Keynes' Journey

The book “The Physiology of Industry”, published in 1889 by J. A. Hobson and A. F. Mummery, was the first open step in my heretical career.

How could there be any limit to the amount of useful saving when every item of saving went to increase the capital structure and the fund for paying wages? Sound economists could not fail to view with horror an argument which sought to check the source of all industrial progress.[45]

The object of production is to provide “utilities and conveniences” for consumers, and the process is a continuous one from the first handling of the raw material to the moment when it is finally consumed as a utility or a convenience. The only use of Capital being to aid the production of these utilities and conveniences, the total used will necessarily vary with the total of utilities and conveniences daily or weekly consumed. Now saving, while it increases the existing aggregate of Capital, simultaneously reduces the quantity of utilities and conveniences consumed; any undue exercise of this habit must, therefore, cause an accumulation of Capital in excess of that which is required for use, and this excess will exist in the form of general over-production.[46]

In the last sentence of this passage there appears the root of Hobson’s mistake, namely, his supposing that it is a case of excessive saving causing the actual accumulation of capital in excess of what is required, which is, in fact, a secondary evil which only occurs through mistakes of foresight; whereas the primary evil is a propensity to save in conditions of full employment more than the equivalent of the capital which is required, thus preventing full employment except when there is a mistake of foresight.

A page or two later, however, he puts one half of the matter, as it seems to me, with absolute precision, though still overlooking the possible role of changes in the rate of interest and in the state of business confidence, factors which he presumably takes as given= We are thus brought to the conclusion that the basis on which all economic teaching since Adam Smith has stood, viz. that the quantity annually produced is determined by the aggregates of Natural Agents, Capital, and Labour available, is erroneous, and that, on the contrary, the quantity produced, while it can never exceed the limits imposed by these aggregates, may be, and actually is, reduced far below this maximum by the check that undue saving and the consequent accumulation of over-supply exerts on production; i.e. that in the normal state of modern industrial Communities, consumption limits production and not production consumption.[47]

Finally he notices the bearing of his theory on the validity of the orthodox Free Trade arguments= We also note that the charge of commercial imbecility, so freely launched by orthodox economists against our American cousins and other Protectionist Communities, can no longer be maintained by any of the Free Trade arguments hitherto adduced, since all these are based on the assumption that over-supply is impossible.[48] The subsequent argument is, admittedly, incomplete. But it is the first explicit statement of the fact that capital is brought into existence not by the propensity to save but in response to the demand resulting from actual and prospective consumption.

The following portmanteau quotation indicates the line of thought= It should be clear that the capital of a community cannot be advantageously increased without a subsequent increase in consumption of commodities. … Every increase in saving and in capital requires, in order to be effectual, a corresponding increase in immediately future consumption.[49]

When we say future consumption, we do not refer to a future of ten, twenty, or fifty years hence, but to a future that is but little removed he present.

If increased thrift or caution induces people to save more in the present, they must consent to consume more in the future.[50] … No more capital can economically exist at any point in the productive process than is required to furnish commodities for the current rate of consumption.[51] … It is clear that my thrift in no wise affects the total economic thrift of the community, but only determines whether a particular portion of the total thrift shall have been exercised by myself or by somebody else. We shall show how the thrift of one part of the community has power to force another part to live beyond their income.[52] … Most modern economists deny that consumption could by any possibility be insufficient.

Can we find any economic force at work which might incite a community to this excess, and if there be any such forces are there not efficient checks provided by the mechanism of commerce? It will be shown, firstly, that in every highly organised industrial society there is constantly at work a force which naturally operates to induce excess of thrift; secondly, that the checks alleged to be provided by the mechanism of commerce are either wholly inoperative or are inadequate to prevent grave commercial evil.[53]

The brief answer which Ricardo gave to the contentions of Malthus and Chalmers seems to have been accepted as sufficient by most later economists. “Productions are always bought by productions or by services; money is only the medium by which the exchange is effected. Hence the increased production being always accompanied by a correspondingly increased ability to get and consume, there is no possibility of Overproduction” (Ricardo, Prin. of Pol. Econ. p. 362).[54] Hobson and Mummery were aware that interest was nothing whatever except payment for the use of money.[55]

They also knew well enough that their opponents would claim that there would be “such a fall in the rate of interest (or profit) as will act as a check upon Saving, and restore the proper relation between production and consumption”.[56] They point out in reply that “if a fall of Profit is to induce people to save less, it must operate in one of two ways, either by inducing them to spend more or by inducing them to produce less”.[57]

As regards the former they argue that when profits fall the aggregate income of the community is reduced, and “we cannot suppose that when the average rate of incomes is falling, individuals will be induced to increase their rate of consumption by the fact that the premium upon thrift is correspondingly diminished”; whilst as for the second alternative, “it is so far from being our intention to deny that a fall of profit, due to over-supply, will check production, that the admission of the operation of this check forms the very centre of our argument”.[58]

Nevertheless, their theory failed of completeness, essentially on account of their having no independent theory of the rate of interest; with the result that Mr. Hobson laid too much emphasis (especially in his later books) on under-consumption leading to over-investment, in the sense of unprofitable investment, instead of explaining that a relatively weak propensity to consume helps to cause unemployment by requiring and not receiving the accompaniment of a compensating volume of new investment, which, even if it may sometimes occur temporarily through errors of optimism, is in general prevented from happening at all by the prospective profit falling below the standard set by the rate of interest.

Since the war there has been a spate of heretical theories of under-consumption, of which those of Major Douglas are the most famous. The strength of Major Douglas’s advocacy has, of course, largely depended on orthodoxy having no valid reply to much of his destructive criticism.

On the other hand, the detail of his diagnosis, in particular the so-called A + B theorem, includes much mere mystification. If Major Douglas had limited his B-items to the financial provisions made by entrepreneurs to which no current expenditure on replacements and renewals corresponds, he would be nearer the truth. But even in that case it is necessary to allow for the possibility of these provisions being offset by new investment in other directions as well as by increased expenditure on consumption.

Major Douglas is entitled to claim, as against some of his orthodox adversaries, that he at least has not been wholly oblivious of the outstanding problem of our economic system. Yet he has scarcely established an equal claim to rank — a private, perhaps, but not a major in the brave army of heretics — with Mandeville, Malthus, Gesell and Hobson, who, following their intuitions, have preferred to see the truth obscurely and imperfectly rather than to maintain error, reached indeed with clearness and consistency and by easy logic, but on hypotheses inappropriate to the facts.

Author’s Footnotes