more remarkable because most of them were men of practical affairs and primarily interested in practical measures. We are accustomed to a different state of things: few modern economists would look to men of practical affairs and especially to bankers for help in their analytic task or even consider them as authorities on the principles of their own business. But this situation developed in the next period. In the one under survey, it was the practitioners who were in the van of analytic advance, and research workers of different types were in most cases content to take their clues from them. With most of the leading performers we are already acquainted, especially with Ricardo, Malthus, Senior, Tooke, Torrens, and J.S.Mill. 1 A small num- ber of others will be introduced as we go along. But Henry Thornton (1760–1815) must be saluted at once. He was a banker, M.P., philanthropist, and—which he himself and many who knew him would presumably have put first—a leading figure in the influential group of Evangelicals that was known as the Clapham Sect. His Enquiry into the Nature 1 Some of the relevant publications of these and others have also been mentioned already. Others will be mentioned in the appropriate places. Ricardo’s main contributions will, however, be listed at once. As the reader knows, it was as a writer on monetary policy, in the discussion on war inflation, that Ricardo first made his reputation. His three letters to the Morning Chronicle (1809, Hollander reprint as Three Letters on the Price of Gold, 1903) were followed by a fuller statement of his views in pamphlet form: The High Price of Bullion, a Proof of the Depreciation of Bank Notes (1810). The Reply to Mr. Bosanquet’s Practical Observations on the Report of the Bullion Committee, Ricardo’s only exploit in ‘factual’ work—but very interesting as and Effects of the Paper Credit of Great Britain (1802) 2 is an amazing performance. The product, according to Professor von Hayek’s estimate, of work that extended over about six years during which the author’s energy was largely absorbed by business and political pursuits, not faultless in detail and not fully matured, it anticipated in some points the analytic developments of a century to come. No other performance of the period will bear comparison with it, though several, among them Ricardo’s, met with much greater success at the time as well as later. In part this was because the author put no emphasis at all upon his novel results—the book reads as if he himself had not been aware of their novelty. Perhaps he was not, though he paid an almost academic amount of attention to such predecessors as he knew. He was one of those men who see things clearly and who express with unassuming simplicity what they see. We shall confine ourselves almost exclusively to English work—a decision which, for the epoch and the topic, may be justified even apart from the considerations of space that impose it. With qualifications to be mentioned, this work was successfully summed up by J.S.Mill. The relevant chapters of the Principles contain some of Mill’s best work. It displays indeed some contradictions, hesitations, and unassimilated compromises—as does his work on value—but even these were not unmixed evils since they brought out, in strange contrast to Mill’s own belief in the finality of his teaching, the unfinished state of the analysis of that time and thus indicated lines for further research to follow. In any case, it was primarily in Mill’s formulation that such—appeared in 1811; the Proposals for an Economical and Secure Currency in 1816. Chapter 27 of the Principles (1817), ‘On Currency and Banks’ retains independent importance in spite of the long quotation from the Proposals. The Plan for the Establishment of a National Bank (1823) has been reprinted by Professor Hollander in Minor Papers on the Currency Question, 1809–23, by David Ricardo (1932; see the discussion of this plan in Professor Rist’s, History of Monetary and Credit Theory, pp. 177–9), which contains also other pieces that are quite essential to a full understanding of Ricardo’s views. Other items might be added. Ricardo’s theory of money, credit, and banking gains on acquaintance, and in perusing his letters as well as his evidence before the Committees on the Usury Laws and on Resumption, one discovers more and more fragments that might be combined into a spacious structure. No attempt will be made, however, to do so. We shall have to be content with a few features of Ricardo’s analysis that are of major importance to doctrinal history. The reader is warned that this may involve some injustice to his performance as a whole. But the impression the reader is bound to get, that Ricardo did not contribute much that was both true and original, agrees with Viner’s judgment (op. cit. p. 122), and so does, I believe, my opinion that as an analyst of money and credit Ricardo was inferior to Thornton. 2 The Library of Economics reprint (1939) is prefaced by an essay by Professor von Hayek, the scholarship of which is surpassed only by its charm. The reader who misses it deprives himself not only of much valuable information but of an exquisite pleasure. History of economic analysis 658 the work of the first half of the nineteenth century reached the writers of the second half, and we shall therefore keep this formulation in view, as a point of reference, throughout this chapter. I have commended the taste and ability for theoretical analysis of the writers of that period. Nevertheless, their analysis was too closely bound up with the conditions and problems of their time and country to admit of exposition without reference to these conditions. Accordingly we shall now cast a perfunctory glance at them—neglecting entirely, for the reason stated, the much more exciting experiences of the United States and of some continental countries. Sources of more adequate information are presented below. To the student who wishes to have a single reference on which to concentrate I recommend Professor Viner’s presentation in Studies in the Theory of International Trade, Chapters III, IV, and V. This masterly piece of research—admiration for which does not, however, imply agreement in every particular—will serve both for the history of the most important facts and controversies, and as a guide to further historical literature. For statistical figures, see N.J.Silberling, ‘Financial and Monetary Policy of Great Britain during the Napoleonic Wars,’ Quarterly Journal of Economics, May 1924, and ‘British Prices and Business Cycles, 1779–1850,’ Review of Economic Statistics, Preliminary vol. V, 1923, and E.V.Morgan, ‘Some Aspects of the Bank Restriction Period, 1797–1821,’ in Economic History, A Supplement to the Economic Journal, February 1939. By far the greatest contemporaneous histoire raisonnée is Tooke and Newmarch, History of Prices (discussed above ch. 4, sec. 8a). Perusal of Sir T.E.Gregory’s introduction to the 1928 edition of this work is the second recommendation I have to make. Mr. R.G.Hawtrey’s Currency and Credit (3rd ed., 1928, ch. 18) and Art of Central Banking (1932, ch. 4), usefully supplemented by Mr. W.T.C.King’s History of the London Discount Market (1936), come next. Further help will be derived from J.W.Angell, The Theory of International Prices (1926); E.Cannan, The Paper Pound of 1797–1821 (1919), which contains a reprint of the Bullion Report; A.E. Feavearyear, The Pound Sterling (1931, ch. 9); A.W.Acworth, Financial Reconstruction in England, 1815– 22 (1925); R.S.Sayers, ‘The Question of the Standard in the 1850’s,’ Economic History, A Supplement to the Economic Journal, January 1933, and ‘The Question of the Standard, 1815–44’ (ibid. February 1935); R.H.I.Palgrave, Bank Rate and the Money Market (1903); and Elmer Wood, English Theories of Central Banking Control, 1819– 1858 (1936), with a valuable bibliography which in particular presents a list of reports of committees on monetary subjects and of other official papers to which, as usual, no justice can be done here. Money, credit, and cycles 659 (a) War Inflation, 1793–1815. In spite of the suspension of the Bank of England’s obligation to redeem its notes in gold, 1797, 3 war finance did not produce any great effects upon prices and foreign-exchange rates until about 1800. To the modern student who is inured to stronger stuff, the most striking feature of the subsequent inflation is its mildness: at no time was the public’s normal behavior with respect to money seriously disturbed; at no time did the impact of the government’s war expenditure blot out those fluctuations that might have been expected to occur in the usual course of things; at no time was the government driven to anything more unorthodox than abnormally heavy borrowing from the Bank, and even this borrowing never surpassed the limits beyond which the term ‘borrowing’ becomes an euphemism for printing government fiat; at no time, finally, was the national wage bill— the chief conductor of inflationary effects—so seriously expanded as to endanger the currency. It was in fact this very mildness of the inflationary process that made diagnosis so difficult. In particular, it made it more difficult to recognize the inflationary element in the situation and to distinguish it from the effects upon foreign exchange of the two circumstances that a great part of war expenditure was for financing allied and English armies on the Continent, and that English exports and imports were for years together seriously interfered with. Government spent lavishly. But it also did its best, by the introduction of an income tax and in other ways, to keep the inflationary advances from the Bank down to a minimum, and its finance never ceased to remain competent and responsible. But the reticence of the government about the extent of its borrowings from the Bank, quite understandable until Waterloo, was a contributory factor in people’s propensity to blame the Bank for whatever consequences they did not like. This propensity, strong at all times, which was fully shared by the majority of writers, must be borne in mind throughout: from Ricardo to the most unsophisticated man in the street, everybody loved to make a whipping boy of the central bank, a habit economists have retained to this day. In public at least, the Bank was unable to defend itself, because no effective defense was possible without giving the government away—and politicians in power are in a position to make their resentment felt. This may conceivably explain much that strikes historians as lack of insight in the official pronouncements. As a matter of fact, the Bank was obviously not free to refuse the government’s ‘requests’ for advances. If there can be any question at all of its ‘responsibility for inflation,’ it must be understood to refer to its loans to (discounts for) the public, which were inevitably increased as a consequence of the government’s deficit spending. But they were rationed and kept down whenever government borrowed heavily, and cannot be said, everything considered, to have been obviously excessive—though it is, of course, always possible to argue that they could have been less had the Bank been willing to take the responsibility for disturbing production in wartime. Moreover, punitive rates 4 above 5 per cent were rendered impossible by the usury laws until 1832. There is no doubt that such inflation as there was 3 This Restriction Act was not passed as a war measure but in order to stop a run upon the bank. 4 I shall take this opportunity to clear up a point that played a role in the discussion of the Bank’s responsibility and arises in every war inflation. Government expenditure financed in any way that does not reduce the public’s expenditure by the same amount will raise prices, if it impinges on a well-employed business organism, which in the case before us was so at times but not at others. History of economic analysis 660 When prices have risen, then, the money cost of producing being increased thereby, nongovernmental borrowing will be increased also: the government inflation produces in this case a secondary wave of credit inflation and also reinforces itself currently. Now it is evidently possible to say, since such government inflation by definition implies increase in the means of payment and since was strong enough to accentuate speculative excesses and breakdowns, a boom in agriculture, and conditions of general prosperity in most of the years to 1815, none of which could, however, have been entirely prevented by the Bank. On the surface, then, the controversy that contributed so much to monetary analysis was simply a controversy between writers who sought to prove and to indict inflation and to locate the responsibility for it with the Bank, and other writers who sought to deny the presence of inflation or to justify it and to locate the responsibility for rising prices and unfavorable exchanges with circumstances other than the behavior of the Bank. So far as this goes, it is possible to speak of two fairly well defined and opposing groups or parties. Also, the first one may be said to have prevailed in the sense that it succeeded better than did the other in impressing its views upon the famous Bullion Report of 1810. 5 In consequence, it has become usual to affix to the members of this group the meaningless label Bullionists and to the opponents of the report the label Anti-Bullionists, although the report itself really represents various compromises. However, the practical issues and the recommendations as to ‘what should be done about it’ are of no great importance for us. Important is the analytic quality of the arguments and diagnoses produced. And from this standpoint the party lines lose much of their definiteness and almost all their interest. The differences between the supporters of the Bullion Report are actually much more interesting than is the common bond between them. But before taking leave of this historic document, let us note the significant fact that the Report of the Cunliffe Committee that recommended England’s return to gold at prewar parity in 1918 (final report, 1919) displayed little, if any, knowledge of monetary problems that was not possessed by the men who drafted the Bullion Report. (b) The Question of the Standard. About twenty years of irredeemable paper and all the economic changes that had occurred during that time made the problem of deciding on a monetary policy much more difficult than it would have been after a shorter disturbance. De facto, though not legally, the secondary inflation does the same, that the whole trouble is ‘increase in the quantity of money.’ But since this increase in the quantity of money is an incident in a process that involves many more fundamentally ‘causal’ elements (the policy that led to the war, among others), and since the secondary inflation is in fact induced by a preceding rise in prices, it is equally possible to say that the bank or banks which finance the increase in both governmental and business expenditure are playing a ‘passive’ role and in particular, so far as business borrowing is concerned, are but ‘responding to needs’ that have arisen in consequence of high prices and high money wages—or else that the ‘quantity of money’ (notes and deposits) increases because prices have risen. Neither of these two statements is necessarily erroneous. But each of them becomes erroneous as soon as it is interpreted to deny the element that the other one emphasizes. This, however, is what happened in the English controversy of 1800–1810, as it happens in any discussion of any inflation. But the Money, credit, and cycles 661 . stretch of economic history. History of economic analysis 654 torical facts, which fill out his analysis in that chapter, contains a considerable number of qualifications of his. not only of much valuable information but of an exquisite pleasure. History of economic analysis 658 the work of the first half of the nineteenth century reached the writers of the second. to Hicks’s Theory of Wages, first footnote of this subsection). Nevertheless, in order to understand an important phase of past doctrinal History of economic analysis 652 history, a few clarifications